Weathering the Storm: Chinese Banks Brace for Narrowing Profit Margins

As China's banking industry navigates the challenges of a shifting economic landscape, experts warn that the pressure on net interest margins (NIMs) is set to intensify in the coming year. The looming drop in loan prime rates (LPRs) is poised to exert further strain on bank profitability, underscoring the need for strategic adaptations to safeguard the sector's resilience.

Navigating the Tides of Change: Chinese Banks Face NIM Squeeze

Bracing for Narrowing Profit Margins

According to Li Ying, the head of financial institutions ratings at S&P Global (China) Ratings, the second half of the year is likely to see bank profit margins under increased pressure if the LPRs drop again. S&P's Li projects that Chinese banks' NIMs in 2024 will be 20 to 25 basis points lower than in 2023, although the degree of NIM decline in the latter half of the year is expected to be more moderate, as NIMs are already at a relatively low level.

Navigating the NIM Decline

China Construction Bank, the country's second-largest lender, experienced a 1.8% year-on-year drop in net profit, reaching 164.3 billion yuan. The bank's NIM shrank from 1.79% to 1.54%, while its non-performing loan (NPL) ratio fell slightly from 1.37% to 1.35%.The Agricultural Bank of China, however, bucked the trend, reporting a 2% year-on-year increase in net profit to 135.9 billion yuan. Despite this, its NIM declined from 1.66% to 1.45%, and its NPL ratio narrowed from 1.35% to 1.32%.The Bank of China, another major player, posted a net profit of 118.6 billion yuan, down 1.24% year-on-year. Its NIM contracted from 1.67% to 1.44%, and its NPL ratio fell from 1.28% to 1.24%.Smaller peer Bank of Communications also saw its net profit decline by 1.63% to 45.3 billion yuan. Its NIM narrowed from 1.31% to 1.29%, and its NPL ratio decreased from 1.35% to 1.32%.

Navigating Asset Quality Challenges

Despite the pressures on NIMs, Chinese banks are expected to see stabilizing NPL ratios, thanks to the support of policymakers. According to S&P's Li, the "16 Measures to Support Real Estate" allow banks to avoid classifying property development loans in forbearance as bad debts, and loans to local government financing vehicles (LGFVs) that have undergone restructuring may not be classified as non-performing either. These measures provide banks with more leeway in managing their asset quality, potentially limiting the increase in NPL ratios, even in the face of severe external stress.

Mitigating the Impact: Strategies for Sustaining Profitability

Iris Tan, a senior equity analyst at Morningstar, highlights the challenges ahead for banks' second-half NIM performance, stemming from a rising term deposit mix and weaker retail loan growth. However, she notes that the increased corporate real estate lending following the property rescue package is not expected to pose significant risks to banks' asset quality, as the exposure to property developers remains low, and new lending is restricted to quality projects on the whitelist.As the banking sector navigates these evolving dynamics, the ability to adapt and implement strategic measures will be crucial in maintaining profitability and weathering the storm of narrowing profit margins.