China's third interest rate rise in four months could boost banks' profits by widening interest rate margin but the higher rates could also increase risks of non-performing loans, analysts said.

The People's Bank of China, the central bank, raised interest rates for the second time in just over six weeks to ward off asset price bubble and anchor inflation expectations.

The one-year benchmark deposit rate goes up to 3 percent from 2.75 percent while the one-year key lending rate increases by the same 25 basis points to 6.06 percent.

Larger increases of 35-45 basis points are seen in longer-term deposit rates while longer-term lending rates attract 20-25 basis points for loans of more than one year.

The rate on demand deposits, which account for close to half of total deposits, was also raised slightly by 4 basis points to 0.40 percent.

"The lion's share of banks' deposits are less than one year, while most of their loans are long-term ones," said Wu Yonggang, a Guotai Jun'an Securities Co analyst. "So, the asymmetric rate increase is positive for banks with higher interest margin."

Limited options

Economists said that limited options may have forced the central government to raise interest rate aggressively in a bid to manage inflationary pressure.

Barclays Bank analysts also shared the same view.

"We expect a 20-percent profit growth in 2011/2012, backed by net interest margin expansion, decent loan growth and benign asset quality," said the British bank in a research note. "Despite continued macroeconomics tightening and bank regulatory uncertainties, we believe China banks are attractively valued at an average 8.6 times of earnings per share for 2011."

On the other hand, some economists said the cycle of interest rate increases could not be good news for banks as they factor in the possibility of higher risks of bad loans as some companies may be unable to afford the higher rates.

"Higher inflation and the slowdown of economic growth could translate into higher asset risks for banks," said Guo Min, a Shanghai Securities Co analyst. "Thus, we rate the interest rate increase neutral for the banking industry."

Credit expansion in January remained strong with new loans extended expected to be around 1.25 trillion yuan (US$190 billion).

China's new yuan lending beat its target in 2010, adding pressure on authorities to tighten policy. Banks in China granted 7.95 trillion yuan of yuan-denominated loans last year, beyond the official target of 7.5 trillion yuan.