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Triggered by the fourth rate cut since September, shares in the six Hong Kong-listed mainland banks rose yesterday. Bank of Communications outperformed its peers, ending 3.62 percent higher. Bloomberg

Mainland banks will have their loan business margins squeezed after the central bank announced a hefty reduction in the benchmark lending rate, analysts said.

On Tuesday, the People's Bank of China (PBOC) lowered the benchmark one-year lending and deposit rates by 108 basis points, the steepest reduction in 11 years.

The central bank's rate cut, the fourth since September, will cut lending margins at mainland banks by 0.2 percentage point on average, according to Deutsche Bank AG. It comes as China Construction Bank and Bank of China have pledged to increase lending to bolster economic growth.

Although the one-year lending rate and deposit rates were slashed by the same magnitude, the rate on demand deposits, which accounts for almost half of the total at these banks, was only reduced by 36 basis points. In other words, the banks' funding costs are likely to fall less than returns on loans.

The net interest margins at the six largest Hong Kong-listed mainland banks will narrow by 12 basis points on average and profits will fall by 7.7 percent following the PBOC's move, Warren Blight, a Hong Kong-based analyst at Fox-Pitt Kelton Asia, wrote in a note.

In order to encourage lending, the central bank also lowered the reserve requirement ratio for the bigger banks to 16 percent from 17 percent; for smaller banks, the requirement was lowered to 14 percent from 16 percent.

Some analysts expect banks, following the PBOC's aggressive rate cuts, to increase loans that may somehow ease the negative impact of shrinking margins.

However, Goldman Sachs' banking analysts believe that the net interest margins for major banks could expand due to the asymmetrical long-dated lending and deposit rates cut (deposit rates with long maturities cut deeper than lending) and their relatively high deposit concentration in long-dated time deposit.

The asset quality risks could decline as decisive rate cuts should mitigate the downside tail risks and is supportive of asset prices, the analysts added.

Shares in the six Hong Kong-listed mainland banks rose yesterday, and Bank of Communications outperformed its peers ending 3.62 percent higher.

Both Goldman Sachs and Credit Suisse said further rate cuts will be needed to ease the credit stress in domestic economy and to help stimulate consumption and investment demand.

Credit Suisse forecasts that the one-year lending rate might be lowered by another 135 basis points to 4.22 percent by the end of 2009, probably before the end of May. It is currently 5.58 percent after the latest reduction.

After the latest adjustment, Goldman Sachs expects the central bank to cut interest rates further by 200 basis points to 3.58 percent and deposit rates by 150 basis points to 1.02 percent by the end of 2009, with the potential cuts likely being front-loaded in the first half of 2009.

(HK Edition 11/28/2008 page3)