Chinese banks may not be taking the beating that their foreign counterparts have suffered due to the US credit crisis, but their share prices have recently been falling like a stone.

Although Chinese lenders have nowhere near the same amount of risk exposure to toxic bonds, they are suffering as a result of the slump in the nation's property sector.

Shares of China Merchants Bank slumped more than 27 percent over the past month, while Industrial and Commercial Bank of China also dropped 7 percent during the same period.

David Cui, head of China equity research & strategy of Merrill Lynch, said: "We strongly urge investors to avoid the financial and property sectors."

Properties prices in various major cities are casting a shadow over the performance of China's banking sector. The less than rosy outlook for the Chinese economy, which could be dragged down by the decline in exports to the United States and Europe, is also increasing concerns.

So far, bank profitability has been largely locked in by the spread between the lending and deposit rates. The latest reduction in interest rates should make little difference to banks' earnings, because both the lending and deposit rates were reduced by the same amount.

However, few economists expected the cut of 27 basis points in the lending rate to encourage many more people to borrow at a time when business environment deteriorated.

This is particularly so in property sector, where developers are selling properties at bigger and bigger discounts.

Official figures show that the price of new real estate in Guangzhou in August dropped more than 21 percent to an average of 9,078 yuan per sq m, after peaking last October.

Total turnover in the new residential building market fell 11.3 percent year-on-year to 612,000 sq m.

At this rate of price drop, many property owners will find themselves uncomfortable when the market value of a property drops below the outstanding amount of their mortgage.

In this situation, some property owners may either be unable or unwilling to pay back their mortgages.

Analysts said fewer people will seek new loans, with the slump in property market meaning that demand for mortgages will decline.

"Changing monetary policies and the sluggish property market will put pressure on banking sector earnings in the coming months," said Wu Xiaoling, an analyst at Great Wall Securities Co.

"Pressure on banks' earnings from the sluggish property market mainly stems from less individual mortgages and loans from property developers," she added.

Financial experts said banking sector earnings are closely related to the economic cycle. With the global economic heading for a downturn, commercial banks' clients will take a beating, pushing up the non-performing loan ratio.

At present, the capital adequacy ratio of 14 listed commercial banks remains above the level required by the banking regulator. But financial experts and analysts said that with all these uncertainties mounting, Chinese commercial banks earnings, whose earnings largely come from the deposit and lending rate spread, will face difficulties in the coming quarters, if not years.

Industry analysts said Chinese commercial banks' traditional model of relying on the interest spread will face further challenges.

(China Daily October 28, 2008)