Morgan Stanley: Pricing of loans in the Chinese banking industry tends to be rational, no need to overly worry about net interest margin pressure

Morgan Stanley believes that the Chinese banking industry is gradually shifting from its past reliance on loan growth to a more rational competition and loan pricing strategy. This shift is expected to help stabilize the banks' Net Interest Margin (NIM) and may reduce long-term risks. Morgan Stanley predicts that the performance of the banking industry will outperform the broader market in the next 12 months.

On September 8th, analysts including Richard Xu from Morgan Stanley released a report stating that most banks have indicated a weakening expectation for various types of loan growth, including total loan growth and loans to small and medium-sized enterprises. In this context, banks will focus more on the quality rather than the quantity of loans, which may foster a more rational competitive environment.

The key focus areas for corporate loans are still industries supported by policies and industries with growth demand. Banks have stated that they will prioritize supporting strategic emerging industries, medium to long-term manufacturing, technology, inclusive finance, and green finance.

Some banks have outlined specific strategies: Industrial and Commercial Bank of China plans to deploy more loan resources in advance in case of declining loan yields; China CITIC Bank plans to focus more on industries at risk of overcapacity; Shanghai Pudong Development Bank has shifted more credit resources to enterprises, especially in infrastructure, utilities, manufacturing, and wholesale, and will continue to focus on these areas...

Pressure on Net Interest Margin in the second half of the year may decrease

Morgan Stanley points out that while the decrease in Loan Prime Rate (LPR) in the loan market may reduce the interest income banks earn from loans, at the same time, the interest costs banks pay to depositors are also decreasing, which helps alleviate the negative impact on NIM.

Furthermore, although repricing of existing mortgage loans may increase pressure on NIM, most banks have stated that they have not received consultation requests from policymakers regarding adjustments in this regard. This means that there are currently no policy requirements forcing banks to lower mortgage loan rates.

Banks also state that if necessary, they are confident in further reducing deposit costs, which may be achieved by offering lower deposit rates or attracting more low-cost funds to maintain or improve NIM.

Morgan Stanley writes:

On the liability side, many banks acknowledge that controlling funding costs is a key factor for the relative stability of NIM in the second quarter of 2024. The impact of the deposit rate reduction is gradually showing, and banks are actively attracting low-cost deposits, which we expect to continue supporting NIM.

In particular, China Construction Bank stated that the July deposit rate cut may offset the 10 basis points cut in the one-year and five-year LPR in July, with limited impact on 2024. On the other hand, most banks, including China Construction Bank, Postal Savings Bank of China, China Merchants Bank, China CITIC Bank, and Shanghai Pudong Development Bank, have indicated a continued shift to more time deposits in the second quarter of 2024.

On the asset side, many banks state that as competition becomes more rational, loan yields are stabilizing. In addition, banks have been actively adjusting their asset portfolios, including asset categories and maturities, to offset the impact of declining loan yields

China Merchants Bank stated that they have not received any instructions from regulatory authorities yet, but if such policies are implemented, it is expected to have a negative impact on banks.

Pressure on Non-Interest Income is Expected to Ease

Morgan Stanley also believes that in the second half of this year, the pressure on the decline of non-interest income has eased. For example, banks like Construction Bank have optimized their non-interest income structure through new businesses. China Merchants Bank has implemented fee discounts to enhance customer service, while Industrial and Commercial Bank of China has promoted non-interest income growth through investment banking and asset management businesses.

Some banks have seen strong growth in retail Assets Under Management (AUM), especially in Ningbo Bank and Beijing Bank, while city banks have witnessed rapid growth in retail deposits. Although the deposit growth of state-owned enterprise banks has slowed down, overall, banks are responding to the challenges of rate cuts through diversified strategies.

In terms of asset quality, although the credit quality of small and medium-sized enterprise loans and retail loans of some banks has declined, analysts are optimistic about the stability of banks' medium and long-term credit costs. Banks are also taking measures to control long-term risks by raising loan pricing and optimizing loan structures.

Construction Bank, Agricultural Bank of China, and Bank of China have expressed confidence in their ability to maintain stable asset quality, while China CITIC Bank has confidence in the improvement of asset quality.

Morgan Stanley also pointed out that banks are looking for other assets to generate returns or liquidity, including increasing bond investments and allocating more assets to non-bank financial institutions, all of which are beneficial for the steady recovery of the banking industry