The news: Last week, the People's Bank of China raised the cap on deposit rates and lowered the floor on lending rates for banks while simultaneously cutting the benchmark interest rate.
The significance: Of the policy changes last week, the 10% higher cap on deposit rates will likely have the largest impact on profits at mainland banks. Of lesser influence are the floor on the lending rate - at which one-third or less of loans are offered - and the lower benchmark rate, which will stimulate lending but fundamentally does not change the differential between the deposit and lending rate that banks pocket. Deposit rates, meanwhile, are poised to rise with the cap as banks raise the amount paid out on accounts as they compete to draw new account holders. This will have a substantial impact on profits with Citigroup predicting the sector's earnings to fall 10% in 2012. Smaller banks will likely suffer most as they already have more pressure to compete for depositors because they have a higher ratio of loans to deposits than big banks. Nevertheless, Chinese banks appear reasonably valued at an average 5.7 times forward price-to-earnings. As concerns of a China slowdown loom, the stocks may additionally trade more on sentiment regarding the overall economy - which benefits from the benchmark rate cut - than on individual earnings.
The takeaway: Investors might consider buying previously recommended Industrial and Commercial Bank of China (1398.HKG) and China Construction Bank (0939.HKG) as they will likely deal with rate liberalization better than most. Consider holding but not investing further in smaller banks previously suggested by CER Alpha, such as China Merchants Bank (3968.HKG) and China Minsheng Banking (1988.HKG), which will face increased pressure to compete for depositors.