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Banks' earning potential dented by ratio hike

By Wang Lan (China Daily)
Updated: 2008-06-12 09:27

The latest 1 percentage point rise of the bank reserve requirement ratio to 17.5 percent could further squeeze commercial banks' earnings potential as many are not moving quickly enough to diversify their income sources, analysts say.

The People's Bank of China, the central bank, said last week it would raise banks reserve requirement ratio by 100 basis points two steps of 50 points first on June 15 and then on June 25. The fifth such increase this year hit small and medium-sized banks at a time when the banking sector's excess reserves amounted to 2 percent of deposits at the end of March.

"This probably suggests that further reserve requirement ratio hikes may start to bite, in particular the medium and small banks," said Frank FX Gong, chief economist at JPMorgan Securities (Asia-Pacific), in a report.

"The newly raised reserve ratios, means commercial banks have to set aside more deposits as reserves and reduce capital available for lending," said Nie Wen, an analyst at Industrial Securities in Shanghai. "This will add more pressure to commercial banks' profit earnings, as interest spread is still their major income source compared with off-balance-sheet businesses," he added.

The latest reserve ratio rise will freeze about 420 billion yuan ($60 billion) in the banking system, reflecting the central bank's intention to absorb excess domestic liquidity arising from the rapid increase in forex reserves, analysts said. They said the high reserve ratio may force commercial banks to reduce their lending or other asset classes, such as fixed-income securities.

"The latest reserve ratio hike by the People's Bank of China is likely to keep its short-term focus on managing liquidity and credit conditions in the banking system," said Zhang Yang, an analyst at Orient Securities.

Many analysts said they expected further increases in coming months.

Frank FX Gong at JPMorgan Securities expected further reserve ratio hikes, bringing the ratio to at least 18 percent later this year.

"For those banks with relatively higher reserve deposit ratios - say above the level of 75 percent - they tend to have less capital cushion to cope with the newly raised reserve requirement ratio," said Cai Rong, an analyst at Everbright Securities.

Latest figures show that among the 14 banks listed on Shanghai or Shenzhen stock exchanges, the number of commercial banks with reserve deposit ratio higher than 75 percent has dropped to two in the first quarter of 2008 from four in the third quarter of 2007.