THE biggest Chinese commercial banks are facing leaner times as rising bad loans, narrowing interest margins and a weaker economy put the brakes on what was once China’s most profitable sector.

“The ‘Great Leap Forward’ in the banking system has ended, and all players are experiencing tough times,” Shao Ping, president of Ping An Bank, told a forum in Shanghai in July. “Some lenders will post zero-growth or even negative growth this year. The challenge is unprecedented.”

Indeed, half-year financial reports from listed banks confirm Shao’s dour outlook. Profit growth at the nation’s top five lenders fell below 2 percent, and growth in earnings at joint-stock banks slowed to single digits.

Overall, first-half aggregate profit of all 16 listed banks in China rose a mere 3.5 percent from a year earlier to 708.6 billion yuan (US$114 billion). The average bad loan ratio was 1.45 percent, rising from 1.13 percent a year ago.

Industrial and Commercial Bank of China, the world’s largest bank by assets, remained the highest-grossing lender in China during the first six months of this year, with net profit of 149 billion yuan, according to the bank’s filing with the Shanghai Stock Exchange on August 28. But the performance was a mere 0.7 percent above first-half earnings last year.

Non-performing loans rose to 163.5 billion yuan, ICBC said. The increase was at more than double the pace of the same period in 2014. The bank blamed its weak performance on poor results from China’s western, Yangtze River Delta and Bohai Rim regions.

Slowing profit growth and rising bad-loan ratios were also the tale of woe for the other four major banks in China.

Agriculture Bank of China had profit growth of 0.5 percent. Bank of China reported a 1.7 percent gain; China Construction Bank, a 0.9 percent increase; and Bank of Communications, a 1.5 percent rise. The figures were a far cry from a year earlier, when all the major banks reported profit growth of more than 5 percent.

A rebound in bad loans

“A rebound in nonperforming loans seems to be the key factor behind the earnings slowdown,” said Sophie Jiang, a Nomura banking analyst. “That, in turn, affects internal capital replenishment capacity.”

With China’s economy forecast to grow this year at its weakest pace in almost a quarter of a century, the lenders told the stock exchange that they are bracing themselves for even more bad loans. They blame a slump in heavy industry production and poor returns from large local government infrastructure projects for the weaker balance sheets.

“Banks will have to bear extra costs during the economic downturn because many of their clients are trying to deal with problems like overcapacity, deleveraging and destocking.” Jiang Jianqing, chairman of ICBC, told a media briefing. “We will continue to face pressure from non-performing loans for a period of time.”

In addition to increasing bad loans, China’s slowing economy raises the specter of more interest rate cuts, which would put further pressure on the spread between lending and borrowing rates, the prime factor in bank income.

Bank of Communications, China’s fifth-biggest lender, said in its interim report that it faces margin pressures in the second half of the year from interest rate deregulation. The People’s Bank of China has cut interest rate five times since November and freed deposit rates to reflect market conditions. That means the banks are having to pay higher rates for deposits and receive lower rates for lending.

Financial analysts have predicted that further monetary easing may be needed if China is to meet its 7 percent growth target this year and calm turbulence in the stock market.

Some banks are trying to shift their focus from interest-generated income to other fee businesses, like credit cards and wealth management.

Joint-stock banks have been adopting this strategy, while smaller regional lenders played it even more aggressively amid a previous market fever.

Net non-interest income at China Merchants Bank, the country’s sixth-biggest lender, jumped 35.6 percent in the first half to 35.3 billion yuan, accounting for nearly 36 percent of income. That proportion was 3.2 points higher than last year, ranking China Merchants at the top of the eight listed joint-stock banks in Shanghai and Shenzhen.

At China Everbright Bank, an arm of state-owned China Everbright Group, non-interest income jumped nearly 57 percent to 13.6 billion yuan. Citic, China’s seventh largest bank, reported that its non-interest income jumped 22.6 percent to 20.2 billion yuan on commission charges from bankcards and financial services.

Smaller banks’ agility

Smaller regional banks seem to be faring better, thanks to their greater agility in responding to changing market trends. Net profit at Bank of Nanjing in the first half soared 24.5 percent, largely on fees from its stock-related services. Ningbo Bank’s profit jumped 18.4 percent on fees from non-traditional services.

But even smaller banks face tough times ahead. The financial sector has been roiled by volatility in equities in the last two months, which wiped out about US$5 trillion of market capitalization.

Fee-generated banking businesses in the current half-year are not looking optimistic, Fitch Ratings said. Moody’s Investors Service is forecasting Chinese banking profits will deteriorate further in the rest of this year, citing shrinking fee income from stock-related services.

To give banks more lending room, the central bank removed its 75 percent loan-to-deposit ratio on August 29. But bank managers shrugged off the importance of the move.

“The will is strong but the want is weak,” said Xu Jingjing, an account manager at Shanghai Pudong Development Bank. “We barely have suitable and low-risk cases to lend to, so why would we care about the loan-to-deposit ratio?”

The net interest margin at Chinese banks, which is a measure of lending profitability, narrowed to 2.51 percent in the second quarter from 2.62 percent a year earlier, according to the China Banking Regulatory Commission.

“Banks see no urgent need to seek deposits because liquidity is ample and there’s weak incentive to lend,” said Zhu Lixu, a Shanghai-based analyst at Xiangcai Securities Co. “They are reluctant to lend because their risk appetite is dropping as the economy continues to slow and the overcapacity problem persists.”

Fitch tends to agree that government measures so far will have limited impact on the plight of bankers this year.

“Interest rate cuts, reserve requirement ratio cuts and the removal of the loan-to-deposit ratio may help ease some pressure on the banks, but they are unlikely to reverse the subdued earnings trend in the short term,” Fitch said.

Instead, Fitch said it expects state-owned banks to shift their focus more to overseas expansion to try to fill the gap left by shrinking earnings at home.