The reduction in the loan rate is expected to negatively impact the interest margins and profits of Chinese banks. China Construction Bank, ICBC, and CITIC Bank are among those predicted to face the most significant challenges.

Following China's decision to reduce its five-year loan prime rate (LPR) by 25 basis points, the banking sector is anticipated to see a shrinkage in interest margins, with increased demand unlikely to compensate for the loss.

On February 20, China executed its most substantial reduction in the five-year LPR to date, setting it at 3.95%, while the one-year LPR remained at 3.45%.

Banks with a higher proportion of mortgage and long-term corporate loans, such as China Construction Bank (CCB) and Industrial and Commercial Bank of China (ICBC), are expected to be particularly affected, according to UOB Kay Hian analyst Kenny Lim Yong Hui.

Lim's analysis suggests that banks' net interest margins could contract by 3.9 basis points, translating to a 4.3% decrease in total net profit for 2024, assuming that 50% of loans linked to the five-year LPR are repriced and all other factors remain constant.

In a scenario where 50% of the five-year LPR loans are repriced, CCB and ICBC could see their net interest margins decrease by 4.5% and 4.7%, respectively, in 2024. This would also result in a net profit reduction of 3.3% for CCB and 3.9% for ICBC.

CITIC Bank might experience a 5.8% decrease in both net interest margin and net profits, while Bank of China (BOC) could see a 4.5% reduction in interest margin and a 3.8% drop in profits, if they reprice 50% of their five-year LPR loans.

China Merchants Bank (CMB), with its lower exposure to corporate loans, is expected to face a less severe impact. A repricing of 50% of five-year LPR loans could lead to a 2.9% decline in net interest margins and a 1.5% decrease in net profits for CMB, significantly lower than other banks.

Additionally, the banking sector's margins may continue to suffer into 2025, as per Lim's warning. He suggests that without regulatory measures to reduce banks' funding costs, the recent LPR cut could lead to a delayed and less significant recovery in net interest margins.

Lim recommends a cut in deposit rates as a more immediate solution to reduce banks' interest expenses compared to cutting time deposit rates, due to the longer repricing period of the latter. Despite lower interest rates, consumer caution towards purchasing houses is expected to persist, influenced by economic uncertainties and diminished confidence in the property market.