Chinese megabanks are expected to grapple with profitability challenges due to a further squeeze in net interest margins and slowing loan growth.

Industrial and Commercial Bank of China Ltd., Agricultural Bank of China Ltd., China Construction Bank Corp. and Bank of China Ltd. saw their net interest margins (NIMs) decline and loan growth decelerate in the second quarter from a year ago, according to data compiled by S&P Global Market Intelligence from the world's biggest lenders' half-yearly income statements released recently.

"Profitability has become the number one concern for Chinese banks amid shrinking NIM and the new normal of slower asset growth," said Alicia Garcia-Herrero, Hong Kong-based chief economist, Asia-Pacific, at Natixis Corporate and Investment Banking. "It's truly a gray rhino that could push banks, including the big four, into a profit decline cycle," Garcia-Herrero said during a Sept. 10 conference.

ICBC, the world's largest bank by assets, reported a NIM of 1.32% in the second quarter, down 29 basis points from a year ago, while that of Construction Bank fell 24 basis points to 1.49%, according to Market Intelligence data. ICBC's earnings slipped 0.9% to 82.8 billion yuan in the period, while Construction Bank booked a profit of 77.5 billion yuan, down 1.4% year over year. It was the second-straight quarter of earnings decline at the two banks.

Loan growth at ICBC was 10.1% in the second quarter, 3.1 percentage points slower than a year ago, while that of Agricultural Bank was 12.1%, a decline of 3.9 percentage points.

NIMs at state-owned banks can slip another 15–25 basis points in 2024, said Iris Tan, senior equity analyst at Morningstar, in a Sept. 2 note. "We also expect [state-owned] banks' NIM to be more adversely affected by potential mortgage rate adjustment given their higher related loan exposure," Tan said, adding that the slower loans to the industrial sector following the government's warning of overcapacity risks should result in more rational new lending among government-owned banks.

Growth in the total assets of China's banking system decelerated to 6.6% in June 2024 from 10.5% a year ago, marking the slowest loan growth pace since December 2018, according to National Financial Regulatory Administration data.

Agricultural Bank's earnings grew by 6.2% to 65.5 billion yuan in the second quarter, while that of Bank of China edged up 0.3% to 62.6 billion yuan, but both banks saw their margins contract. The NIM contraction was 16 basis points at Agricultural Bank and 17 basis points at Bank of China.

The sluggish property market, a significant part of the $17.801 trillion economy, remains a challenge for policymakers in China. The People's Bank of China has maintained an easing stance and the government has announced steps to support the real estate market.

In late July, the central bank reduced its one- and five-year loan prime rates by 10 basis points each. The five-year rate, considered the benchmark for mortgages, was reduced to an all-time low of 3.85%. Local media reports suggest that the government is considering repricing existing mortgages.

China's Real Estate Climate Index, compiled by the National Bureau of Statistics, edged higher for two straight months to 92.22 in July, up from its record low of 92.00 in May.

Most analysts expect the central bank to stay on an easing path, especially with global rates also expected to fall. The central bank needs to cut rates further, and it may be more comfortable to do so once the US Federal Reserve makes the first move, adding pressure to the already thin NIM amid stubborn funding costs, according to a Natixis note circulated at the Sept. 10 conference.