4Q: Industrywide Bad-Debt Ratio Fell, While We Believe Credit Cycle Has Yet to Peak

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Thematic (Sector/Industry)

China Financials / Thematic (Sector/Industry)

After lifting the medium-term lending facility rate by 10 basis points on Jan. 24, the People's Bank of China raised the overnight short-term lending facility rate by 35 basis points on Feb. 3. Other SLF rates and reverse repo rates were raised by 10 basis points. In contrast to market concerns, we do not believe the 35-basis-point increase in overnight SLF is a strong signal to raise future funding cost by this amount. Instead, this reflected PBOC's higher tolerance for short-term interbank-rate volatility, as SLF is regarded as the ceiling of the interest-rate corridor. We are maintaining our fair value estimates for the Chinese banks we cover, as we believe PBOC’s move is cautious, with an interest-rate hike of 10 basis points.Given the dual-track interest-rate system, where rates in the largely liberalized money and bond market rates fail to transmit to rates in the traditional bank lending and deposit market, we believe the move will have much less of an impact on the real economy than the lending-rate hike. We believe the impact on the industry will be negative, as it increases inter-bank funding rates, especially for banks which recorded robust asset expansion via inter-bank market funding and bond raising, such as rural and urban commercial banks, smaller joint-stock banks, and policy banks. Deposit rates are likely to be affected, but the upward pressure is mild, as banks are largely coordinated. As the largest inter-bank lender, large banks are likely to benefit from higher market rates, partially offsetting the impact of tighter liquidity. Inter-bank funding represented about 20% and 40% of total liabilities for the Big Four banks and nine listed joint-stock banks, respectively.Some impacted banks: <a href="https://www.smartkarma.com/entities/656" target="_blank" data-smartkarma-citation="entities:656:1">Bank Of China Ltd (H) (3988 HK)</a>, <a href="https://www.smartkarma.com/entities/45" target="_blank" data-smartkarma-citation="entities:45:1">China Construction Bank (H) (939 HK)</a>, <a href="https://www.smartkarma.com/entities/1119" target="_blank" data-smartkarma-citation="entities:1119:1">Ind &amp; Comm Bk Of China (H) (1398 HK)</a>, <a href="https://www.smartkarma.com/entities/1120" target="_blank" data-smartkarma-citation="entities:1120:1">Agricultural Bank Of China Limited (1288 HK)</a>Analysts: Iris Tan, CFA and Michael Wu, CAIA

After lifting the medium-term lending facility rate by 10 basis points on Jan. 24, the People's Bank of China raised the overnight short-term lending facility rate by 35 basis points on Feb. 3. Other SLF rates and reverse repo rates were raised by 10 basis points. In contrast to market concerns, we do not believe the 35-basis-point increase in overnight SLF is a strong signal to raise future funding cost by this amount. Instead, this reflected PBOC's higher tolerance for short-term interbank-rate volatility, as SLF is regarded as the ceiling of the interest-rate corridor. We are maintaining our fair value estimates for the Chinese banks we cover, as we believe PBOC’s move is cautious, with an interest-rate hike of 10 basis points.Given the dual-track interest-rate system, where rates in the largely liberalized money and bond market rates fail to transmit to rates in the traditional bank lending and deposit market, we believe the move will have much less of an impact on the real economy than the lending-rate hike. We believe the impact on the industry will be negative, as it increases inter-bank funding rates, especially for banks which recorded robust asset expansion via inter-bank market funding and bond raising, such as rural and urban commercial banks, smaller joint-stock banks, and policy banks. Deposit rates are likely to be affected, but the upward pressure is mild, as banks are largely coordinated. As the largest inter-bank lender, large banks are likely to benefit from higher market rates, partially offsetting the impact of tighter liquidity. Inter-bank funding represented about 20% and 40% of total liabilities for the Big Four banks and nine listed joint-stock banks, respectively.Some impacted banks: Bank Of China Ltd (H) (3988 HK), China Construction Bank (H) (939 HK), Ind &amp; Comm Bk Of China (H) (1398 HK), Agricultural Bank Of China Limited (1288 HK)Analysts: Iris Tan, CFA and Michael Wu, CAIA

Haitong Securities Co Ltd (A) (600837 CH)

Chongqing Rural Commercial Bank (3618 HK)

Shanghai Pudong Development Bank Co. (600000 CH)

China International Capital Corporation (3908 HK)

China Financial Services Holdings (2980 HK)

China Merchants Securities Co Ltd (A) (600999 CH)

China Pacific Insurance (Group) Co., (601601 CH)

Flying Financial Service Holdings (8030 HK)

China Huirong Financial Holdings (1290 HK)

Changjiang Securities Company (000783 CH)

China Merchants Securities Co Ltd (H) (6099 HK)

Hang Seng China Enterprises Index (HSCEI INDEX)

Shanghai Stock Exchange Composite Index (SHCOMP INDEX)

Tighter Monetary Policy to Facilitate Financial Deleveraging in China