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China banks see margins squeezed by efforts to spur economy

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China's biggest banks responded to government demands to help spur a slowing economy. The cost of their efforts has been disappointing profits and shrinking loan margins.

[SHANGHAI] China's biggest banks responded to government demands to help spur a slowing economy. The cost of their efforts has been disappointing profits and shrinking loan margins.

Repeated calls by policy makers for banks to advance more credit to the struggling private sector and small businesses have taken a toll on the industry's financial performance this year. China Construction Bank Corp and Bank of Communications Co posted weaker-than-expected first-half profits as lending margins declined.

On Thursday, Industrial & Commercial Bank of China Ltd said its profit was up 4.7 per cent to 167.9 billion yuan (S$32.6 billion), matching analyst estimates, according to a survey conducted by Bloomberg. Net interest margin at the world's biggest lender narrowed to 2.29 per cent from 2.3 per cent a year earlier.

In response to government requirements, the big banks increased loans to small businesses by 35 per cent in the first six months, while cutting their financing costs by more than the 1 percentage point that authorities wanted, according to the industry regulator.

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"What's going to end up in the medium-and-longer term is you're still going to have the margin pressure from the mispricing of risk," Grace Wu, a senior director at Fitch Ratings, said in a Bloomberg Television interview on Thursday. "Ultimately that's going to have asset quality pressure down the road."

ICBC, the nation's largest bank, is facing pressure on its net interest margin, president Gu Shu said on Thursday after the earnings announcement. CCB's margin may drop by one or two basis points in the second half, Chief Financial Officer Xu Yiming said at a briefing in Beijing.

Lenders will face further challenges, analysts have said, after China's central bank changed how it calculates the nation's one-year benchmark rate. While the effort is intended to liberalize interest rates and ease borrowers' financing costs, net interest margins across the industry will be squeezed by the reform, Postal Savings Bank of China Co. said last week.

While the moves are likely to win political points for the firms, offering loans to riskier companies at lower rates has raised concerns, and investors have never been so downbeat. The MSCI China Banks Index underperformed the MSCI China Index by about 13 per cent this year as valuations of mainland lenders approach historic lows.

Bank shares gained on Friday along with the broad market after China indicated it wouldn't immediately retaliate against the latest American tariff increase.

Changes to how China sets the one-year benchmark were first used on Aug 20. Most of the impact will surface and hit banks' profit in 2020, according to Citigroup analysts.

 

Shanghai-based Bocom, which saw its margin narrow by 3 basis points quarter-on-quarter, said on Tuesday that switching to the new benchmark rate will lead to a slight decline in loan pricing. The bank will rein in its own funding costs to keep margins stable, it said.

While Chinese banks are cheaply valued, that doesn't mean their stocks will soon rise, Ismael Pili, co-head for Asian bank research for CreditSights Singapore, said in a Bloomberg Television interview on Friday.

"The problem is margin pressure, which is the predominant driver of their profitability," he said. "If that's coming down then overall profitability will likewise come down."

BLOOMBERG