Banks' pain can turn out to be a gain

Greater competition will force state banks to improve services and pay more attention to small businesses

Chinese banks face challenging times amid a shrinking deposit base, rising financing costs and narrowing profit margins. But that is not necessarily a bad thing, as the pain of banks, a result of healthy competition, is the gain of the financial industry as a whole.

Among all the difficulties, making profits is not as easy as it used to be for banks. Last year, the profits of commercial banks totaled 1.55 trillion yuan ($249 billion; 218 billion euros), 9.65 percent higher than the previous year, the China Banking Regulatory Commission says. That compares with profit growth of 14.5 percent the previous year and 18.9 percent in 2012.

The non-performing loan ratio stood at 1.25 percent by the end of last year, a rise of 0.25 percentage point from a year ago.

Apparently, commercial banks are having a difficult time.

The difficulty banks are facing is part of a broad picture of the economic slowdown and industrial overcapacity. But, more importantly, it is a result of intensified competition in finance, which helps reduce state banks' monopoly, diversify and enrich a multilayer financial market, and improve the overall efficiency and service levels of the sector.

The fiercer competition in the financial market can be particularly reflected in banks' losing ground in attracting deposits.

A survey by the China Banking Association in December found that more than 72.7 percent of bankers questioned said "boosting deposits" is the largest challenge for the banking industry, beating other challenges such as controlling bad assets (55.9 percent), maintaining net interest rate levels (37.6 percent) and increasing intermediate business income (34.3 percent).

The worries over deposits are justified given that total deposits of banks are growing more slowly. Last year, they grew 9.48 trillion yuan, 3.08 trillion yuan less than in the previous year. Among them, deposits of households rose 4.14 trillion yuan, a fall of 1.35 trillion yuan. There were also occasional drops. In the third quarter of 2014, Chinese banks experienced their first quarterly deposit drop since 1999.

To rectify the situation, banks are engaged in a war of competition for deposits by jumping on the bandwagon of raising deposit rates.

China still sets a ceiling for deposit rates with a limited range of flexibility.

The benchmark one-year deposit rate is now 2.75 percent, but the central bank allows lenders to raise the rate by as much as 1.2 times.

Usually, small regional banks such as Jiangsu Bank, Ningbo Bank and Pingan Bank tend to raise their real deposit rate to the upper limit allowed by the central bank to attract depositors. But the Big Four state banks - Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China - often use the benchmark rate, as they see no need to raise the rate given their large deposit bases built on their advantage of industrial dominance and wide branch networks.

But things have changed recently.

The Big Four all quietly have raised the deposit rates to the upper limit, either nationwide or in some areas, to improve their deposit bases amid increased competition.

Where does the competition come from?

There are four major reasons for the outflow of bank deposits.

First, many depositors would like to put their money into online financial products since Alibaba, China's largest e-commerce company, launched Yu'ebao, an Internet financial fund product that offers a better return rate than do bank deposits, and has done so since 2013. Indeed, Ye'ebao can be described as an enlightening product that has contributed greatly to raising the awareness of wealth management among the general public. The product, which was followed by many similar products launched by other Internet companies, successfully leveraged the influence and convenience of the Internet. More than 100 million users have opened accounts to invest in such products. Yu'ebao alone had attracted nearly 580 billion yuan by the end of last year. This amount of money, if not invested in Yu'ebao, could have largely been put in banks as deposits - as it had been in past decades.

The second major channel that causes outflows of bank deposits is peer-to-peer platforms. Although irregularity and bankruptcy have haunted the P2P sector from time to time, those platforms still win the hearts of many small investors thanks to advantages such as higher returns and lower thresholds. Many depositors have chosen to withdraw their money from banks and invest in P2P products. Last year the scale of the P2P market rose more than 110 percent to more than 200 billion yuan.

The stock market also caused some money to flow out of banks. The market rose in the last quarter of 2014, attracting some people to put money that was in banks into the stock market.

Finally, people's increased awareness also contributed to their reluctance to put their money in banks by way of deposits. Even though they still want to put their money in banks, they would like to invest them in wealth management programs launched by banks, hence reducing the level of deposits. Although banks can still use the money, the financing costs have been increased because return rates of wealth management products are usually higher than rates of deposits.

Considering the long-term trend of an aging society where savings will be turned into consumption, it is evident that China's banks will face a slower growth of deposits. This means that banks' financing costs will grow, net interest rates will narrow, and profit margins will shrink.

Such a difficult situation is a result of rate liberalization and financial industrial opening-up. With more players such as Internet financial companies and private banks joining the market with larger freedom to set interest rates, traditional banks, especially state behemoths, will have to face competition, improve their efficiency and services, step up innovation and pay more attention to smaller businesses.

In this sense, the tough times in the state banking industry bode well for the long-term development of the country's financial sector.

For these banks, they must address the current problems from the following aspects.

First, they should take steps to rein in the outflow of deposits. Apart from raising deposit rates, they could issue more guaranteed-income products to retain depositors. Although financing costs of these products are a bit higher than deposits, they are better than nothing.

Second, commercial banks could consider launching direct banking and Internet financial products to increase their capital bases. With their large client bases, and images, they are able to attract some users from existing online companies.

Third, traditional banks must cut their reliance on interest income by boosting investment banking, intermediate businesses and asset securitization services. For example, China Everbright Bank has diversified its capital sources through activities such as leasing finance and asset-back securities. The bank recently bucked the industrial trend by reducing its deposit rates, in a move showing its reduced reliance on deposits as the bank's capital source. The future trend is for banks not only to be lending but also offering a full-range of financial services that can create multiple capital sources.

In addition, it is very important for Chinese banks to step up their efforts to globalize. Offshore yuan markets are developing and offering cheap financing opportunities. Issuing bonds in the global market has already become an effective way for Chinese banks to boost their capital bases. They should continue to take advantage of the rich liquidity in overseas markets.

The author is a Shanghai-based financial analyst. The views do not necessarily reflect those of China Daily.