The largest banks in China may see easing pressure on their net interest margins, after they stayed in contraction in the first quarter, as lenders may extend fewer loans at the cheapest interest rates.

In the three months ended March 31, Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Bank of China Ltd. and Agricultural Bank of China Ltd. reported lower net interest margins compared with a year ago. Apart from Agricultural Bank of China, which did not disclose its NIM for the fourth quarter of 2020, three other state-backed lenders also reported a quarter-over-quarter contraction in their margins.

"We believe the net interest margin for large Chinese banks will bottom out after the first quarter. Many banks have already seen new loan yield going up as the economy recovers while loan growth is capped," Chen Shujin, Hong Kong-based head of China financial institution group research at Jefferies, told S&P Global Market Intelligence.

The Chinese banks' margins have been under pressure in recent years, first due to a slowdown in exports related to the U.S.-China tension and then the COVID-19 pandemic. Although the nation's loan growth and short-term money market rates have accelerated since the beginning of this year as China's economic recovery continued apace, major lenders' NIMs fell further as they heeded the government's call to reprice more loans at the new, lower benchmark interest rates and charge struggling borrowers less than their credit risk.

Mitigating pressure

Although accommodative policies will likely remain in place for now, Chen expects pressures on the sector's margins to relax.

Beijing has reportedly asked banks to slow their loan growth to preempt systemic risk. Chen said loan yields, in general, could edge higher amid a slower growth of credit supply. She estimated loan growth would slow by "around 1 percentage point" for this year. Relatively stable deposit costs will also help alleviate the pressure on margins, she said.

"The rebound of the producer price index, for example, allows manufacturers to shift their costs of borrowing to clients," said Chen. She added that the NIMs of major banks may start to rise, albeit modestly, in the second half of this year.

In the first quarter, Agricultural Bank of China's outstanding loans grew 5.95% to 15.419 trillion yuan from a year earlier, followed by a 5.49% growth at Bank of China, 5.24% at China Construction Bank and 4.58% at ICBC. As of end-March, the nation's outstanding bank loans grew roughly 12.34% year over year to a record 186.437 trillion yuan from a restated 165.965 trillion yuan in March 2020, according to the latest data from The People's Bank of China.

Tough to manage

Apart from the improving economy, banks have been finding other ways to mitigate the pressure on margins, including buying more domestic bonds as short-term market interest rates climb. However, some said it will still be tough to manage NIMs.

"Money market rates may fluctuate within a narrow range, so there will be difficulty and pressure on interest margin management in 2021, but we believe that the overall situation will remain stable, with no major ups and downs," China Construction Bank President Wang Jiang said in an earnings conference March 29, adding that the bank's NIM "will also remain within a reasonable range."

Among the Big Four, China Construction Bank reported the sharpest decline in NIM in the first quarter. It dropped 38 basis points from the previous quarter and was down 10 bps from the same quarter in 2020.

The Shanghai interbank offered rate, or Shibor, rose to 2.285% as of April 30, from 0.899% at the beginning of 2021, according to China Foreign Exchange Trade System and Nation Interbank Funding Center.

In addition to the improving outlook on margins, the recovery of China's economy and regulators' effort to lower systematic risks will continue to bring down lenders' nonperforming loan ratios, a matrix to gauge banks' bad loans, according to Chen.

In the first quarter, all of China's Big Four banks posted lower NPL ratios, with Bank of China reporting the steepest decline to 1.30% from 1.46% in the previous quarter.

As of May 5, US$1 was equivalent to 6.47 Chinese yuan.