China banks:PBOC hijacked

Central bank forced to ease to support A-shares.

PBOC’s decision to cut the benchmark rate by 25bps and RRR by 50bpsfor selected institutions follows a 19% drop in SHCOMP in the past twoweeks. The central bank seems to be hijacked by market sentiment,responding more to A-shares rather than economic data. Bank marginsare again put to test. Yet, we reiterate the OW view: effectiveness ofloosening is in doubt and banks are more defensive on the way down.

Interest rate and RRR reduction.

It is rather rare the PBOC cuts the benchmark and RRR at the same time. But it didhappen, after SHCOMP dived 11% in the past two days and 19% in two weeks.

One-year benchmark deposits will fall by 25bps to 2% and lending to 4.85%; RRRfor institutions with enough agri and small businesses will be 50bps lower.

Both changes take place 28 June.

Effectiveness in doubt.

We have expressed our doubt over the effectiveness of the previous easing. SMEshave failed to benefit from previous rate cuts as banks get more risk averse.

The rise in NPL has led to a tightening of credit underwriting. Large SOEs and Ashareshave been the biggest beneficiaries.

The PBOC’s actions suggest it is responding to A-shares rather than economic data.

It seems hijacked by the market to ease, to avoid any social backlash.

Negative to bank margins.

The targeted RRR cut may not stimulate more lending to agri and small businesses,it will, however, allow banks to buy more local government debt.

Interest has been low as the yield is unattractive. It makes sense to release reservedeposits, earning only 1.62%, to buy the local debt.

While it is a symmetrical cut on benchmark, the downward trend puts bank marginsunder more pressure as deposit pricing, below a 1.5x ceiling, has room to go up.

Yet OW on defensiveness.

We do not change our forecast for now but profit may drop by 1-7% in 15CL shouldNIM fall by 5-30bps in 2H15. A falling interest rate is negative for banks andinsurers.

It is all about how much multiple re-rating liquidity can still drive, though this playis getting dangerous with rising margin debt and market valuations.

As we enter half-year earnings, disappointment in results will prompt questions onthe effectiveness of monetary policy, hurting the A-share momentum. We prefer toOW banks for their defensiveness.