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China's banks face earnings squeeze due to rate reform, trade war uncertainty

By Cheng Leng and Engen Tham
The logo of Industrial and Commercial Bank of China (ICBC) is pictured at the entrance to its branch in Beijing

By Cheng Leng and Engen Tham

BEIJING/SHANGHAI (Reuters) - China's banks face pressure on earnings and asset quality in the coming months as interest rate reforms squeeze margins and a Chinese-U.S. trade war adds to economic uncertainty.

Three of the nation's top listed banks this week each reported a profit rise of nearly 5% in the first half of the year, but warned they faced headwind.

"The trade war causes uncertainty, and there is downward pressure on the economy," Gu Shu, president of the world's largest commercial lender, Industrial and Commercial Bank of China (ICBC), told a news conference on Thursday.

ICBC, the third of China's top five state-owned listed banks to post half-year results, reported a 4.7% rise in profit.

"We expect margin pressure in the second half of the year," said Ray Heung, senior vice president of the Financial Institutions Group at Moody's Investors Service.

He said a government drive to encourage banks to lower lending rates, including through its reform earlier this month of the loan prime rate (LPR), was one factor putting pressure on earnings.

Banks must now set interest rates on new loans with reference to the LPR, which is now set under a revamped mechanism designed to help lower borrowing costs for companies.

ICBC's president said LPR reform would only have a limited impact on his bank's net interest income, adding that about 48% of ICBC's new loans in the first half referenced that rate.

But the bank's results still showed it faced a squeeze, posting a fall in net interest margin, a key gauge of profitability, from 2.31% at the end of March to 2.29% at end of June.

Bank of Communications (BoCom), which reported a 4.9% rise in first-half net profit earlier this week, said asset quality would be key.

Hou Weidong, vice-president of BoCom, told an earnings briefing that "China's commercial banks are facing a great amount of pressure on asset quality".

China Construction Bank (CCB), another of the top five, also reported a net profit rise of 4.9% for the first six months.

Both banks reported a drop in net interest margin.

"Banks are expected to focus on lending to build up their assets in the second half of the year, but the growth of lending will be constrained or remain stable due to risk appetite," said Liu Zhiping, banking analyst at Ping An Securities, who predicted that net interest margins would shrink further.

"The overall performance of the sector will continue to fall, and the valuation on Chinese banks will be under pressure," he added.

By the end of June, the non-performing loan (NPL) ratio for China's banking sector reached 1.81%, the highest since 2009, data from the China Insurance and Banking Regulatory Commission showed.

But ICBC's non-performing loan ratio was 1.48% at end of June compared with 1.51% at the end of March. BoCom and CCB also reported steady or falling NPL ratios.

"The main challenge is how to maintain asset quality as the macro economy slows," CICC analyst Victor Wang said of the outlook for China's banking sector.

The biggest banks have already been enlisted to rescue their smaller brethren, who have faced a liquidity crunch as well as the effects of slower economic growth.

ICBC said in July it planned to spend up to 30 billion yuan on a 10.82% stake in troubled Bank of Jinzhou, which struggled to report 2018 results after its auditor refused to sign off on them and resigned. In May, CCB took charge of Inner Mongolia-based Baoshang Bank.

(Reporting by Cheng Leng in Beijing and Engen Tham in Shanghai; Editing by Jennifer Hughes and Christopher Cushing)