China Banks See Margins Squeezed by Efforts to Spur Economy

(Bloomberg) --

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. Lending margins declined at the nation’s top lenders in the first half of the year, while some firms posted weaker-than-expected profit for the period.

Policy makers are trying to address the needs of the economy, which grew at its slowest pace in three decades last quarter, without damaging the country’s largest banks. But for lenders, meeting authorities’ demands may mean losing favor with analysts and investors.

“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.”

Agricultural Bank of China Ltd. said Friday that its first-half profit rose 4.9% to 121.4 billion yuan ($17 billion). Analysts on average estimated net income of 120.3 billion yuan, according to a Bloomberg survey. Bank of China Ltd. reported profit that increased 4.5% to 114 billion yuan, compared with consensus estimates of 112.2 billion yuan.

In response to government requirements, the big banks increased loans to small businesses by 35% 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.

Industrial & Commercial Bank of China Ltd., the nation’s largest bank, is facing pressure on its net interest margin, President Gu Shu said Thursday after the earnings announcement. China Construction Bank Corp.’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 on the same day.

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.

Even as 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% this year as valuations of mainland lenders approach historic lows. ICBC and CCB saw their China-listed shares fall on Friday.

What Bloomberg Intelligence Says

“Changes to how China’s central bank sets lending rates, including revamping the loan-rate benchmark, may usher in an extended period of muted returns and margins for the nation’s banks.”

-- Analyst Francis Chan

-- Click here for the research

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 Inc. analysts.

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.”

--With assistance from Heng Xie.

To contact Bloomberg News staff for this story: Jun Luo in Shanghai at jluo6@bloomberg.net;Alfred Liu in Hong Kong at aliu226@bloomberg.net

To contact the editors responsible for this story: Sam Mamudi at smamudi@bloomberg.net, Ryan Lovdahl

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With assistance from Bloomberg