* Public criticism of bank profits puts execs on back foot
* Commercial banks defend interest rate regime
* Chinese banks don't depend on regulated rates - ICBC
* Freeing rates may disintegrate into a free-for-all - BOC
* Smaller banks hardest hit by any change
By Kelvin Soh and Koh Gui Qing
BEIJING, March 15 Public anger about
soaring profits at Chinese banks has strengthened calls to
address the country's interest rate regime, forcing bank
executives to defend the regulated deposit and lending terms
that have helped them reap mega profits.
Some delegates attending China's rubber stamp annual
parliamentary meetings in Beijing over the past two weeks openly
criticised rising bank profits, taking a public stand that is
rare for the country's normally docile legislature.
Critics include Wu Xiaoling, a former deputy head of the
People's Bank of China, which has long promised to speed up rate
reforms, who called the banks' profits "unreasonable" in today's
Many blame Beijing's interest rate policy, which puts a
ceiling on the interest rates banks can pay to attract deposits
and sets a floor on lending rates, ensuring a healthy interest
rate spread that is currently hovering around 270 basis points.
The government has for years talked about freeing up rates
to let banks compete without restraint, but has so far failed to
act, in part due to fears that the banks -- bailed out for about
4 trillion yuan ($630 billion) in the early 2000s -- may succumb
to the pressure of free competition.
The rising tide of criticism, however, has put top Chinese
bankers on the defensive. Net profits at China's four biggest
banks leapt between 28 percent and 45 percent in the first-half
of 2011 to a total 336 billion yuan ($53 billion).
Yang Kaisheng, the president of the world's biggest and most
profitable bank, ICBC, said banks did not enjoy any
discernible advantage because of the country's regulated rate
"Chinese banks' net interest margins are actually low when
compared to other markets where rates are liberalised," Yang
said on the sidelines of the parliamentary meeting. "To suggest
that Chinese banks depend on a wide interest margin to drive
earnings growth doesn't conform with reality."
Generally, bank executives worry that free competition would
drive up deposit rates and crimp banks' profits by forcing them
to pay more to woo savers.
Bank of China Chairman Xiao Gang told reporters
that any hasty lifting of deposit rates could spur overly
aggressive competition for deposits, which would in turn push up
funding costs in the country.
"China has been working on interest rate liberalization for
the past 20-30 years, and it won't just decide one day that
it'll suddenly become a free-for-all," Xiao said.
U.S. BANKS HIGHER?
Chinese bankers point to the United States to bolster their
argument, where U.S. Federal Reserve numbers show that U.S.
lenders have a wider net interest margin than their Chinese
peers, coming it about 315 basis points as of the end of 2011.
However, analysts note that U.S. banks typically securitise
many of their top-quality loans, taking them off balance sheet
by selling them to investors in the secondary market.
This leaves higher-yielding unsecured loans such as credit
cards or credit facilities on their balance sheets, which
artificially boosts their net interest margin figures.
At the same time, the high level of funds that Chinese
commercial banks must place in low yielding reserves with the
central bank -- currently at 20.5 percent -- leads to an
artificial narrowing of their net interest margins, said Patrick
Pong, an analyst at Mirae Asset Management in Hong Kong.
SMALL BANKS TO SUFFER
Any liberalisation would be especially severe for smaller
banks that cannot compete against the extensive branch networks
of China's giant state banks and rely on paying higher deposit
rates to draw customers.
Most small- and mid-sized banks in China already have
loan-to-deposit ratios (LDR) that are close to the regulatory
limit of 75 percent, while large state-owned banks such as ICBC
have reported numbers of about 65 percent.
"The worst hit will likely be the smaller banks," said
"Most of these banks have already hit the limits to their
lending, so the only way to grow loans is to acquire more
deposits, which may lead to cut-throat price competition on
Well aware of the threat, executives at smaller banks were
busy doing the rounds at China's parliament, talking about the
dangers of changing the regime too quickly.
"Interest rate liberalisation needs to be a slow and gradual
process," cautioned Ma Weihua, chairman at mid-sized China
Merchants Bank, whose LDR is just below 75 percent.
Other mid-sized banks all report similar numbers, with
lenders such as Shenzhen Development Bank and
Shanghai Pudong Development Bank all reporting LDRs
of about 70 percent.
HIGHER PROFITS POSSIBLE
But for those who blame high net interest margins at Chinese
banks for the past years of high earnings, a liberalised regime
might yield some surprises.
Banks in countries that moved from a regulated to free
interest rate regime have mostly been able to transfer the
higher cost of funding to borrowers, said Mike Werner, an
analyst at Sanford Bernstein in Hong Kong.
Japan, which freed up deposit rates in its banks around
1979, saw net interest margin remain largely stable for most of
the 1980s until the country's own asset bubble popped late that
"What happens is that demand from the state-owned companies
will decline," Werner said. "Small- and medium-sized enterprises
will step in, but their higher risk profile means higher
borrowing rates, which may drive up profits."
Banks could even take advantage of a change in interest
rates in a system which still faced other shortcomings to
increase their profits, said Jim Antos, an analyst at Mizuho
Securities in Hong Kong.
"The only way banks don't make more money is if you change
something else. You have to have risk-based pricing and you have
to have a logical credit rating system and a logical credit