China's latest cut to long-term lending rates is likely to crimp banks' net interest margins (NIMs), as efforts to boost economic growth add fresh drag on lenders' profits.
The People's Bank of China (PBOC) on June 20 cut its one-year and five-year Loan Prime Rates (LPRs) by 10 basis points each to 3.55% and 4.2%, respectively. This followed last week's reductions in the seven-day reverse repurchase rate and the one-year medium-term lending facility rate. Together with expectations of further monetary policy loosening, the latest rate cut could negate the boost the country's banks could have received from prior reductions in deposit interest rates.
"It could drag banks' NIM by as much as 30 basis points if there is a rate cut on outstanding mortgages," May Yan, head of Greater China financials equity research at UBS, said in a June 16 report. "We do not expect loan growth to be up markedly, and forecast 11% to 12% year over year growth for 2023, as it is constrained by high macro leverage," the report said.
In China, the one-year LPR is used as a benchmark for corporate loans, while the five-year rate is used to price mortgages. The PBOC lends to large commercial banks at the medium-term lending facility rate, which is often seen as a guide for LPRs, while reverse repo refers to a short-term borrowing window for commercial banks. The PBOC decides on the LPR on the 20th of every month.
The world's second-largest economy was running behind its 2023 GDP growth target of "around 5%," growing 4.5% year over year in the first quarter after missing the 2022 target. To boost the sluggish economy, particularly the downward spiral of the property sector, market watchers expect continual "counter-cyclical adjustments," as PBOC Governor Yi Gang put it earlier, to be rolled out. This is likely to include interest rate cuts and even a boarder stimulus package for the sector.
While the 5% growth target is still likely achievable, banks' NIMs are expected to narrow further in the second quarter to factor in three rounds of LPR cuts in 2022, Yan said.
More rate cuts likely
Chinese authorities are likely to cut lending rates further as they seek to boost economic growth, analysts said.
"We expect another 10-basis-point cut on both one-year and five-year LPR in the second half of 2023, and [a] one to two 25-basis-point reduction on Reserve Requirement Ratio (RRR)," Ricky Choi, chief economist at Hong Kong-based Bank of East Asia, said at a June 20 conference.
The PBOC lowered its RRR, which refers to a portion of deposits banks must hold as reserves, in late March by 25 basis points to 7.6% for all banks, except those that have implemented a 5% ratio.
"[Today's cut] brings to an end of this round of formal rate reductions, though more will likely follow in the months ahead as the economy continues to struggle," Robert Carnell, regional head of research for Asia-Pacific at ING, said in a June 20 note.
Even with further reductions, it is not likely to see demand for property swing around strongly, according to Carnell, although lower mortgage rates will provide a little additional cash-flow boost to households and help consumer spending.
