China Banks Rate &RRR cut:+ve for funding/banks’asset quality;limited NIM impact

25bps rate cut and 50bps RRR cut; deposit rate ceiling removal.

    PBOC announced, effective from October 24, 25bps symmetric benchmarkrate cuts for both loans and deposits and a 50bps broad-based RRR cut forthe banking system (plus additional 50bps RRR cut for financial institutionsthat have met certain level of agriculture-related/MSE loan exposure). Italso removed the rate ceiling for time deposits with <= 1 year maturity anddemand deposits, marking another milestone of rate liberalization in Chinaafter PBOC removed lending rate floors in July 2013.

    Positive for interbank liquidity and corporate funding; limited NIMpressure on banks.

    We believe continued FX outflow in Aug/Sep (in total c.Rmb1.5tn according tothe balance sheet of all FIs) necessitated the RRR cut, which could initiallyrelease Rmb 600-700bn in liquidity by our estimate, while the low inflationenvironment (Sep CPI: 1.6%) provided room for rate cuts to boost economicactivity via lowering corporate financing costs. We view the overall impacton banks as positive. (1) Lower borrowing costs at corporates couldbenefit banks’ asset quality. Our sensitivity analysis on EBITDA interestcoverage of 1780 A-share non-FI listed companies suggests a 25bp rate cutcould reduce implied NPL ratio of these firms by 1.2pp to 8.6% based on 1H15corporate earnings, although the benefit of lower funding cost was more thanoffset by weaker 1H15 corporate revenue growth. (2) NIM pressure on banksshould be limited as near-term deposit competition can be mitigated by (a)interest rate easing cycle/ lower yield environment, (b) removal of the 75%loan-to-deposit cap in June, and that (c) over 90% of banks’ funding liabilitieswas largely based on market pricing before the removal of deposit rate ceilingsas per PBOC, and banks generally priced 1yr deposit rates at 1.2x to 1.3x thebenchmark rate when a max 1.5x was allowed. (3) Better interbank liquidityand limited deposit pressure also mean lower financing cost at banks, whichcan encourage banks to do more mortgages to support consumer credit.

    We have seen improving credit allocation to consumers YTD.

    Further easing and demand-boosting policies needed.

    We think further RRR cuts are likely to support M2 and GDP growth, whilerelatively low real deposit rates/RMB depreciation pressures lower thepossibility of further rate cuts this year. In addition to monetary loosening, webelieve more demand-boosting policies/reforms and removal of SOEs’ implicitguarantees are needed to lift corporate sales and re-balance corporate vs.

    household leverage. We prefer banks with undemanding valuations or strongbalance sheets. Top picks: CNCB H, CMB A (both CL Buy).