Banks in China Face Pressure from Market Liberalisation and Capital Rules

China’s banking sector is expected to see profit margins under pressure as competition intensifies due to market liberalisation, and new capital rules, according to KPMG’s latest annual survey of the mainland banking sector.


KPMG’s seventh annual Mainland China Banking Survey notes that China’s banking sector has remained broadly stable in 2013 following the exceptional rapid growth in 2010-12, but with more challenges ahead.


China’s commercial banks may face pressure in terms of capital replenishment in the future because of slower organic capital growth under the rapid growth of bank assets, and slowing profitability.


“A number of the commercial banks are considering replenishing capital through the issuance of innovative capital instruments, although higher capital costs and limited market acceptance may be an issue,” says Simon Gleave, Regional Head, Financial Services, KPMG China.


Recent Government guidelines have encouraged banking sector transformation in order to improve the banking industry’s capital efficiency. One of the initiatives that may have a breakthrough effect is the proposed establishment of private banks using private capital.


“The decision to grant banking licences to private capital entities can invigorate China’s banking sector," explains Arthur Wang, Partner, KPMG China. "The traditional state capital controlled banking industry should welcome new competitors who may be more proactive and efficient. These new joiners can further improve the banking industry’s overall performance through more volatile competition.”


Meanwhile, slowing economic growth and increased interest rate liberalisation have seen the banking sector experience an increase in non-performing loans and a slowdown in profit growth in 2013.


“We believe interest rate liberalisation will be in its final stages over the next few years, with a subsequent move to more market based rates,” adds Gleave.


In the first half of 2013, the loan balance increased by a rate (15.89 percent) lower than in the same period of 2012. By the end of June 2013, non-performing loans (NPL) rose to RMB 539.5 billion, up from RMB 492.9 billion in the end of 2012 and RMB 456.4 billion a year earlier; while NPL rate is on the rising track from 0.94 percent in June 30, 2012 to 0.95 percent in end of 2012 and 0.96 percent in June 30 2013.


Net interest spreads and net interest margins are declining with a narrowing disparity between the lending and deposit rates following several rate relaxations. This affects both domestic lenders and foreign banks in China, according to the report.


In the last two years, net interest income has accounted for an average of 73–77 percent of total income for major foreign banks. With their heavy reliance on net interest income and further liberalisation of interest rates, competition between foreign banks and domestic banks is likely to intensify.


Additionally, the report notes that internet and mobile computing are bringing dramatic changes to the delivery of traditional banking products such as deposits, lending, settlements and investments. These changes are likely to overhaul the traditional channels, products and services developed by commercial banks.


“Commercial banks should change their business mindset swiftly and adopt a more proactive approach to using innovative technologies," says Wang. "Otherwise, it is very likely that in the ensuing competitive environment, these banks will quickly be overtaken by faster acting competitors.”


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