Banks, Insurers Swimming Different Currents

Following last weekend’s interest rate cuts by The People’s Bank of China, which signaled a move toward a more market-based banking system, The Wall Street Journal reports that China’s banks will likely feel the squeeze on their bottom lines:

Analysts say the changes should make capital allocation more efficient, but they are concerned about eroding bank interest margins, the biggest profit driver for Chinese lenders. On average, net interest income—the difference between interest rates received and paid—accounts for more than 80% of the operating income at banks overall. The ratio is much higher at smaller banks.

“These changes are credit-negative for Chinese banks as a wider official interest-rate range and reduced interest rates will lead to lower loan-to-deposit spreads,” said Christine Kuo, a Moody’s Investors Service analyst.

Citigroup says the policy change will trim 10% from its estimate of bank earnings this year, assuming all deposits are priced at the new ceiling and 20% of total corporate loans will be set at 80% of benchmark rates.

Another segment of China’s financial system, however, stands to benefit from deregulation. The Shanghai Securities Journal reported on Tuesday that China’s Insurance Regulatory Commission (CIRC) may allow insurers to seek higher returns and diversify their investments through a broader range of financial instruments, according to Reuters. Two people close to the situation told The Wall Street Journal that draft rules have already been circulated by the CIRC:

The new rules by the China Insurance Regulatory Commission will allow insurers to invest in financial derivatives—including forward contracts, swaps, options and futures, such as China’s nascent stock-index futures—both in the domestic market and overseas, said the people. They will also allow insurers to put more funds into equities and real estate.

Still, “insurance companies which participate in derivatives trading must confine their activity to risk hedging,” rather than for speculation, the draft rules say.

The CIRC also said it would allow insurance firms to conduct margin trading and short-selling of securities, the people said.

In comments posted on the regulator’s website last week, an unnamed CIRC official said the insurance watchdog is exploring ways to give insurers more flexibility in making investment decisions. The easing of controls is in line with economic trends and the government’s efforts to give insurers more leeway on how they use their funds, the official said.