China's order may endanger banks' long-term profit outlook

The State Council’s unclear directive could have bigger implications.

China’s call on banks to anchor the country’s economic growth shows that policy factors can impede on profitability in the long term, according to a Fitch Ratings report.

The State Council order will push banks to forgo revenues through lower lending rates, waiving interest payments, and slashing fees. However, the State Council has yet to clarify the exact meaning of its statements, so if authorities were implying that the banking sector’s profit should fall by $211b (CNY1.5t) it could have bigger consequences, the report said.

It has already been forecasted that profitability would come under pressure this year due to the pandemic, with NIM compression and elevated impairment charges as the main culprits. Various measures to support micro and small enterprises (MSEs) lending could slow down profits in the medium term and raise asset-quality issues given the distorted risk-return profile.

Provisioning pressure could also rise for the rest of the year and into 2021, as official loan forbearance policies will spread NPL recognition over several quarters and the effect of a feeble global demand would eventually reflect on credit books, Fitch explained.

On the other hand, other regulatory moves, such as reserve requirement ratio (RRR) cuts, relending by the People’s Bank of China (PBOC), official subsidies or tax cuts, and possible slashing of deposit rates, can counteract the negative effects on profitability.

Regulators will watch out for efforts to raise income by rising lending volumes, even if they may show some patience in regulatory capital requirements. However, they are unlikely to allow a surge in aggregate lending, considering high system leverage levels and their focus on restraining sector risk.

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