China’s government is reaching beyond its monetary policy tool box to free up capital and direct funds towards the nation’s cash-starved businesses to help the economy claw its way out of its worst slump in four decades.

The government has called on banks to sacrifice as much as 1.5 trillion yuan (US$212 billion) in profits this year to finance cheap loans, cut fees, defer loan repayments and grant more unsecured loans to help small businesses survive the downturn caused by the coronavirus lockdown.

Separately, the State Council, China’s cabinet, signalled late on Wednesday that it would cut the amount of reserves banks are required to hold at the central bank, freeing up more money to spur lending.

“We are guiding the market to lower lending rates through interest-rate reform,” Yi Gang, the governor of the People’s Bank of China (PBOC), told the Lujiazui Forum on Thursday, confirming the move was a de facto cut in interest rates. “Financial institutions are urged to sacrifice profits to benefit corporate borrowers, helping reduce their borrowing costs.”

Yi added that the PBOC would achieve the goal by directing financial institutions to offer lower lending rates, adding fresh funds at low rates that can be accessed by borrowers directly, and slashing service fees.

The profits to be sacrificed would be equivalent to roughly 75 per cent of the entire net profit of the commercial banking industry in 2019, based on the data from China Banking and Insurance Regulatory Commission (CBIRC).

China’s US$41 trillion banking system earned profits of about 2 trillion yuan (US282.1 billion) in aggregate in 2019.

The plan to sacrifice profits to bolster companies would exacerbate bearish sentiment in the banking sector, which has already been walloped by the Covid-19 outbreak.

Shares of Chinese banks fell broadly in Hong Kong and mainland markets on Thursday.

A gauge tracking 36 banks listed in Shanghai and Shenzhen declined 0.4 per cent, according to Wind data. Industrial and Commercial Bank of China (ICBC), China’s largest lender, led the losses with a 1.3 per cent drop in Shanghai to 5.19 yuan.

“The surrender of profits is essentially an interest-rate cut, aimed at reducing the borrowing cost of all enterprises, indicating that the policy easing is still continuing,” Yan Xiang, an analyst with Guosen Securities, wrote in a note on Thursday.

Li Chao, chief analyst with Zheshang Securities, said the surrendering of profits could cut the weighted average interest rate of loans by 0.68 percentage point throughout this year.

Lu Ting, chief China economist at Nomura, said the PBOC would likely cut the medium-term lending facility rate to guide down the loan prime rate (LPR) soon, but the probability of cutting benchmark deposit rates appeared to be fading.

The PBOC has cut its benchmark lending rate two times this year following the first quarter economic contraction caused by the pandemic. The last adjustment was on April 20, lowering the one-year LPR to 3.85 per cent from 4.05 per cent.

The move, however, was dwarfed by the aggressive interest rate cut from the US Federal Reserves to near zero in March. The American central bank indicated last week it is likely to keep the rate low through 2022.

The central government’s call for banks to sacrifice the lion’s share of their profits may have come as a surprise to the Chinese financial sector but was not without advance warning.

In his annual work report to the National People’s Congress in late May, Chinese Premier Li Keqiang encouraged banks to surrender a reasonable amount of their profits to help firms hit by the pandemic, although he did not elaborate at that time.

The latest move to support economic growth comes amid a gradual improvement in the economy, though pockets of weakness remain.

The measure to provide additional credit at lower cost is largely aimed at helping small private businesses, particularly in the services sector, that are struggling to recover from lockdowns to contain the virus earlier this year.

Tens of thousands of small businesses in Beijing are now facing the threat of a second wave of infections after a cluster of new infections was discovered. Authorities in the capital have locked down large parts of the city.

China’s economy shrank 6.8 per cent last quarter, its first quarterly contraction since such records began in 1992 and the worst economic performance since the Mao Zedong era, due to widespread factory shutdowns in January.

Financial institutions are among the most profitable businesses on the mainland.

Banks, enjoying high net interest margins due to the guided interest rates by the central bank, have made handsome profits over the past three decades. On the A-share market, they have normally made up more than half of the total profits by all the listed firms.

In its statement on Wednesday, the State Council, which premier Li chairs, said the country will continue to take advantage of reserve requirement ratio (RRR) cuts to maintain ample market liquidity and so “intensify the efforts to solve financing difficulties and ease fund pressure on companies”.

The Chinese central bank has cut the RRR three times this year, pumping a total of 1.75 trillion yuan into the banking system.

“A RRR cut is likely to come soon, perhaps even this weekend,” predicted Nomura’s Lu in a note on Thursday.

Li of Zheshang Securities agreed that a RRR cut could happen within two weeks based on previous experience.

Analysts at Citic Securities expected the next cut to be 0.5 percentage points.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP’s Facebook and Twitter pages. Copyright © 2020 South China Morning Post Publishers Ltd. All rights reserved.

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