Chinese banks: tightening measures threaten profits from lower deposit rates

Earlier this year, market experts pointed to China’s economic recovery as a catalyst for global equities. Beijing has decided to give some life to that feeble hope by allowing local banks to cut deposit rates. This could help lift their sluggish profitability.

News on Monday that more local lenders will do so prompted some of the sharpest gains for bank stocks in nearly a decade. This will distract investors from the current crackdown on China’s banking sector, the third largest in the market.

Major state-owned lenders, including Bank of China and China Citic Bank, also reached their 10% daily trading limit that day. The fact that larger banks are following their smaller counterparts in cutting deposit rates suggests an enduring trend. But it’s too early to celebrate.

The major lenders are state-owned. The industry is strictly regulated. They must limit themselves to prudent investments despite holding huge deposits, which grew by $2.6 trillion last year alone.

Chinese banks have struggled to maintain profitability. Politicians have pushed state lenders to provide cheap loans to small businesses and home buyers. Non-performing loans, which reached a record RMB 3 billion ($434 billion) last year, are on the rise. The four largest banks have a deficit of RMB 3.7 trillion in total capital for loss absorption. Net interest margins narrowed last year due to declining earnings.

Shares of Bank of China and Agricultural Bank of China are up more than a third this year. They still trade well below regional peers at about a third of tangible book value. This reflects caution regarding regulatory investigations of more than 20 executives in the financial sector. A wider crackdown on leverage continues, limiting lending.

When the crackdown on local tech groups began in late 2020, the sector’s profit margins were robust. What followed was a years-long decline in their stock. What Beijing gives with one hand, it can take away with the other. Chinese banks remain a risky choice.