Chinese commercial banks come under pressure due to rate cuts
Further interest rate cuts could hinder consumption and spur speculative investment.
The profitability of China’s commercial banks has come under pressure since 2024, as a result of Beijing’s push to reduce borrowing costs and the resulting squeeze on net interest margins.
The problem could become more acute, should the Chinese central bank resort to further cuts to interest rates to help the economy tide over Trump’s mercurial game of tariff hikes.
This would prompt commercial banks to reduce deposit rates, which could in turn revive or worsen long-standing challenges in the Chinese economy - chief amongst them the weak levels of consumption and heightened proclivity for speculative investment created by low returns on savings.
Narrowing net interest margins undermine bank profitability
As of 23 April, 36 of China’s listed commercial banks had released their 2024 annual results, with the data pointing to tepid growth in profit levels last year.
The combined operating revenues of the 36 listed lenders was 5.58 trillion yuan, for a year-on-year (YoY) increase of just 0.05%. Net profits attributable to shareholders were 2.12 trillion yuan, for a YoY rise of 2.38%.
Xue Hongyan (薛洪言), deputy-head of the Xingtu Financial Research Institute, (星图金融研究院), says this weak profitability is the direct result of the continued narrowing of bank net interest margins.
The net interest margin is the difference between the income generated by banks from interest on the loans they extend, and the interest they pay out to the depositors that provide them with funds.
“This data indicates that the sector is in the predicament of an ongoing squeeze on net interest margins,” Xue wrote in a recent opinion piece (薛洪透:视36家银行年报，拐点何时来临?).
“Net interest margins are the core variable for the banking sector, and in 2024, they continued to be the biggest drag [on performance.]”
According to Xue, compared to 2023 the full year net interest margin for the Chinese banking sector fell 17 basis points to 1.52%, directly holding back growth in net profits by roughly 11 percentage points.
Beijing’s push for low cost finance squeezes banks
This pressure on profitability is especially pronounced on the asset side of bank balance sheets, following the push from China’s policymakers for reductions in loan rates.
While Beijing’s hope is that cutting the cost of borrowing for businesses and households can boost activity in China’s real economy, this also has the effect of eroding the revenues and thus profits of commercial lenders.
“Multiple reductions to the loan prime rate, adjustments to outstanding mortgage rates and inadequate effective demand for loans has led to continued declines in the pricing of commercial bank loans,” Xue wrote.
“The weighted average interest rate for a standard loan in Q4 2024 was just 3.82%, for a 55 basis point reduction compared to the same period a year previously.”
Chinese savers take the hit for low bank profits
Li Gengnan (李庚南), a banking regulator who previously held positions at the Chinese central bank and the Industrial and Commercial Bank of China, notes that the squeeze on revenues from loans has forced commercial lenders to continually cut their deposit rates.
Their goal is to increase profits by reducing their own borrowing costs, which helps to pry their net interest margins wider.
In a recent opinion piece (李庚南：商业银行如何理性应对净息差收窄的压力?), Li wrote of multiple “waves of interest rate cuts” that have undermined the deposits of Chinese savers.
Li further notes that ongoing reductions to deposit rates across the entire Chinese banking sector became even more pronounced in April, following US President Donald Trump’s launch of an indiscriminate tariff war against its global trade partners.
“Since the beginning of April, another wave of deposit rate cuts has arrived,” Li wrote.
“From village county banks and rural commercial banks to municipal commercial banks, joint-stock banks and the big state-owned banks - all of them have made downward adjustments to bank deposit rates.
“Household deposit rates have rapidly taken the path from the 3% plus era to the 1% plus era.”
Li notes that the rates for deposit products at many Chinese banks have fallen beneath 2%, while three-year and five-year deposit products with rates above 2% have since become “extremely rare.”
Low deposit rates could worsen long-standing economic challenges
Weak returns on bank deposits have long been viewed as the culprit for key problems in the Chinese economy, including lacklustre consumption and the bubble in the housing market.
One of Beijing’s signature policy themes during the reform era has been the use of financial repression, in the form of heavy regulation of the interest rates offered by the state-dominated banking sector.
While this has helped to drive down borrowing costs for Chinese enterprises, it’s come at the expense of ordinary households, who are left with comparatively meagre returns on their savings as a result.
This is considered a major contributor to the overheating of housing prices and heightened investment risk, as it’s prompted Chinese households to search for more lucrative alternatives to the poor returns on deposits.
In 2023, Wall Street Journal columnist Joseph Sternberg opined that, “the financial repression that suppressed interest income from household savings to subsidize lending to politically well-connected companies helped stoke outsize demand for real estate as an alternative investment.”
Chinese economist Mo Kaiwei (莫开伟) highlights the tendency of low deposit rates to drive risk-fraught speculative investment by members of the general public.
“If there is a large-scale decline in deposit rates, this could spur more members of the public to withdraw their deposits and engage in other financial investment and wealth management activities,” Mo wrote in December 2023, just as China’s big state-owned banks launched reductions to rates on their deposits.
“Because the public in general lacks professional investment ability, investment risk will inevitably see an increase.”
Cutting rates could undermine China’s domestic demand drive
One of the chief themes for China’s macroeconomic policymakers in 2025 is boosting domestic demand - and consumption in particular, to compensate for any shortfall in exports caused by a Trump-led trade war.
The “Consumption Action Plan” unveiled by Beijing in March highlighted the use of more equitable wealth distribution as one way to achieve this.
It outlined plans to increase earnings derived from both salaries and assets, as a key means of raising levels of disposable income and nurturing consumption.
Cutting interest rates is traditionally considered an effective means of driving consumer demand, by achieving a wealth effect via higher asset values as well as reducing borrowing costs.
In China’s case at present, however, rate cuts could have a highly ambivalent impact on consumer demand.
This is because of the narrow net interest margins of banks and the pressure this puts on them to reduce deposit rates.
On the one hand, low deposit rates have long been viewed as a key source of income inequality that holds back spending by Chinese households.
Mo Kaiwei points out that further reducing deposit rates will have negative wealth effects that could undermine consumption.
“A decline in deposit rates leads to a direct contraction in the wealth stowed by households with banks as deposits,” he wrote.
“As deposit rates further decline, the modest contraction in wealth will further magnify.”
Mo further notes that this negative impact on the wealth of Chinese households could worsen if they incur losses on any risky investments undertaken in response to low deposit returns.
On the other hand, however, Mo points to the possibility that low deposit rates could make Chinese households more inclined to spend instead of save, while at the same time reducing their debt burdens.
“In theoretical terms, households could use the money in their hands for consumption as a result of low deposit rates, which would play the role of effectively driving domestic demand,” Mo wrote.
“Households are also beneficiaries of declines in deposit rates, [if] rates for home loans, consumer loans and business loans all decline.
“This will bring the advantages of lightening the burden of loans on households and alleviating their economic pressures.”
Mo shares the general consensus opinion within China that efforts to boost consumption will depend more than anything else on improvements to China’s social welfare system, as well as a more equitable path of economic development.
“Without achieving major and effective improvements in the socio-economic environment, without positive changes in employment and income conditions, and without fundamental changes to housing, healthcare and aged care, then households are likely to remain highly cautious and restrained when it comes to consumption,” he wrote.