Profits at China’s four-biggest banks were further squeezed in the third quarter, as shrinking interest margins and rising bad loans took their toll on the once high-flying sector

Profits at China’s four-biggest banks were further squeezed in the third quarter, as shrinking interest margins and rising bad loans took their toll on the once high-flying sector

The lacklustre reporting season is a sharp reversal for the banks, led by Industrial and Commercial Bank of China, which in 2012 ballooned to eclipse global peers in terms of assets. That prompted then-premier Wen Jiabao to comment that the banks “make profits far too easily”

Third-quarter earnings data released last week are the latest sign that the era of easy profits is ending as China’s economy slows and interest rates are deregulated. Net profit at Bank of China, the country's fourth-largest lender, fell in the third quarter for the first time on record, while profit was flat at China Construction Bank, the second largest

Net interest margins, the spread between the rates at which banks borrow and lend money, are shrinking as China completes interest rate deregulation. Alongside an interest-rate cut last month, the central bank said that it was eliminating the cap on deposit rates. The move followed a gradual loosening of the cap over the past two years

The combination of a cap on deposit rates and a floor on lending rates for years ensured fat margins for Chinese banks. Combined profits at the big four banks rose from Rmb250bn ($39.6bn) in 2007 to Rmb738bn ($116.8bn) five years later. The loan-rate floor was eliminated in 2013. Analysts are undecided on the extent to which banks will now begin to raise deposit rates as they compete for customer funds

“Interest-rate liberalisation is ushering in a new era of hand-to-hand combat for the banking sector,” Yang Rong, analyst at China Securities, wrote last week. “

For now, Chinese banks remain among the most profitable in the world. Return on equity at CCB was 19.5 per cent in the first nine months of the year, down nearly 3 percentage points from the year before but still comfortably ahead of HSBC at 10.6 per cent

Bad loans are also rising as the economy slows and China’s manufacturing sector struggles with overcapacity and falling prices

Non-performing loans rose at all four major Chinese banks, with Agricultural Bank of China suffering the largest jump, to 2.02 per cent of total assets at the end of September from 1.83 per cent three months earlier

Analysts note that headline profits at Chinese banks are skewed by the share of profits set aside as provisions against future bad loans. Less provisioning boosts quarterly profits but makes the balance sheet less resilient if defaults rise sharply. Some banks are now provisioning less conservatively

“Considering that the NPL growth rate reached a new all-time high of 73 per cent year-on-year, we feel [AgBank’s] policy of reducing impairments to loans in each successive quarter this year is not conservative,” wrote James Antos, Asia banks analyst at Mizuho Securities. “

For the banking system as a whole, bad loans rose by Rmb398bn in the year to June to Rmb1.1tn, according to the latest government figures. The bad-loan problem is suspected to be more serious at small, unlisted banks. The official NPL ratio at rural commercial banks was 2.03 per cent at end-June

Many analysts doubt the veracity of China’s official NPL figures, suspecting that lenders conceal delinquencies by rolling over or extending overdue loans