Ernst & Young report says economic slowdown will chip away at growth

The Chinese banking industry's business model, which has seen high earnings growth driven by interest income over the past several years, is unsustainable, according to a report by Ernst & Young.

Chinese banks will continue to make money, but the momentum will unavoidably be thwarted by a number of factors, including the national economy's slowdown, steady advances in market-oriented interest rate reform and tighter capital restrictions, the international accounting firm said in its review of China's listed banks, which was released in Hong Kong on Wednesday.

The Ernst & Young report analyzed various business aspects of 17 Chinese banks that were either listed on the mainland or Hong Kong, or those with dual listings.

The report said the aggregate net profit of the 17 banks stood at 886.7 billion yuan ($139.6 billion) last year, up 29 percent year-on-year. But the growth rate last year was 4 percentage points lower than the 33 percent profit growth in 2010 because of a slowdown in asset expansion.

According to quarterly reports released by 16 listed banks so far this year, average profit growth further slowed to 13 percent in the first three months of this year, with the profits of two of China's four biggest banks expanding by less than 10 percent in the quarter, said Geoffrey Choi, a financial services partner from Ernst & Young.

"Generally, for Chinese banks, the first quarter is the peak season when they make the most money. After a lackluster first-quarter performance this year, the profit growth of these banks is unlikely to catch up with last year unless the central government initiates another round of stimulus like 2008," Choi said at a media briefing in Hong Kong on Wednesday.

The listed banks have faced increasing challenges in adding to their deposits, which increased by only 11.2 percent last year, compared with 17.6 percent growth in 2010, said the report.

Chinese banks are facing increasing difficulties in making profits by heavily relying on net interest income resulting from their loan portfolio and the net interest margin, as market competition is escalating amid a gradually deregulated environment, said Keith Pogson, a managing partner from the accounting firm.

A research report by the investment banking arm of China Construction Bank Corp dated May 14 also indicated that Chinese lenders find that the demand for loans from customers who are eligible is "rather weak", as "customers in industries that are both supported by regulators and that meet the underwriting standards of the banks often have little need for loans as they either have sufficient financial resources already or else they have deferred their expansion plans in the face of slower economic growth".

The Ernst & Young report, nevertheless, shows a continued rapid increase in net fee and commission income at the 17 listed banks, with their contribution to operating income rising to 18 percent last year, along with the fast development of asset management businesses such as investment banking, custody services, wealth management and private banking in China.

Pogson added that China's banking industry needs to be "more strategic" in determining its market competitiveness and business transformation.

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