China is considering cutting interest rates on as much as US$5.3 trillion of mortgages in two steps to lower borrowing costs for millions of families while mitigating the profit squeeze on its banking system.

Financial regulators have proposed reducing rates on outstanding mortgages nationwide by a total of about 80 basis points, part of a package that includes an accelerated timeline for when mortgages become eligible for refinancing, according to people familiar with the matter. The first cut may come in the next few weeks, while the second move would take effect at the beginning of next year, said the people, asking not to be identified discussing a private matter.

The yet-to-be-finalised plan is likely to apply to first and second homes, pending approval from the top leadership, two of the people said. In China, regulators set benchmarks for mortgage rates that are followed closely by banks. The National Financial Regulatory Administration didn’t respond to a request for comment.

Chinese regulators are walking a fine line as they attempt to shore up the battered property market and economy while safeguarding the nation’s US$66 trillion financial system. Lowering rates too aggressively would pile pressure on the banks, which have already seen their margin tumble to a record low of 1.54% as of end-June, well below the 1.8% threshold regarded as necessary to maintain reasonable profitability.

Bloomberg News reported last week authorities are mulling a plan to allow homeowners to renegotiate terms with their current lenders before January, when banks typically reprice mortgages. They would also be allowed to refinance with a different bank for the first time since the global financial crisis, people familiar with the matter said.

Analysts at China International Capital Corp and Jefferies Financial Group earlier expected that homeowners at some cities would see up to 100 basis points of decline in their mortgage rates.

Concerns about the Chinese economy have intensified after weak earnings reports from major consumer companies and as major global banks downgraded their growth forecasts, suggesting the country may struggle to meet its official target of around 5% this year. The real estate downturn has heavily impacted household wealth and spending.

“In essence, it’s a transfer of wealth from banks to households, so positive for consumption,” Larry Hu, the head of China economics at Macquarie Group Ltd, wrote in an Aug 31 note. If all existing mortgages are to be refinanced, borrowers can save about 300 billion yuan (US$42 billion or RM183.55 billion) in interest payments annually, equivalent to 0.6% of the nation’s retail sales or 0.2% of its gross domestic product, he estimated.

For banks, Citigroup Inc estimated the worse-than-expected potential cut could lead to an average eight-basis-point margin contraction next year and hurt their earnings by 6.4%. Lenders with higher mortgage exposure like the big four state-run banks could be more vulnerable to the reduction, analysts led by Judy Zhang wrote in a note last week.

Existing mortgages carried an average interest rate of about 4.27% as of end-2023, compared with a record low of 3.45% on newly issued home loans.

Cutting rates in tranches may help smooth out the blow for lenders, which are struggling with falling earnings as Beijing has enlisted them to help revive the flagging economy with cheap loans to consumers and corporates including cash-strapped developers. Banks had resorted to multiple deposit rate cuts over the past year or so to mitigate the impact of lower loan yields. 

The proposal is also aimed at narrowing the disparity between rates for new property buyers and existing homeowners, which has driven a wave of early mortgage repayments and strained lenders in recent years. Homeowners have taken advantage of cheap consumer loans to prepay mortgages, a practice that is banned by regulators. 

China’s outstanding amount of home mortgages, which count as prime assets at Chinese lenders, stood at 37.79 trillion yuan at the end of June, the lowest level in nearly three years. Policymakers have taken some forceful steps to lower borrowing costs this year including scrapping a central government-guided mortgage rate floor for first and second home purchases. 

The moves, however, have mostly benefited new property buyers. 

China’s real estate crisis is now extending into its fourth year with no signs of letting up. The sector continues to be a drag on the world’s second-largest economy with the fallout spilling over to everything from the job market to consumption and household wealth.

  - Bloomberg