China’s strong banks choke the weak

May 2, 2011

By John Foley
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

HONG KONG — China’s strong banks are choking the weak. Second-tier lenders have fewer deposits to fund their growth than larger rivals and those they do have are the most fickle kind. The distortions that penalise small banks will eventually bite.

Minsheng, which reported earnings on April 28, typifies China’s smaller lenders. It relies overwhelmingly on corporate deposits for funding, according to an analysis by China Construction Bank. Companies are much flightier than retail depositors, so make for less stable funding. Minsheng’s loans are 77 percent of its deposits, above the 75 percent permitted by regulators, while its Tier 1 capital ratio was just 8 percent at the end of 2010.

Compare that with state-owned ICBC, which relies on corporates for below 50 percent of its deposits. Its Tier 1 capital was a healthier 9.7 percent at the end of the first quarter, and its loans just 61 percent of deposits. It is a similar story at Agricultural Bank, whose 56 percent loan-to-deposit ratio helped it expand its loan book twice as fast as Minsheng in the first three months of the year.

This is no accident. China’s deposit rates are strictly capped, so retail depositors are drawn to banks with the most branches or the biggest advertising budget. With no deposit guarantees, sticking with the biggest lenders feels safer. Finally, Chinese depositors must bank where their employer does — and big companies often favour big state banks.

Second-tier lenders like Minsheng and Citic can borrow deposits from other banks. Some 16 percent of Minsheng’s liabilities are from the interbank market. But that can be expensive, and leaves lenders exposed if sentiment shifts. Alternatively they can stretch the rules: some banks are said to offer wealthy clients cheap loans if they recommend a friend as a deposit customer.

The best thing would be to un-cap deposit rates, and let smaller lenders compete for deposit funding. Savers would benefit from higher rates too. China’s regulator seems reluctant, perhaps for fear smaller banks would compete away their margins. But unless the competitive field is levelled, deposit-poor lenders will be driven towards ever riskier behaviour — or into the arms of their giant rivals.

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