Chinese commercial banks experienced a quarter-over-quarter rise in their net interest margins in the second quarter—marking the first increase in four years. This improvement is attributed to declining funding costs, which alleviated the persistent squeeze on profit margins despite ongoing weak demand for credit and lingering concerns over asset quality.
The net interest margin edged up by 0.01 percentage points from the previous quarter, reaching 1.41%. Meanwhile, total assets grew by 7.5% compared to the same period last year, a slowdown from the 8.9% growth observed in the first quarter, according to data from the national financial regulators.
The convergence of a slowdown in lending rate declines and falling funding costs primarily drove the rebound in net interest margins—the difference between the interest income banks earn and their funding expenses. This suggests that the longstanding pressure on profitability may be easing as lower deposit costs help offset the challenges posed by low loan yields.
Experts anticipate that net interest margins will generally stay stable throughout the remainder of the year. However, they also warn that asset yields could dip further in the second half due to sluggish credit demand and lower returns from reinvesting existing assets.
Much of the recent improvement is linked to reduced funding costs, driven by the re-pricing of maturing high-interest deposits. As existing higher-interest deposits mature and banks manage their broader interbank liabilities more cost-effectively, funding rates have declined and are expected to have a continued, albeit slowing, impact.
On the lending side, regulators have shown strong willingness to stabilize net interest margins by setting lower limits on interest rates, helping prevent excessive competition that could destabilize loan pricing. The interest rates on new loans have remained relatively low; for example, in June, the one-year loan prime rate was steady at 3%, and the over-five-year rate stayed at 3.5%. The average interest rate on new loans was 3.1%, down slightly from the previous year.
This stabilization largely results from lower funding costs associated with re-priced time deposits, which has allowed banks’ liabilities costs to more closely track the decline in yields on interest-earning assets. Analysts expect this trend to continue throughout the year.
However, downward pressure on asset yields persists due to insufficient credit demand, the occasional use of low-interest bill financing to compensate for weak lending activity, and declining yields on existing bond investments. Therefore, overall, margins are projected to remain stable or decrease slightly in the near term.
Asset growth has slowed not only because of limited short-term credit demand but also as part of a broader trend. Since the start of the year, sluggish credit activity has contributed to the modest industry-wide asset growth, which experts believe will likely stay at or below current levels over the longer term.
Despite these challenges, asset quality remains relatively stable, though there has been a slight uptick in bad loans. By the end of the second quarter, total performing loans reached approximately 241.5 trillion yuan (roughly USD 35.82 trillion), with non-performing loans at around 3.7 trillion yuan (USD 548.9 billion). The non-performing loan ratio increased marginally to 1.52%.
While asset quality indicators have shown minor deterioration, these changes are not deemed significant over the long term. A more useful measure, the NPL formation rate—which tracks how quickly performing loans turn non-performing—remains around 0.7%, indicating relative stability over recent years. Nonetheless, banks currently face a situation where their provision coverage for bad loans is insufficient, with losses not fully absorbed by existing reserves, pointing to potential future earnings pressure.
Given the stabilized margins and signs of revenue recovery, banks are likely to focus on increasing provisions to buffer against future risks rather than distributing higher profits. This approach may help explain why overall net profits edged lower despite margins stabilizing. Data shows that, in the first half of the year, the banking sector’s net profit was nearly 1.24 trillion yuan (approximately USD 184 billion), reflecting a slight decrease of about 0.57% from the previous year.