Analysis | China’s half-measure rate cut protects banks’ profit margins and ensures financial stability, analysts say

‘Protecting bank margins is at the core of stabilising the entire financial system,’ says economist Huang Wentao
The central bank might have more tools up its sleeve to shore up the economy, including reserve requirement ratio (RRR) cuts, says China Securities

Banking & finance

Yuke Xiein Beijing

Published: 7:00pm, 22 Aug 2023

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The Chinese central bank’s underwhelming rate cuts this week may have taken the markets by surprise, but it will help to preserve the profit margins of commercial banks, the linchpin of the nation’s financial stability, according to analysts.

The five-year loan prime rate (LPR), a reference for mortgages, was left unchanged at 4.2 per cent on Monday. The one-year LPR, a benchmark for household and corporate lending, was reduced by a smaller-than-expected 10 basis-point to 3.45 per cent, according to data released on Monday by the People’s Bank of China.

The decision not to make bigger cuts surprised investors, with some worried that it could spark a slew of defaults in China’s crisis-ridden property sector, which could potentially spill over to the broader financial economy.

The move struck many as going against the country’s pressing goal of propping up its flailing economy and stabilising its property sector.

Some analysts, though, interpreted it as an attempt on the part of financial regulators to preserve the net interest margin (NIM) of commercial banks.

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“Lowering credit costs is essential for boosting economic growth, but protecting bank margins is at the core of stabilising the entire financial system,” wrote Huang Wentao, chief economist at China Securities in a report that came out on Tuesday.

The average NIM, which is a measure of banks’ growth and profitability, has already dropped to a historically low level of 1.7 per cent, according to analysts.

The central bank’s decision to refrain from aggressive loan rate cuts will allow banks to preserve their margins and accumulate profits, freeing up capital to support local governments as they struggle to sort through their own property-related debt problems.

“It is unlikely that the central government will launch a wholesale campaign [to prop up the property sector], but [the moderate LPR cuts will] enable and motivate local governments to come up with their own solutions,” the report said.

“Protecting interest margins … will also allow commercial banks to support businesses, whose growth is crucial for the vitality of the real economy.”

The effectiveness of loan cuts in stimulating demand was called into question by other analysts, who observed that households and businesses are already hesitant to take out loans in the face of macroeconomic uncertainty.

“The key challenge facing the Chinese economy right now is persisting confidence weakness underpinned by demand-side structural imbalances,” said Alfredo Montufar-Helu, head of the China Center for Economics and Business at the Conference Board, a global non-profit think tank.

“This is especially the [case] for the property sector: given how weak China’s real estate market is performing, except for tier-one cities, I don’t think households have lots of incentives to commit themselves to pay a mortgage.”

The central bank might have more tools up its sleeve to shore up the economy and restore confidence, including further reserve requirement ratio (RRR) and LPR cuts to help commercial banks access cheap capital and survive in a low interest margin environment, according to the China Securities report.

On the demand side, Chinese authorities could ease restrictions on home purchases in first- and second-tier cities and reduce down payment ratios for first-time buyers. This could help boost demand and home prices, which are crucial for confidence, analysts said.