Chinese megabanks could face lower margins as interest rates may fall further

China's biggest banks are expected to face lower net interest margins (NIMs) as a potential fall in interest rates puts a drag on earnings.

Industrial and Commercial Bank of China Ltd. (ICBC), the world's biggest bank by assets, reported a 0.8% year-over-year growth in net income in the fourth quarter of 2023, according to S&P Global Market Intelligence data. China Construction Bank Corp. also posted a 0.8% gain, while Agricultural Bank of China Ltd. registered 0.5% growth. Bank of China Ltd., the smallest lender of the country's big four banks, had net profit growth of 4.9% in the fourth quarter — its strongest quarter of the year.

All four megabanks reported contraction in NIMs to between 1.41% and 1.60% in the fourth quarter of 2023, versus a range of between 1.69% and 1.90% in the corresponding quarter a year ago.

"Some further cuts in the policy rate and therefore also the lending rates" are possible, Louis Kuijs, chief economist, Asia-Pacific, at S&P Global Ratings said during an April 11 webinar. This would not be a huge amount, "but 20 basis points." However, "that will probably only happen if the US interest rates come down," Kuijs said.

Growth challenge

China set its 2024 GDP growth target at around 5% after the world's second-biggest economy surpassed a similar target and grew 5.2% in 2023. A slowdown in the real estate sector will pose a challenge to the growth goal, prompting some economists to predict that the central bank will keep its easing bias to support the economy.

"Most banks are still expecting more downward pressure on NIMs due to continued loan repricing and higher time deposit growth, though this could be partially offset by further deposit rate cuts," Singapore-based Oversea-Chinese Banking Corp. (OCBC) analysts wrote in an April 5 note.

The People's Bank of China in February cut its five-year loan prime rate, the mortgage rate benchmark, to a record low to boost housing demand. This came after the central bank cut the banks' reserve requirement ratio in January. Central bank monetary policy easing usually adds pressure on commercial banks' margins and can increase asset quality risks as lower rates spur lending.

"Despite the continued contraction in NIMs in the lower interest environment in China, the big four banks do keep a healthy loan growth to support the economic recovery, which we believe will partly offset their pressure on the top line revenue growth," said Phyllis Liu, director, financial institutions rating, at S&P Global Ratings.

Increasing loans

For example, the big four banks will continue to prioritize lending to the policy-favored sectors to support the government's goal of rebalancing the economy, Liu said.

Compared with a year ago, loan growth in Bank of China accelerated by 2.1 percentage points to 13.8% in the fourth quarter of 2023, according to Market Intelligence data, while that of Agricultural Bank decelerated by 0.9 percentage point to 14.5%. Growth in ICBC and China Construction Bank, at 12.4% and 12.6%, respectively, remained unchanged.

Still, all four megabanks improved their asset quality, measured by their nonperforming loan (NPL) ratios. The NPL ratio at Bank of China was 1.27%, or 5 basis points lower than a year ago, according to Market Intelligence data, while that of the remaining three edged lower to between 1.33% and 1.36%.

Asset quality trends remain at largely stable and comfortable levels, especially for the larger banks, according to OCBC.

"Local government financing vehicle, real estate and credit card loans and exposure will be key areas that the market will be paying attention to in 2024 when assessing the asset quality of the banking sector," OCBC said.