Top Chinese banks' first-half results on Friday will underline the impact of slowing loan growth in a deflationary economy, a piling up of bad loans as defaults by small businesses and consumers rise, and narrowing margins due to lower rates.
As the outlook for the world's No.2 economy is clouded by heightened geopolitical tensions, frail consumption and a protracted crisis in the property sector, the strain on the bank balance sheets will deepen in the near-term, analysts said.
Investors will be focussing on the banks' management comment on loan growth and asset quality outlook, and how they plan to balance the need for maintaining a risk-averse stance with Beijing's policy priorities to revive the economy.
Net profit of Industrial and Commercial Bank of China (ICBC) (601398.SS) is estimated to fall 0.8% year-on-year in the first half, while Bank of China (601988.SS) is expected to post a drop of 0.9%, an average of three analysts' forecasts showed.
China Construction Bank (601939.SS), Agricultural Bank of China (601288.SS), and Bank of Communications (601328.SS) are estimated to report first-half net profits rose 0.4%, 1.2%, and 0.5% on year, respectively.
All the top five state-owned banks will report their results after market hours on Friday, which would be followed by calls with analysts.
Chinese banks' net interest margin (NIM) - a key gauge of profitability - shrunk to a record low of 1.42% as of end-June, official data showed, below a 1.8% threshold regarded in the industry as necessary to maintain reasonable profitability.
The profit margins in the Chinese banking sector have been under pressure since the post-COVID period, weighed down by successive interest rate cuts by the central bank to kickstart the slowing economy.
Despite several rounds of deposit rate reductions to ease cost strains, banks continue to struggle with shrinking profit margins as savings pile up.
"We expect NIM compression to continue for Chinese banks, including state banks, and to weigh on their profitability and internal capital retention for the rest of the year," said Elaine Xu, a director Fitch Ratings.
Impaired-loan ratios at Chinese banks are expected to rise moderately this year, given the challenges to the domestic economic recovery amid weakness in the crucial property market and uncertainties over trade tensions, said Xu.
The CSI Banks Index (.CSI399986) gained 15.5% in the first six months, roughly in line with the broader CSI 300's (.CSI300) 15.4% rise. However, bank shares have fallen out of favour after climbing to a record high in July, dropping 1.1% this month while the benchmark CSI 300 advanced 8.7%.
Besides the lower interest rate environment, the local banks face mounting pressure to offer cheaper loans to help stimulate the economy, and tepid private sector borrowing compresses their profit margins.
In a move to bolster the banking sector's stability and ensure flow of credit to the economically-crucial sectors, four of China's largest state lenders in March unveiled around a $72 billion recapitalisation plan.
Chinese banks will "probably not be able to earn quite enough to sustain themselves", and periodic government recapitalisation means they will not fall either, according to Gavekal Dragonomics China finance analyst Xiaoxi Zhang.
"With corporate profits declining again in 2025, more bad loans are certainly being created, and the recent recapitalisation only goes so far," she wrote in a research report this month.
"The future of China's banks seems likely to be a cycle of policy-directed lending followed by recapitalisation. The banks will limp along - never quite able to sustain themselves, but never collapsing either."
