China Construction Bank Corporation (HKG:939) is a large-cap stock operating in the financial services sector with a market cap of HK$1.72t. As major financial institutions return to health after the Global Financial Crisis, we are seeing an increase in market confidence, and understanding of, these “too-big-to-fail” banking stocks. Following the crisis, a set of reforms termed Basel III was enforced to bolster risk management, regulation, and supervision in the financial services industry. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like banks to vulnerabilities. As a large bank in HKD, 939 is exposed to strict regulation which has focused investor attention on the type and level of risks it is subjected to, and higher scrutiny on its risk-taking behaviour. We should we cautious when it comes to investing in financial stocks due to the various risks large banks tend to face. Today we will analyse some bank-specific metrics and take a closer look at leverage and liquidity.

View our latest analysis for China Construction Bank

Why Does 939’s Leverage Matter?

Banks with low leverage are better positioned to weather adverse headwinds as they have less debt to pay off. A bank’s leverage may be thought of as the level of assets it owns compared to its own shareholders’ equity. While financial companies will always have some leverage for a sufficient capital buffer, China Construction Bank’s leverage ratio of less than the suitable maximum level of 20x, at 12.23x, is considered to be very cautious and prudent. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. If the bank needs to firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.

How Should We Measure 939’s Liquidity?

Due to its illiquid nature, loans are an important asset class we should learn more about. Normally, they should not exceed 70% of total assets, which is consistent with China Construction Bank’s state given its ratio of 57.3%. At this level of loan, the bank has preserved a sensible level between maintaining liquidity and generating interest income from the loan.

What is 939’s Liquidity Discrepancy?

939 profits by lending out its customers’ deposits as loans and charge an interest on the principle. Loans are generally fixed term which means they cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. This mismatch between illiquid loans and liquid deposits poses a risk for the bank if unusual events occur and requires it to immediately repay its depositors. Since China Construction Bank’s loan to deposit ratio of 71.7% is within the sensible margin, below than the appropriate maximum of 90%, this level places the bank in a relatively safe liquidity position given it has not excessively lent out its deposits and has maintained a suitable level for compliance.