Just hours ago, the PBOC announced that it decided to cut the benchmark lending and deposit rates, and to expand the bands within which lending and deposit rates can float. Overall, we see this is a welcome policy response from the PBOC to the on-going weakness in economic activities, and it should help lift demand for loans and effectively reduce the funding costs for corporates. The commencement of interest rate liberalization should also in the longer term help improve the allocation of financial resources, although it may generate short-term pressure on banks' NIM.
The PBOC decided to cut both the 1-year benchmark lending and deposit rates by 25bps, and also reduced benchmark rates for other maturities. After the cut (to be effective tomorrow), the 1-year benchmark deposit rate will be 3.25%, and 1-year benchmark lending rate will be 6.31%. Simultaneously, the PBOC announced that commercial banks are now allowed to set lending rates at or above 0.8x the benchmark rates (previously the lower bound was 0.9x benchmark rates), and they can set deposit rates at levels at or below 1.1x the benchmark rates (previously deposit rates were not allowed to exceed benchmark rates). The direction of these policy moves is generally in line with our expectation; the interesting difference is that, instead of an asymmetric benchmark rate cut which we thought make more immediate sense, the PBOC decided to symmetrically cut the 1-year benchmark rates but introducing EFFECTIVE asymmetric rate changes by expanding the interest rate bands. The net impact on banks' NIM and on corporates should be similar to that of an asymmetric benchmark rate cut.
More specifically, we see several implications of these decisions:
1) The forthcoming May economic data release on Saturday may surprise to the downside. That is, IP and investment growth may remain weak, although yoy export growth may improve on calendar effects. CPI and PPI inflation should also decline further. The weakness in both real economic data and inflation justify this pre-emptive move by the PBOC.
2) A 25bp cut to lending rates can effectively reduce funding costs for many highly leveraged sectors and improve demand for loans. For example, a 25bp reduction in lending rates should boost the power sector's annual profit by about 7%. The positive earnings impact on property, transport, and raw materials sectors can also be significant, as they are also quite leveraged. The lending rate cut should also help lift demand for loans, at least marginally. Note that the weakness in loan demand has been a major downside risk to investment growth.
3) Our banking analysts believe that banks may bid up deposit rates immediately (i.e., tomorrow) due to competition between banks for deposits and competition from wealth management products. In the extreme case of all banks pushing up deposit rates to 3.575% (the new cap) tomorrow while lending rate only decline by 25bps in line with benchmark rate cut, the banking system's net interest margin should fall by about 19bps from the current 250bps.
4) Another possibility is that given the implicit state guarantee, larger banks do not need to raise deposit rates as much the smaller deposit taking institutions, which are generally perceived as less safe by depositors. As a result, larger banks may gain market shares from smaller banks or outperform smaller banks due to less contraction in NIM.
5) Over the longer term, we believe interest rate liberalization will provide the basis for more efficient financial resource allocation, and form an important condition for China's capital account liberalization. These fundamental reforms will eventually improve the performance of the economy.
Overall, we believe that although the short-term impact of the PBOC decisions may be negative for banks' margin, they are positive for the real economy by limiting the downside risk to investment growth, and will eventually help improve the efficiency of the economy through market based pricing for financial resources. Highly leveraged sectors such as power, real estate, transport and materials should benefit the most.(Jun Ma)
Jun Ma (马骏)
Chief Economist, Greater China
Head of China/Hong Kong Strategy
Deutsche Bank Hong Kong
