China Banks:Interest rate fully liberalised

PBOC announced that it would remove the deposit rate cap for commercialbanks today, signalling the completion of rate liberalisation. Benchmarkinterest rates could still be in place for a while, but marketized rates wouldplay an increasingly important role going forward, which is negative forbanks’ NIM but favourable for domestic liquidity efficiency and RMBinternationalisation, in our view. Stick with quality plays in the bankingspace, including ICBC (1398 HK, Buy) and CCB (939 HK, Buy).

    Rate liberalisation in 2015 well expected; reiterate our margin cycle callthat 2.18% could be covered banks’ NIM by FY18F

    Interest rate liberalisation in 2015 is a key assumption for our margin cycle forecast from2015 to 2018 (see our Initiation, 15 April 2015), which may have limited impact on banks’NIM in the short term (especially when it came with interest rate cut and RRR cut) butcould have a long-tail impact on banks’ margin in the coming three years as household,corporates, and banks adapt to the liberalisation interest rate environment. We seeChina banks’ NIM declining to 2.18% by FY18F, down 42bps from 2.60% in FY14, as thec.10bp margin contraction, primarily driven by rate liberalisation, could sustain for fouryears, based on our estimates.

    Benchmark interest rates could still be in place for a while, butmarketized rates are expected to play a bigger role ahead per PBOC

    The marketized interest rate curve will be built and strengthened in future.Short-term repo and SLF rates could become reference rates for shorttenors, while PBOC re-lending, MLF, and PSL rates are suitable for longertenors, per PBOC release today. In other words, we may see morefrequent operations through innovative facilities in the future, asPBOC builds and enhances the marketized yield curve.

    Benchmark interest rates will still be announced for the coming period, asthey serve as important benchmarks before marketized rate mechanism isready per PBOC. As such, marketized rates could become increasinglyimportant while benchmark rates may fade out over time.

    25bp interest rate cut brought 1Y benchmark lending rate to 4.35% p.a.,while 50bp RRR cut took China’s RRR down to 17.5%

    Interest rate cut may negatively affect banks’ NIM by 2.5bps and NP by1.5%, based on FY15F numbers per our calculations. The impact islimited, as we see effective loan and deposit rates diverging frombenchmarks with further rate liberalisation. In particular, we see limitedroom for deposit rates to decline in the coming 12 months.

    The 50bp RRR cut could inject c.RMB670bn liquidity into the bankingsystem, per our estimate. While it’s good for banks’ liquidity conditions, itcould take time to see the impact on the real economy, given banks’ liftedrisk aversion in the credit cycle and the relatively weak loan demand fromhousehold and corporates.

    The impact on asset quality alleviation could be limited; we maintain ourcredit cycle estimate of 1.8% NPL ratio for covered banks by end-FY15Fand 2.5% by FY16F.