Once again, China’s largest banks performed better in the first half of 2017 than their smaller competitors, with each of the so-called big four reporting profits above analysts’ expectations thanks to improved margins and better asset quality. However, some analysts have now raised red flags about the quality of that growth, particularly at Bank of China – the institution with the highest growth across the sector. “Large banks were the winners in the first half,” said Chen Shujin, head of financial research at Huatai Financial. “Compared with the mid-caps, China’s big four banks recorded better improvement on asset quality, faster net interest margin recovery ... and still kept decent capital buffers,” said Sophie Jiang, head of China bank research at Nomura in a note to clients. ICBC’s interim profits beat expectations, bad loan ratio falls In contrast, as a group, China’s mid-sized banks, the joint stock commercial banks, had a rather more mixed performance. First half profits at China Merchants’ Bank, one of the most favoured by analysts, rose by 11.4 per cent year on year, while profits at Shanghai listed Huaxia Bank rose by just 0.1 per cent. The main reason for the disparity in performance was that across China’s banking sector, net interest margins continued to diverge, depending on the size of an institutions’ deposit base. Net interest margin is the difference between the interest a bank receives, and the interest it pays out, relative to its interest earning assets. Interest rates in the interbank market were higher in the first half of this year than the whole of 2016. This meant that those banks who were net lenders in the interbank market – with high deposit bases – boosted their margins, while those who were net borrowers with lower deposits and needed to borrow more to meet their short term obligations, and saw their margins shrink. Overall, net interest margins narrowed four basis points on average in the second quarter of 2017, whereas the big four banks saw their margins increase by four basis points on average, according to banking analysts at Morgan Stanley. And indications are that this trend will continue. “We believe net interest margins for most large banks have widened since the second quarter, and will continue to broaden, thanks to the high proportion of deposits with these banks,” analysts at Daiwa Capital Markets wrote in a report. Zhang Qinsong, Bank of China’s executive vice-president, told a press conference in Beijing on Wednesday he expected its net interest margin to remain stable for the rest of the year. But as well as the difference in growth figures, analysts also said there was a clear disparity in the quality of banking growth, with some achieved high numbers at the cost of depleting other parts of their balance sheets. Bank of China profits up 11.5 per cent, but analysts concerned about quality This was seen most strikingly seen at Bank of China, which posted the highest profit growth of the big four banks (11.5 per cent year on year). But to achieve that growth it slashed its provisions set aside to cover bad loans, by 46 per cent, from 50 billion yuan to 27 billion yuan. “Although BOC’s result is definitely a beat, it’s low quality beat to me,” said Marco Yau senior analyst at China Everbright Bank International. “I would prefer ABC’s [Agricultural Bank of China’s] accounting treatment: building up provision when there is room, although there is improvement in asset quality.” “We see superior earnings quality at banks with earnings growth recovery, lower NPL ratios, and maintaining a high provision to loan ratio,” wrote Chen in a note to clients. “China Merchants Bank, and China Construction Bank stand out. Citic, Postal Savings Bank and ICBC are relatively good.” Across the sector as a whole, asset quality improved slightly, particularly by the largest players. Chinese banks do not report just one headline figure for loans that have soured, but a variety. “We should tighten our belts,” says AgBank board chair In increasing order of concern, these are loans that have been overdue for less than 90 days, those that have been overdue for more than 90 days, special mention loans, and non performing loans. However, all four indicators at each of the big four banks declined in the second quarter of this year. This improving trend is likely to continue into the rest of the year, as a change in the proportion of loans that have been overdue for less than 90 days in one quarter tends to be reflected in an equivalent change in the higher categories the following quarter. The banks themselves are also becoming more optimistic. In first half earnings press conferences last year, senior managers were talking about further cuts and “belt tightening.” This is now starting to change, and Yi Huiman, chairman of ICBC, told reporters in Beijing on Wednesday that the bank’s management team was confident that asset quality would keep improving.