China's banks must evolve or perish

As China's traditional banks raise interest rates to claw back lost deposits, they must find new profit sources as Internet finance is booming.

Earlier this week, the China Construction Bank, the Agricultural Bank of China and the Bank of Communications raised the deposit rate by 10 percent to the upper limit in some branches, for some clients, or for a fixed period.

Experts see this as an attempt to restore some of the deposits that have been diverted into Internet products such as Yu'E Bao, a personal online finance product by Internet giant Alibaba which allows users to place any amount of savings into a money market fund.

At the end of 2013, Yu'E Bao had 43 million users with aggregate deposits of 185 billion yuan (about $31 billion), the single biggest public fund in China.

"Although the rate increase might not bring back deposits that had gone to the Internet, it is still attractive to clients who make daily capital demands on banks," said Guo Tianyong, a professor at the Central University of Finance and Economics.

In the short term, banks might face liquidity problems due to the competition from Internet finance, Guo warned. "This would also serve as a wake-up call that there are no more easy profits for banks in China, solely on deposits, loans and remittances," said Guo. "They must promote intermediary business and wealth management and provide all-round service to clients."

In previous years, banks often saw their profits grow 30 to 40 percent annually, according to Zong Liang, deputy head of the international finance institute of the Bank of China, but as the financial sector is liberalized it becomes difficult, forcing banks to be more innovative, said Zong.

Even before the emergence of Internet finance, profit growth was slowing down. In 2012, the Industrial and Commercial Bank of China and the China Construction Bank saw their profits grow by 14.5 percent and 14.3 percent respectively, sharply down from the 36 percent and 34 percent in 2008.

The People's Bank of China (PBOC), the central bank, has already initiated liberalization of the financial sector. In June 2012, the PBOC announced that the upper limit of the floating band of deposit rates would be adjusted to 1.1 times the benchmark, or up 10 percent at most.

Guo saw the rate increase as a "rehearsal" for banks ahead of total liberalization of interest rates, to prepare themselves for the future.

Interest rate freedom means the future is not all rosy for the new Internet financiers either, such as Yu'E Bao, who invested more than 80 percent of its fund into an "agreement deposit," using the interest rate spread to make a profit.

Interest rate liberalization would make it impossible for Yu'E Bao to make profits this way. They too must explore new ways of making profits or find their current high rate of return unsustainable, said Guo.