Deposit-Hungry Banks Feel Squeeze in China

MAY 5, 2011   THE WALL STREET JOURNAL

By TOM ORLIK

Desperate times call for desperate measures at China's smaller banks.

Repeated increases in the amount of funds banks must keep on reserve with China's central bank is forcing smaller institutions to pay a premium rate for deposits. That will crimp profits.

For monsters like Industrial and Commercial Bank of China, the four increases so far this year in the reserve requirement aren't a problem. A nationwide presence means ICBC has little trouble attracting extra deposits.

It is a different story at institutions like China Citic Bank. A high loan-to-deposit ratio means that, as of the end of 2010, 73.3 of every 100 yuan of deposits was already loaned out. A record-high reserve requirement means that another 20.5 yuan is locked in the central bank's vault. With other deposits funding illiquid assets, banks like Citic are operating with little room to maneuver, especially if the central bank at some point raises reserve requirements for a fifth time.

The solution for Citic and other small banks is costly, says Victor Wang, Macquarie's China bank analyst. To get additional funds necessary to keep growing, small banks are offering to pay depositors a premium to the benchmark deposit rate. A typical deal to attract "negotiated" deposits might see a bank offering a corporate customer a premium of two percentage points above the benchmark five-year deposit rate of 5.25% in return for a fixed-term, five-year deposit of five million yuan ($763,000) or more.

Such a transaction would add to a small bank's deposit base, giving it cash to meet demand for withdrawals, funds to make more loans, and a buffer against further increases in the reserve requirement. But by paying a premium above the benchmark deposit rate, the banks will also hurt their net interest margins, a key driver of profitability.

Investors are already punishing deposit-strapped banks. With a loan-to-deposit ratio of 72.74 at the end of 2010, China Minsheng Bank is trading at about 6.4 times earnings. ICBC, in contrast, has a loan-to-deposit ratio of 62. It trades at a 11.7 times earnings, partly reflecting the fact it won't have to engage in a costly scramble for deposits in order to keep lending.

With China looking set to continue moves to reduce inflation, and the People's Bank of China warning ominously that there is no upper limit to the reserve requirement, investors are right to take a dim view of deposit-light banks.

Write to Tom Orlik at tom.orlik@wsj.com