China’s fledging private banks get off to a smooth start in nation run by the Communist Party

China’s growing number of fledging private banks are expected to keep posting higher-than-average net interest margins after enjoying a smooth opening start, according to analysts.

At the same time, however, they are being urged to expand their fundraising channels to trim a heavy reliance on interbank lending, amid tighter regulatory scrutiny.

Average private banking net interest margins sat at 4.86 per cent at the end of June, more than double the industry average of 2.05 per cent, according to quarterly regulatory data, down from 4.95 per cent as the end of March.

Net interest margin is essentially a performance metric that examines how successful a firm’s investment decisions are compared to its debt situation and is considered a crucial measurement to reflect profitability of banks.

It is the difference between interest a bank gains on its assets, or loans and investments, and the interest it pays out on its liabilities, or deposits, as a proportion of its assets.

“It’s a case of ‘so far so good’ for Chinese private banks,” said Zhao Yarui, a senior researcher at Bank of Communications, noting the higher net interest margins could also reflect higher risk appetite than traditional banks.

Rebecca Fu, a partner at consultancy Roland Berger, added that China’s growing community of private banks “are differentiating themselves as a niche to cater to the under-served group of small business and individuals”.

“That’s why they can enjoy a higher margin than traditional banks and that trend may well go on for at least two to three years.”

Private banks are becoming increasingly dependent on evolving technology and the internet, as their physical networks are limited to having just one outlet only, in the city in which they are headquartered, she said.

As that reliance grows, Fu predicts the number of private banks could at least double within the next two to three years, with Beijing encouraging their growth, backed up by better regulation in the banking sector, she added.

China has approved the setting up of 17 private banks since 2014, at least 15 of which are already operational. Their average bad loan ratio sat at 0.7 per cent as the end of June, compared with an banking industry average of 1.74 per cent.

Nicholas Zhu, a Moody’s senior analyst, said it takes time for sour loans to be exposed and it might not be straightforward to consistently compare non-performing loans of recently incorporated private banks with established ones.

The banks with heavy reliance on interbank funding could be among the most vulnerable to tighter scrutiny, he added, noting that Moody’s does not yet rate any private-owned Chinese banks.

Interbank business shrank for the first time since 2010 in the first half.

Roland Berger’s Fu suggested private banks could also turn to assets-backed securitisation, joint loans and bond issuance to quench their thirst for capital in trimming their reliance on interbank liability.