Loan interest rate liberalization will change the economic environment for Chinese banks. The policy will certainly facilitate development of China’s banking sector, but this change will be accompanied by increased competitiveness in the market.
In China, loan-deposit spread is the main source of a bank’s profit; the loan pricing level directly influences a bank’s profitability. In the short term, we speculate most Chinese banks will not lower their loan interest rate. Instead, banks will adjust loan interest rates steadily to prevent dramatic declines in bank profitability. Therefore, the liberalization will not immediately affect the Industry as a whole, however as foreign competitors decrease their rates to attract Chinese borrowers, we suspect the local market will respond.
Source: CBRC, 2013
Large enterprises are more likely to successfully negotiate a lower loan interest rate now there is no regulatory policy governing the loan interest rate floor. Banks often lead new business relationships with one competitive product and accept lower margins to capture the entire business; which may include depository services such as cash and wealth management products.
On the other hand, small and medium enterprises already borrow at higher lending rates, and due to bank lending parameters, these businesses may not be able to secure financing at lower rates; hence the interest rate spread may not decrease significantly for this borrowing segment.
Surviving the Changing Environment
While supporting the real economy, this new regulatory environment will cause Chinese banks to adjust their business model. Without the regulatory protection, Chinese state-owned banks, joint-stock banks, and city and rural commercial banks will have to develop their business strategy differently and reposition themselves in the market, playing on their strengths.
State-owned banks can apply their dominant market position to increase synthesized financial service ability. Joint-stock banks, and city and rural commercial banks should focus on supporting small and medium enterprises, and stress their ability to provide local financial services.
Interest rate liberalization also forces Chinese banks to reconsider the importance of loan pricing and risk management as a business model, instead of blindly expanding credit to achieve business scale.
As depicted in the 2012-2013 net profit growth rate chart, Chinese bank’s interest rate spread has started to decrease since the beginning of 2013. Most bank interest rate spreads are currently around 2%. Based on observations of interest rate liberalization in most foreign countries, the interest rate spread will continue to decrease, and small to medium banks adjust their structure when the banking system moves toward complete interest rate liberalization.
Although bank can choose to turn their business to small, medium, and micro enterprises, Chinese banks cannot avoid the challenges and possibilities of decreased profit growth during the interest rate liberalization process. There is no turning back. In order to adapt the new macro and regulatory environment, the next step for Chinese banks is to accelerate the pace of strategic transformation to their business model and focus on innovating their business.