Chinese banks embrace cheaper short-term loan rates despite margin risks

Chinese commercial banks are increasingly pricing corporate loans against a short-term interbank repo rate instead of the benchmark loan prime rate, sparking concerns about the sector's thin profitability. The industry's average net interest margin fell to a record low of nearly 1.4% in the first quarter, below the 1.8% threshold regulators deem necessary for healthy capital growth.

This shift could put additional pressure on banks' margins in the near term, as market-linked pricing may lead to lower yields. However, proponents argue that a multi-benchmark system would enable lenders to price risk more accurately, aiding margin recovery. Regulators warn that margin compression could undermine state lenders' ability to generate capital and absorb asset-quality risks.

Standard Chartered's chief economist for Greater China and North Asia, Ding Shuang, suggests the People's Bank of China's liquidity management will determine the impact on bank profitability. If the central bank injects more liquidity and lowers the repo rate, loan rates tied to it will fall. Conversely, tighter liquidity could widen margins.

Adoption of the new pricing approach is concentrated among China's "big four" state-owned lenders, with some joint-stock and commercial institutions following suit. Larger banks are better positioned to transition, while smaller institutions may face significant margin pressure.