Chinese Banks at the Heart of the Recovery Plan

Chinese state banks are following the path set by the Chinese party, devoting a significant portion of their energy and margin to boost domestic consumption. This week, China is expected to announce that major public banks will reduce rates on most of the existing $5.3 trillion in mortgage loans. The reductions are expected to apply only to loans for primary residences. In July 2021, over 90% of the ongoing mortgage loans in China were for a first purchase. At the same time, lenders such as the Industrial and Commercial Bank of China and China Construction Bank are expected to lower deposit rates for the third time in a year to shore up their plummeting margins.

The eagerly anticipated mortgage credit reductions come as Beijing struggles to reignite economic growth, borrowing demand collapses, deflationary pressure sets in, and confidence crumbles. Investors are also concerned about contagion risks from real estate issues. The accumulation of these risks has prompted policymakers to take strong measures.

The government has been cautious about implementing broad stimulus measures, relying more on targeted measures to boost household spending. While China has reduced reference rates and pushed the average mortgage cost to a record low, most Chinese households haven't benefited, as banks don't reassess existing loans until the beginning of the following year.

These measures raise questions about the state of banks that are under pressure. The latest policy moves have raised concerns about the burden on banks to provide a "national service" and are expected to weigh heavily on their margins. Major state banks might reduce rates on local currency deposits by 5 to 20 basis points across all key terms to offset the cost. However, is this enough if growth does not rebound and defaults increase? It is a fair question to ask with no clear answer.

The Chinese financial sector is already grappling with a rise in defaults from shadow banks, sparking fresh concerns about hidden challenges and potential fallout on public lenders. Analysts have also noted the growing risks associated with heavily indebted local government financing vehicles. Until now, Beijing has acted cautiously to stimulate the economy while preserving financial stability. According to a report by the People's Bank of China, in June, 100 of the 343 Chinese cities lowered the floor rate for new home mortgages or removed the required minimum. This brought the country's average mortgage rate to 4.11%, down 0.51 percentage points from the previous year.

In the worst-case scenario, assuming that the entire mortgage loan portfolio is refinanced with a rate cut of 60 basis points, Chinese bank profits for the next year would be reduced by 8%, with a net interest margin narrowing by 7 basis points, according to JPMorgan. The American bank expects about 50% of mortgage holders are likely to refinance and that the main impact on bank earnings will be felt in the short term. But of course, this assumes an economic environment that stops deteriorating.

The last time China allowed a similar measure was at the beginning of 2009 when some public banks granted interest rate reductions to qualified borrowers in certain regions in response to the global financial crisis.