Chinese banks embrace cheaper short-term loan rates despite margin risks

Chinese commercial banks have begun pricing corporate loans against a short-term interbank repo rate rather than the benchmark loan prime rate (LPR), a shift drawing sharp scrutiny from investors worried about the sector’s already thin profitability.The industry’s average net interest margin – the spread between what banks earn on loans and pay out on deposits – slid to a record low of nearly 1.4 per cent in the first quarter, according to official data. That was well below the 1.8 per cent threshold long regarded by regulators as necessary for healthy, self-funded capital growth.Market observers noted that broader adoption of market-linked pricing could put further pressure on margins in the near term, even as it promises to improve interest-rate risk management over time.Under the new approach, loans are pegged to the depository institutional repo rate (DR), specifically overnight and seven-day interbank rates. These short-term borrowing benchmarks reflect the actual cost of funds that commercial banks charge one another in the open market.Dong Ximiao, chief economist at Merchants Union Consumer Finance and executive director of the Shanghai Institution for Finance and Development, cautioned that the transition could be painful in the near term. “If a large volume of loans shifts to DR-based pricing, loan yields could decline further under a market-driven mechanism, placing additional pressure on banks’ net interest margins,” he said.Short-term repo rates currently sit well below the one-year LPR of 3 per cent, Dong noted in comments published by domestic media in early August. As of Wednesday, overnight and seven-day rates both traded at about 1.38 per cent, per official data.Over time, however, he argued that a multi-benchmark system would allow lenders to price risk more accurately, helping margins recover from years of aggressive price competition.