China’s leaders’ pledge to tackle the “new challenges and difficulties” that plague the second largest economy in the world last month appeared to pave the way for more aggressive government measures to boost activity.
The People’s Bank of China’s subsequent call for lenders to make “reasonable profits” may explain why the core interest rate reductions were smaller than expected.
Experts say the limited cuts highlight a dilemma Beijing faces: how to balance the desire to stimulate a stuttering Chinese economy — by reducing the borrowing costs — and the need to maintain the stability of China’s $56tn bank system, as well as support the currency’s weakening.
China’s central banks stated in a report on monetary policy: “It takes time for the lending risk of banks to be exposed, and they should maintain a certain level of financial reserves and buffers.”
The modest change in lending rates on Monday — which is partly determined by the top commercial bank of the country — was made despite recent gloomy data.
The “loan-prime rate” for five years, which is the basis of mortgage rates, remained unchanged, despite economists’ unanimous predictions that it would be cut. Meanwhile, the LPR for one year was reduced by 10 basis points, rather than 15bp as expected.
Concerns about the profitability and stability of China’s largely state-owned banks were seen as central factors in a recent decision which raised questions about the authorities’ willingness to implement bold measures for stimulus. Low interest rates reduce the profits of banks by reducing the difference between what they pay for deposits and the amount that they charge for loans.
Goldman Sachs analysts stated that “pressures on banks’ net-interest margins” was “one of the key reasons behind the smaller LPR reduction than expected”, while Morgan Stanley’s counterparts pointed out policymakers’ attention to “sharp decreases” in these margins.
Banks are also concerned about the health of the overall economy.
Larry Hu, Macquarie’s chief China economist, said that the worst thing for China banks would not be a [narrowing] of interest margins. The worst-case scenario for China is a recession.
In recent weeks, market participants have been alarmed by signs that a liquidity crisis affecting China’s $2.9tn trust industry is spreading to the country. The trust sector pools savings and provides loans like the banking system.
Country Garden, China’s largest privately-owned homebuilder, has missed payment on its international debts in the past month. Entities linked to the sprawling conglomerate Zhongzhi have also failed to pay back savings products.
China is facing a number of challenges, including the impact of the slowdown in the real estate market, as well the soaring youth employment and the slide into deflation that occurred in July. In recent weeks, big investment banks cut their forecasts of full-year economic growth below the government’s target of 5%. This was already China’s lowest level in decades.
These economic issues will be reflected by the Chinese banks’ quarterly results when they announce this week or next.
According to the PBoC which didn’t disclose a figure for the entire sector, their net interest margin – a crucial indicator of profitability – has already shrunk in the first six months of 2023. Data from the National Administration of Financial Regulation revealed that the sector’s profits grew by 2.6 percent in the first six-month period of this year. However, the growth rate was the lowest since the beginning of the coronavirus epidemic and compared to 7.1 percent in the first half of last year. In the first half, banks reported a profit total of 1.3tn (US$179.6bn).
The cost of bank loans to businesses and households is largely determined by the Chinese prime rate. The PBoC is partly influenced by the 18 leading banks in the country, who submit to it the rates that they charge their most loyal customers.
Even though the cuts were lower than expected, they do not preclude further stimulus in coming months. Carlos Casanova of Union Bancaire Privee’s senior Asia economist said that the decision to “save a little firepower” suggests another LPR reduction in the fourth quarter.
Casanova said that Beijing would likely try other methods to boost the economy. He said that he expected to see a targeted fiscal stimulus as well as a broad-based macroprudential ease.
Hong Hao is the chief economist of Grow Investment Group. He said that we should expect rates to keep falling. Lower mortgage rates will ease the burden on households and increase consumption. It will also result in a compression of commercial banks’ margins.
The challenge for policymakers could be to identify the point where lower bank margins are a greater problem than the economic weakness they were intended to address. Morgan Stanley analysts stated that “[A] continued drop in net-interest margin and [a] decreased capability to digest risks could be the real challenge in the coming years.”
Hu, at Macquarie believes that the PBoC’s ability to inject liquid into the banking system would mitigate any broader financial crisis.
He said, “I am more concerned with the property sector.” If it continues to be weak or becomes weaker, this will impact the growth forecast for this year.