Some of the largest banks in China are considering investing more in domestic bonds this year, hoping the recent recovery of short-term market interest rates will help mitigate the continued pressure on their net interest margins.

Although all six biggest lenders in China increased their bond investments in 2020, four of them still reported their lowest net interest margins since their listing as they lent more but at lower interest rates to help reboot the pandemic-hit economy. Bank of China Ltd.'s NIM slid to 1.85%, the lowest among the quartet. It was followed by 2.15% at Industrial & Commercial Bank of China Ltd., 2.19% at China Construction Bank Corp. and 2.20% at Agricultural Bank of China Ltd.

Meanwhile, Postal Savings Bank of China Co. Ltd.'s NIM fell to 2.42%, the lowest in four years, and Bank of Communications Co. Ltd.'s margin dropped to a two-year low of 1.57%.

"Market interest rates have gradually risen, which is a big positive for our net interest margin," Jinliang Zhang, Chairman of Postal Savings Bank, told a teleconference March 30 after reporting a 5.4% year-over-year increase in 2020 net profit. "The full-year net interest margin may still face downward pressure this year, but I believe the pressure is easing from last year."

Postal Savings Bank's bond portfolio only grew 0.5% in 2020, the least among major banks. It was dwarfed by larger peers, such as ICBC and CCB, whose debt portfolio expanded by 17.4% and 14.0%, respectively.

ICBC's President, Lin Liao, told another conference on March 26 that increasing bond investment could help reduce funding costs for its clients.

Rising bond yield

As China's economy recovers more quickly from the pandemic than most other countries and concerns of defaults by state-linked issuers have eased, the yield on the nation's benchmark 10-year government bond has also been recovering. The 10-year yield stood at 3.20% as of March 29, compared with its recent trough of around 3.00% in April 2020, according to Trading Economics.

Domestic short-term interest rates have risen in recent months. Overnight Shanghai interbank rate, or so called Shibor, rose to 1.825% as of March 30, from 0.899% at the beginning of 2021, according to China Foreign Exchange Trade System & Nation Interbank Funding Center. One-year Shibor also nudged higher to 3.081% from 2.993% during the same period.

As Chinese banks are charging some borrowers interest rates that are lower than their credit risk, declining loan yields have kept a lid on the banks' net interest margins. Lenders are told to charge more affordable interest rates for vulnerable borrowers while allowing some of them to postpone repayment of principals and interests to 2021-end. Agricultural Bank of China, for instance, reported a 13-bp drop in the average loan yield in 2020.

The interest rates on loans to small businesses posted larger declines last year. China Construction Bank said its average rate on the so-called inclusive loans dropped 64 bps, while Bank of Communications said the rate shrank by 96 bps.

As the Chinese government asked the lenders to increase their lending to small businesses by at least another 30% this year, analysts said earlier they expect continued pressure on loan yields, and thus margins. Meanwhile, China's benchmark interest rate, the Loan Prime Rate, is unlikely to rebound as the central bank had said it would maintain monetary policy adequately accommodative to enable the broader economy as well as vulnerable borrowers to survive.

Having said that, analysts expect a modest recovery of Chinese banks' earnings this year, mainly helped by further loan growth amid economic recovery this year.