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Chinese banks face further margin pressure amid softening economic outlook


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Chinese banks face further margin pressure amid softening economic outlook

Net interest margins at the largest Chinese commercial banks will remain under pressure in the coming quarters due to a softening outlook of the world's second-largest economy.

Five out of the six largest state-backed commercial banks in China reported year-over-year decline in net interest margins in the June-end quarter, in which Bank of China Ltd.'s NIM dropped the most, down 11 basis points from the same period of time in 2020. It was followed by eight-basis-point declines at Industrial & Commercial Bank of China Ltd., Agricultural Bank of China Ltd. and Postal Savings Bank of China Co. Ltd. China Construction Bank Corp.'s NIM also narrowed seven basis points. Bank of Communications Co. Ltd. was the only lender in the group that reported an improved NIM in the second quarter, up two basis points from a year earlier.

The average NIM for the six banks was 2.02% for the second quarter of 2021, the lowest in four years, according to data from the China Banking and Insurance Regulatory Commission.

"[The margin was] mainly affected by falling interest rate. We think the NIM will continue to be under stress in the future. We will increase the proportion of demand deposits and better manage our cost of funding. Meanwhile, we will also attract more mid- and long-term loans," Wang Wei, executive vice president of Bank of China, said in an earning conference on Aug. 30.

Net interest margins, a key profitability metric that measures the returns on interest-earnings assets such as deposits, have been trending lower for Chinese banks in recent years. Since 2019, commercial banks started pricing their loans using new benchmark interest rates, namely the one-year and five-year loan prime rates, which are based more on market demand and thus are lower than the old benchmarks. In addition, Beijing has been adopting an accommodating monetary policy to spur economic growth, which has brought down borrowing costs. The Chinese government has also been nudging lenders to offer lower interest loans to or waive fees for small businesses, adding pressure to banks' margins from lending.

"I think net interest margin will continue to decrease as the loan interest rate is expected to drop. The main reasons include the government's drive to support businesses especially small and mid-size manufacturing companies with low interest rate. Return from assets will also continue to slip amid the low interest rate environment," said Bruce Pang, Hong Kong-based head of macro and strategy research at China Renaissance.

Although China was among the first country that came out from the previous waves of the COVID-19 pandemic, the recent spike of delta variant cases, the crackdown of fast-growing sectors and ongoing trade tensions with the U.S. have sparked concerns of an economic slowdown.

"With concern of economy recovery and creating new jobs, we think the possibility of [another] loan prime rate cut is not low," said China Renaissance's Pang. China last cut the loan prime rates in April 2020.

Rate cut

Some analysts expect China's central bank may further lower the required reserve ratio for banks to free up more liquidity and offer more capital support to rural areas after its latest cut in July, adding more pressure on the banks' margins.

"With the rising risk of a growth slowdown and the lack of flexibility in some key existing tightening measures, we believe the probability of an required reserve ratio cut is on the rise in the near term," Japanese investment bank Nomura said in a report on Aug. 27.

Guo Mang, executive vice president of Bank of Communications, said in an earnings conference on Aug. 27: "The tailwind is the borrowing cost may decrease due to recent reserve rate cut ... However, there are still headwinds, such as intensified competitions for deposits."

Despite the eagerness to attract more deposits, both Bank of Communications and Postal Savings Bank of China said they plan to rely less on deposits that offer high interest rates to customers.

"We have reduced 20 billion yuan of three-year high interest rate deposits in the first half, and more than 200 billion yuan of those will mature in the second half of this year and over 100 billion will due next year. As these deposits mature, clients can choose to extend or switch to investment fund, both help reducing funding costs," Zhang Jinliang, chairman of the Postal Savings Bank of China, said in an earnings conference on Aug. 30.

As of Aug. 27, US$1 was equivalent to 6.47 Chinese yuan.