Rocky road ahead for profits of China's smaller banks

Their reliance on government bonds and lack of structural change are worrisome in the long-term, according to Natixis.

Even as China’s small banks recorded results more lucrative than their large counterparts, Natixis said in a report that their relatively better performance was due to a reduction in funding costs instead of structural changes in their business models.

Smaller banks reported a net profit growth of 12.5% YoY YTD in Q3 2019 from only 6.4% YoY in 2018, compared to the larger banks’ net profits increase of 5.5% YoY in 2019 from 4.9% YoY in the previous year. Small banks also boasted a slightly improved net interest margin (NIM) to rebound from the poor performance last year.

But Natixis expressed concern on the fact that smaller banks had to rely on government intervention to survive. After a poor performance in 2018 coupled with decelerating loan growth have pushed smaller banks to allocate more local government bonds. This led to a 20% growth in local government bonds held by total commercial banks since end-2018.

“The rapid increase in investment to boost profitability is worrisome as it is opposite to policy targets, namely loans to small firms,” commented Natixis.

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Further, the structural problems in small banks remain unsolved. The first and foremost is their lack of comparative advantage in the intermediation of savings, pushing them to investment and the still high funding costs, the report stated.

The news on policy-driven consolidation in China’s banking sector to reduce systematic risk also does not augur well for smaller banks’ future.