MNI: PBOC Seen Helping Banks To Cut Existing Mortgage Rates

The People’s Bank of China will need to provide incentives such as targeted reserve requirement ratio cuts if it is to persuade banks with squeezed interest margins to heed its recent call to lower rates on existing residential mortgages, advisors and analysts told MNI.

Despite unconfirmed reports that banks have already received guidance to cut rates gradually by an unspecified amount in the fourth quarter, as Beijing looks for ways to hold up sagging consumption, lenders will drag their feet at a time when net interest margins fell to a new low of 1.74% in Q1, the sources said. (See MNI INTERVIEW: China Stimulus To Boost Economy In H2)

But officials will be keen to find ways to reduce the interest burden on households, after mortgage rates rose sharply in response to government efforts to curb excessive house price inflation, to about 5.5% in 2017-2018, and to more than 6% in some areas from the second half of 2021. Over 50% of outstanding mortgages were issued during this period, according to estimates cited by Dong Ximiao, chief researcher at Merchants Union Consumer Finance Company, and a researcher at the Institute for Financial Studies at Fudan University.

In addition to possibly cutting reserve requirements for banks which are more exposed to mortgages, the PBOC could also guide deposit rates lower, said Dong. Banks would then be able to cut rates for existing customers, with higher-rate loans reduced more, he said, suggesting a 100bp discount for loans on more than 6%, 60bp for rates above 5.5% and 30bp for mortgages at over 5%. Cuts could be implemented for an initial period of three years, and adjusted later if necessary, he said.

NO SWEEPING CUTS

A report by Fitch Ratings shows banks’ net interest margins would be compressed by one basis point for every 10% portion of their mortgage books granted an 80bp cut -- the reduction required to roughly bring them in line with the current five-year loan prime rate of 4.20% and the weighted-average rate for new mortgages of 4.14%.

The PBOC unexpectedly cut its one-year medium-term lending facility rate by 15bp to 2.5% on Tuesday, and lowered the 7-day reverse repo rate by 10bp to 1.8%, moves which raise the likelihood of a cut in the benchmark 5-year Loan Prime Rate next week. (See MNI: PBOC To Support Local Govt Debt Sales, Advisors Say)

At its work conference early August, the central bank said it would “guide commercial banks to adjust the interest rates of existing mortgages in an orderly manner in accordance with law.” This followed the comment by Monetary Policy Department Head Zou Lan in mid-July that the PBOC would “support and encourage banks to independently negotiate with borrowers to change contractual agreements, or to replace them with new loans”.

While the PBOC is keen to reduce the debt interest burden, rate cuts for outstanding mortgages are likely to be impacted by banks’ decisions and negotiation with clients, said Moody’s senior analyst Yulia Wan. But reducing rates would also help banks hold on to mortgage deals and make borrowers less likely to rush to pay off their loans early, she said. According to Moody’s calculations, the annualised rate of total prepayment as a percentage of outstanding residential mortgage-backed securities rose to 17% between April to June from the 8-14% range of the past seven years.

Reducing rates on outstanding mortgages would help banks as they seek to compete in what is now a shrinking market, said Li Yujia, chief research fellow at Guangdong Urban & Rural Planning and Design Institute. The balance of residential mortgages was CNY38.6 trillion by end-Q2, decreasing by 0.7% y/y in the first ever drop recorded for the series, PBOC data shows.

Given this, the PBOC should be careful to avoid disorderly competition and a rapid narrowing of interest margins, said Li.