China’s RRR cut to stimulate loan demand


We reaffirm our constructive stance on China’s large state banks for their c.6% dividend yield and compelling valuations.
Chief Investment Office09 Sep 2019
Photo credit: AFP Photo


What happened?

PBOC cut the RRR. On 6 September, the People’s Bank of China (PBOC) announced a reserve requirement ratio (RRR) cut of 50 bps for all banks effective 16 September, as well as additional targeted cuts of 100 bps – to be applied in two 50-bps cuts on 15 October and 15 November – for selected city commercial banks. The sector-wide RRR cut will release some CNY900b of liquidity into the banking system, equivalent to 1% of China 2018’s gross domestic product (GDP) value. This will also bring the RRR among large banks down to 13%, from 13.5% currently.

Given the inverse correlation between the RRR and loan-to-deposit (LDR), the move will further spur the LDR, which currently stands at 73% (Figure 1). While the net interest margin (NIM) could face downward pressure from the lower lending yield resulting from the latest loan prime rate (LPR) mechanism, the RRR cut will expand bank’s lending capacity because of lower funding costs and potential increases in loan growth. Such an increase in banks’ balance sheet efficiency will also help to support the NIM trend (Figure 2).

The widely-expected rate cut was the first in eight months and demonstrates the government’s determination to stimulate loan demand, especially among small-and-medium enterprises (SMEs) which have been less advantaged in borrowing costs compared to large state-owned enterprises. SMEs form the core of China’s domestic services industries; the services industries make up 52% of the country’s GDP.

Given the close link between loan and economic growth, the easing cycle is a practical move by the authorities to prevent an abrupt slowdown. This is the sixth RRR cut by the PBOC since April 2018, for a total of 400 bps, to counter the impact brought about by trade tensions on the growth outlook and investment sentiment.

Figure 1: RRR cut to 13% is set to boost LDR

Source: Bloomberg, DBS

Figure 2: NIM recovered from trough on higher LDR

Source: Bloomberg, DBS

What does this mean?

Banks are important to China’s economy. The non-performing loans (NPL) ratio among large state-owned banks has been improving after hitting its peak back in 2016. At the current 1.4%, the large state-owned banks NPL ratios are far superior to the sector average of 1.8% (Figure 3).

China banks have sufficient buffer as their loan loss provisions are near double to total NPL (Figure 4). They have also built up balance sheet strength. The tier-1 capital for risk-weighted assets remain healthy at near 12% (Figure 5). Further, China banks are trading at compelling valuations on a stable operating backdrop (Figures 6 and 7).

What should you do?

We continue to like China large banks for their yields. China’s large, state-owned banks are trading at compelling forward valuations on projections that have factored in the impact from trade tensions and policy adjustments. The range of the price-to-book (P/B) ratio is 0.5-0.6x and that of the price-to-earnings (P/E) multiple of 5-6x.

With a c.6% dividend yield, we reaffirm our stance to be invested in China banks as part of our Barbell Strategy.

 

Explore our past coverage on China’s RRR and banking sector reforms:

  • 7 January: China strikes first in 2019 with RRR cut
  • 23 August: China’s lending reform – The loan prime rate
  • 30 August: Video – China's lending reform

Figure 3: Balance sheet quality of large state-owned banks is improving

Source: Bloomberg, DBS

Figure 4: Loan loss provisions are near double of total NPL

Source: Bloomberg, DBS

Figure 5: High capital adequacy ratios (CAR)

Source: Bloomberg, DBS

Figure 6: China banks have attractive earnings and dividend yields

Source: Bloomberg, DBS

Figure 7: China banks P/B is at -1 SD

Source: Bloomberg, DBS

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