How can China banks keep profitability in check despite weak earnings forecasts?

Significantly raising fee income could be imperative.

In a recent report, BBVA cited 3 things that will weigh on China banks' earnings over the next five years, possibly making profit growth slip to single-digit levels.

According to Mike Werner, senior analyst at Bernstein Research, while the banks underperformed the MXAPJ in March, the underperformance occurred on the
final day of the month as the share prices of the Chinese banks fell in response to an announcement by the CBRC indicating greater controls over wealth management products.

In April, Werner expects the share prices of the banks to be driven by their earnings performances as their Q4 '12 results was just released and their Q1 '13 results will be released at the end of April.

"Similar to March, we expect the larger banks to outperform as they will show better balance sheet and credit quality trends in their Q1 2013 results. We prefer CCB, ICBC and BOC (rated Outperform) to China Merchants Bank (rated Underperform) over the next 12-18 months."

Meanwhile, Charlene Chu, head of China financial institutions at Fitch Ratings notes that so far, low impairment charges have been a key factor upholding profitability.

However, Chu reckons this comes at the expense of lower loan loss reserves and weaker loss-absorption capacity, and is only temporary.

"Longer term, banks will have to significantly raise fee income and increase their lending to higher-yielding SME borrowers to preserve earnings, although the latter will also require higher provisioning," adds Chu.