As the State Council calls for cutting banks’ funding costs via lower reserve requirements this evening, results from banks’ 2020 financial reports reveal that banks have actually added to longer-term, higher-cost deposits, while also increasing lending to state-owned firms, rather than the private sector. Both trends contradict Beijing’s objectives to channel lower-cost financing to the more productive sectors of the economy. As a result, the recent cut in banks’ effective long-term deposit rates will meaningfully reduce funding costs.
Banks’ asset quality improved last year, primarily because forbearance following the COVID-19 outbreak prevented recognition of bad loans. Non-performing assets will rebound as forbearance expires, eroding profitability and hurting banks’ capital adequacy levels. Recent policy changes also increase banks’ difficulties in selling bonds to supplement capital. Risks from smaller, increasingly fragile financial institutions pose the most significant threats to overall financial stability.
