Don't Be a Prudent Saver When There's a Crisis On

(Bloomberg Opinion) -- China needs banks to open the credit taps to get the economy back on its feet after the sudden stop caused by the coronavirus outbreak. The trouble is that they’re in far worse shape than in 2008, when a government-mandated lending boom helped revive growth. That’s why a cut in the deposit rate is long overdue.

The People’s Bank of China is in discussions to lower the interest rate banks pay on deposits for the first time since 2015 and a decision could be announced within days, the Financial Times reported last week, citing people familiar with the deliberations. A reduction would shore up banks’ profitability, buying lenders breathing room as authorities lean on them to support companies that are struggling to stay afloat after a shutdown that affected two-thirds of the economy.

It can’t come a moment too soon. The government is pushing banks to extend relief by rolling over debts, lowering loan rates and keeping credit lines open. It has allowed them to refrain from collecting interest from virus-affected companies until June 30 and has loosened the criteria for classifying loans as nonperforming. To encourage lending, regulators have also reduced the percentage of deposits that lenders must lodge with the central bank, known as the required reserve ratio.

All these measures will increase pressure on a state-controlled banking system that is already undercapitalized and having its net interest margins squeezed. What will really help is a reduction in banks’ funding costs. While the rate on demand deposits is a puny 0.35%, the amount paid on time deposits is far higher — as much as 1.5% on sums locked up for one year.

On Monday, the PBOC reduced the interest rate that it charges on loans to commercial banks by the most in five years. The seven-day reverse repurchase rate was cut to 2.2% from 2.4%. While that lowers funding costs, it also signals an impending reduction in lending rates. Analysts say a cut in the central bank’s medium-term lending facility rate, its main policy tool, isn’t far away. That in turn will influence the loan prime rate, set by 18 banks once a month.

Smaller banks — outside the big four of Industrial & Commercial Bank of China Ltd., Bank of China Ltd., China Construction Bank Corp. and Agricultural Bank of China Ltd. — will be the biggest beneficiaries of lower rates for time deposits. These account for a large portion of customer accounts at lenders such as Bank of Communications Co. and Ping An Bank Co., according to to CGS-CIMB Securities Ltd. analyst Michael Chang. Such banks have more small and medium-size enterprises among their loan clients and also lend out more of their deposits.

Even the big four could do with some relief. While they’re better capitalized and more profitable than the rest, they bear the burden of being the government’s principal policy tool, requiring them to hand out low-interest loans and help out struggling smaller banks.

The bigger question is how much difference even lower deposit rates will make given the scale of the challenge the economy faces. A prolonged health emergency will cause the nonperforming loan ratio to triple to 6.3%, S&P Global Inc. estimates.

In 2008, China’s banks were still flush from recapitalizations and initial public offerings conducted earlier in the decade, and their shares were trading above book value. Now, most are at discounts: Bank of China’s Hong Kong-listed stock trades at a price-to-book ratio of less than half. At the same time, the financial system has ballooned in size and leverage has soared. The ratio of debt to gross domestic product jumped to 276% at the end of 2018 from 162% at the end of 2008, according to Bloomberg Economics.

China’s banks “make just enough in profits to keep pace with growth and keep capital ratios stable so they can’t afford to do a lot more than they’re doing now,” said Grace Wu, Fitch Ratings head of Greater China bank ratings.

Regulators could relax capital ratios at mid-size lenders such as China Minsheng Banking Corp. and China Guangfa Bank Co. Still, that would risk storing up bigger problems down the road. Consumer defaults are already piling up, with overdue credit-card debt swelling last month to 50% from a year earlier. Qudian Inc., a Beijing-based online lender, said its delinquency ratio jumped to 20% in February from 13% at the end of last year.

Cutting deposit rates also punishes consumers, the very people the government needs to help get the economy back up and running. Lower rates could also compound banks’ challenges by encouraging depositors to pull out money, though a crackdown on shadow banking has reduced the range of alternatives.

There are no easy answers. Whatever their limitations or unwanted side effects, the need to keep banks in some semblance of health suggests lower deposit rates are coming soon.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Nisha Gopalan is a Bloomberg Opinion columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

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