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Chinese leaders last month pledged to address “new difficulties and challenges” plaguing the world’s second-largest economy, appearing to open the way for bolder steps by the government to stimulate economic activity.
But the PBOC’s subsequent call to allow banks to make “reasonable profits” helps explain why the cut in core lending rates announced on Monday was smaller than expected.
Experts say the smaller-than-expected rate cut highlights the dilemma Beijing faces: how to balance its desire to stimulate the economy by lowering borrowing costs with the need to keep China’s $56 trillion banking system stable and support its weak currency.
As the People’s Bank of China said in its monetary policy report: “It will take some time for bank loan risk exposure, and there should be certain financial reserves and risk buffers.”
The dovish action on Monday on lending rates – which are set in part by some of the country’s top commercial banks – came despite a recent wave of dismal economic data.
The five-year “prime loan rate” underpinning mortgage rates remained unchanged despite economists’ consensus forecast for a cut, while the one-year LPR was cut by 10 basis points instead of the expected 15.
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Concerns about the profitability of most of China’s state-owned banks are seen as central to the decision, which has raised questions about the authorities’ willingness to take bold stimulus action. These banks are often seen as proxies for the overall economy. Lower interest rates typically narrow the gap between what a bank pays on deposits and what it receives on loans, reducing the bank’s profits.
Analysts at Goldman Sachs said on Monday that “pressure on banks’ net interest margins” was “a key reason why LPR fell less than expected”, while their peers at Morgan Stanley noted that policymakers were concerned about a “sharp decline” in net interest margins. .
However, the overall health of the economy is also a big concern for banks.
Larry Hu, chief China economist at Macquarie, said “the worst that could happen to Chinese banks is not the (tightening) spread”. “The worst-case scenario is that the Chinese economy falls into recession.”
In recent weeks, there have been signs that a two-year liquidity crisis among Chinese property developers is spreading to China’s $2.9 trillion so-called “trust” industry, which, like banks, pools savings to make loans. Market participants were shocked by this.
Country Garden, China’s largest private homebuilder, missed its international debt repayment this month, while entities linked to sprawling conglomerate Zhongzhi also failed to repay savings products.
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The concerns come as China grapples with the immediate effects of a housing slowdown, weak exports, soaring youth unemployment and a slide into deflation in July. In recent weeks, major investment banks have slashed their full-year economic growth forecasts to below the government’s 5% target, which has been China’s lowest level in decades.
Those economic problems are expected to be reflected in Chinese banks’ quarterly results this week and next.
Their net interest margin – a key indicator of profitability – has narrowed in the first half of 2023, the PBOC said, without disclosing industry-wide figures.Profits in the industry still rose 2.6 percent in the first six months of the year, but the pace of growth was the slowest since the outbreak of the coronavirus, compared with the same period last year, data from the State Financial Supervisory Authority showed. 7.1% In the first half of 2022, the bank’s total profit in the first half of the year was 13,000 yuan.
Prime lending rates in China determine how much it costs banks to lend to households and businesses. Those rates are determined in part by China’s 18 major banks, which submit to the People’s Bank of China the rates they charge their best customers.
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This week’s lower-than-expected rate cut doesn’t rule out more stimulus in the coming months. Carlos Casanova, senior Asia economist at Union Bancaire Privée, said the decision to “save some firepower” meant another cut in the LPR in the fourth quarter.
Beijing may also try other methods to boost growth, Casanova added. “We expect to see targeted fiscal stimulus and broad-based macroprudential easing,” he said.
“We should expect interest rates to continue to fall,” said Hong Hao, chief economist at Grow Investment Group. “Lower outstanding mortgage rates will ease the burden on (households) and increase consumption. But it also means commercial bank spreads will compress.”
The challenge for policymakers may be to determine at what point falling bank profit margins become a bigger problem than the economic weaknesses they want to address. “(A) Further decline in net interest margin and (a) reduced ability to absorb risk could be the real challenge in the coming years,” Morgan Stanley analysts said.
For Macquarie’s Hu, the PBOC’s ability to inject liquidity into the banking system will ease any broader banking crisis.
“I care more about the real estate industry,” he said. “If it remains weak or gets weaker, that will affect the growth outlook for this year.”
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