China cuts rates, less profitability for lenders

The Chinese central bank unexpectedly cut rates on Friday, reducing the benchmark lending rate by 0.4 percent down to 5.6 percent, and lowering its deposit rate by 0.25 percent down to 2.75 percent.

The People’s Bank of China wants to support small and medium sized enterprises which are struggling to repay loans, helping smaller firms gain access to credit.

The cuts are essentially an attempt to try and revive the country’s slowing economy and prevent a build-up in non-performing loans.

The People’s Bank of China also raised the deposit rate ceiling to 120 percent of the benchmark from 110 percent – a level set in June 2012. It’s long-term plan is complete deregulation of deposit rates.

Jiang Jianqing, chairman of Industrial and Commercial Bank of China, said that the move will “inevitably squeeze banks’ profit margins” adding that “narrower margins are a long-term trend”.

As interest rate margins tighten there is less profitability for lenders, subsequently making it harder to raise regulatory capital.

“In the past when Chinese banks disburse loans, they mainly relied on profits from their own capital to replenish their capital,” Jiang Jianqing commented.

Haibin Zhu, JPMorgan’s chief China economist, wrote in a research note:

“[The rate cut] reflects government concern about the near-term growth outlook and [its] desperate efforts to lower the funding cost for the corporate sector,”

The People’s Bank of China made this move to encourage lending to small businesses. However, is it really going to have a major impact? It is difficult to tell, although it probably won’t have as much of an impact in the amount of lending as expected.

Many of China’s largest banks are far too reluctant to lend to small companies because of their high risk of default. Naturally the country’s big banks will not want to increase their exposure to weaker borrowers.

Video – Is cutting interest rates the right move?

In this video, Michelle Makori of CCTV America asks Dom Gimbel, chief investment officer at Geneva Investment Management, whether China’s latest cut in interest rates is the right move.