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Morningstar | China's Latest RRR Cut Comes as Expected and Has Limited Impact on Chinese Banks

We see China’s latest cut in its reserve requirement ratio as having limited impact on the valuations of the Chinese banks we cover. We believe the benefits of liquidity injection are largely offset by downward pressure on net interest margin, given weaker loan pricing and intense deposit competition. Our top picks are Agricultural Bank of China and Industrial & Commercial Bank of China, which are trading at 29% and 26% discounts to our fair value estimates, respectively. Assuming other assumptions are unchanged, we believe current prices imply bad-debt ratios of about 13.0% and 10.0% for these two banks. We believe risks for these banks are manageable, as their prudent operations and cheap funding costs enable high profitability and thus strong ability to absorb credit losses gradually. Besides, solid progress as witnessed during the two-year financial deleveraging campaign mitigates our long-term credit quality concerns for banks.

The rate cut was largely expected as liquidity pressure is mounting amid record-low growth in M2 and total social financing, and cash withdrawal needs often surge ahead of Chinese New Year celebrations and tax payment dates. The CNY 800 billion net long-term fund injection after paying back maturing medium-term loans in the first quarter is slightly higher than the CNY 750 billion of the previous cut in October. Since mid-2018, the regulator has introduced a combination of policies to support private enterprise financing via bank loans and bond and equity issuance. However, progress is very slow, given increasing risk aversion by lenders. Given the weakening economy and tightened regulations, the RRR cut is unlikely to filter through to boost corporate loan growth in the absence of moral suasion. The rate cut favors banks with large deposit shares or with high sensitivity to wholesale funding costs. We think much of the benefits are eaten up by increasing deposit competition and credit costs.

We estimate a 1-basis-point improvement in net interest margin for banks, assuming 100% of unleased funds, which previously earned a 1.62% return as deposit reserves, are used to replace MLF borrowings priced at 3.3%. This will reduce the funding cost of these reserves by 1.68 percentage points. Thus, we estimate the RRR cut will boost full-year net profits of listed banks by about 1.0% by lowering their funding costs. The interbank market rate, as measured by the seven-day reverse repo rate, has dropped to new low of 2.4% from 2.9% in mid-2018. A lower wholesale funding rate will help ease short-term deposit competition for banks, although upward pressure on deposit pricing will remain over the mid- to long term. We expect steady funding costs and lower asset yields for large banks, translating to only a few basis points deduction, at the most, to banks’ net interest margin in 2019. We expect the People's Bank of China to introduce further RRR cuts to support liquidity conditions with the slowing economy and contracting shadow banking activity.