China’s Banks Can Handle a Rate Cut

In CHINA

Bank stocks in China are underperforming, a sign the market is worried about them. Should you be? Banks make up a big part of indexes for onshore Chinese stocks and are therefore in many portfolios whether investors know it or not.

Beijing has been cutting banks’ reserve requirements to release more cash into the financial system. At some point, central bankers will have to decide whether to start cutting interest rates—which can juice the economy but has done serious harm to the banking sector in the past. This time, though, investors needn’t fear.

China last lowered lending rates in October 2015, only two months before the U.S. Federal Reserve began its series of rate hikes. The cut—plus the devaluation of the yuan—triggered an exodus of foreign money. The current slowdown isn’t severe enough that a cut is imminent, but a shift in the language from the People’s Bank of China indicates it may be open to lowering rates. Ahead of a conference in December, PBOC chief Yi Gang said it would seek an “appropriate balance between tight and loose” monetary policy. The last time it used that language was November 2014, right before it unleashed a series of six rate cuts.

Chinese banks are more capable of handling lower net interest margins than they’ve ever been, because they’ve reduced their risky business loans and added safer mortgage loans. Unlike in the U.S., where reckless home lending led to the 2008 financial crisis, mortgages in China aren’t securitized, and the paperwork is more rigorous. As many as 90 percent are first mortgages, on which homebuyers have to make a down payment of at least 30 percent.

Bad debts will probably rise as the trade war heats up and the economy slows, which has already led Beijing to call on banks to perform “national service.” Even as President Xi Jinping ratchets up pressure on banks to extend more loans to the struggling private sector, they’re more likely to find ways to get around the request (or at least do the bare minimum) than to suddenly open the floodgates. For now, Beijing will continue to cut banks’ required reserve holdings, but if that isn’t enough to prop up the economy and the PBOC begins slashing interest rates, the resulting increase in bad loans will be a lot less than the sector’s current underperformance indicates.

● Seeing Isn’t Believing

China’s financial stocks have traded at less than their price-to-book ratio since May, indicating investors have doubts about their reported results.

● Less Could Be More

The meager price-to-book ratio could mean that Chinese bank stocks are undervalued, an opportunity for risk takers.

 

Note : This article was originally posted on Bloomberg by Nisha Gopalan

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