Profitability of Chinese banks are likely to come under pressure next year after the steep reduction in lending rates, according to bankers and economists.

The central bank while announcing the measures last week had also cut the reserve money requirements for banks and removed curbs on lending. These moves will squeeze interest spread of banks, but at the same time boost the total lending amount, they said.

The lower lending rates, bankers and economists said, have lowered the financing burden for most of the banks and also reduced the chances of loan defaults.

People's Bank of China cut its benchmark interest rate by 1.08 percentage points last Wednesday amid a number of less massive cuts in short-term deposit and lending rate.

The interest margin, which served as Chinese lenders' major income source, was narrowed although the interest rates for the one-year deposit and lending rate fell by the same amount, said She Minhua, a China Securities analyst. The 0.36 percentage points fall in demand deposit interest rate is much smaller than expected, she said.

According to Wu Yonggang, an analyst at Guotai Jun'an Securities, the interest spread is expected to narrow by 32 basis points.

A report by the Bank Of Communications International Trust Co said lenders' profit growth might fall below 10 percent in 2009, compared with the strong growth in recent years.

But many others see a silver lining from the moves. The anticipated surge in lending would offset the negative impact of shrinking interest margins, they said.

"In the short term banks' net income will be reduced along with the narrowing interest spread," said Southwest Securities analyst Zhao Jun. "But over a long time the rate cuts would increase lending and raise income."

Zhu Baoliang, an economist with State Information Center, said the latest rate and reserve ratio cut will make available to Chinese commercial banks around 400 billion yuan (US$58.12 billion) for new lending, higher than the 360 billion yuan planned by regulators last year for whole of 2008.

Chinese bankers, however, prefer to remain cautious on new lending as they still expect a tough year ahead.

"Banks would not follow like sheep the investment projects in the nation's economic stimulus plan," said Zhu Min, Bank of China's vice-president. "Rigorous examination is necessary to guarantee the quality and results of the nation's macro adjustment policies."

(China Daily December 2, 2008)