Chinese banks’ profits to drop following liberalization

China’s recent benchmark interest rate cut and liberalization of the rate regime will hurt the profits of Chinese banks.

According to China International Capital Corporation Ltd, China’s biggest investment bank, the worst case scenario is a narrowed deposit-loan rate spread that will cut listed banks' profits by 4% this year and 9% in 2013. It also said earnings growth in 2013 will be single-digit, perhaps stagnant, if the People’s Bank of China cuts the rate twice in the second half of this year.

The central bank cut the benchmark interest rate by 25 basis points on June 7, the first reduction since 2008. As a result, the benchmark one-year lending rate stands at 6.31% and the deposit rate is 3.25%.

A 25 basis point cut would save borrowers at least US$23 billion in interest costs, which is good news for the economy whose growth decelerated to a three-year low this first quarter.

The discount lenders can offer on the key lending rate was increased from 10% to 20%. For the first time, banks can offer savers' deposit rates up to 10% higher than the benchmark, which is a breakthrough in China's interest rate liberalization.

The widened rate range s expected to intensify competition among banks and push the deposit rate to its ceiling of 3.575%. That means the deposit rate could end up higher after the rate cut.

Banking is one of the most profitable sectors in China. The 16 public lenders posted a combined profit of US$43 billion in the first quarter, more than half of the profit of all the public companies combined.