China's Banks Face 'Japanification Moment,' S&P Warns

China's banking system is nearing a 'Japanification moment,' a prolonged period of low growth and weak profitability similar to Japan's economic stagnation that began in the 1990s, according to a recent S&P Global Ratings report. The rating agency warns that years of Chinese banks sacrificing margins to support the nation's economy have left the financial system with thin profitability and an increased .

The report highlights a growing concern that Chinese lenders may have fewer options for diversifying their revenue streams and cutting costs compared to other banking systems that have navigated ultra-low interest rate environments. This dependency on reducing credit losses to maintain profitability is a significant vulnerability, especially as the country grapples with a struggling property sector and other economic headwinds.

S&P Global Ratings noted that for China's central bank, 'safeguarding growth and social stability will take priority over bank profits.' This has been evident in Beijing's policy decisions, including cutting both one-year and five-year prime loan rates to historic lows, which has further squeezed the profitability of mainland banks. Lenders have also been directed to extend credit to weaker borrowers and offer concessions, such as pandemic-era fee reductions for small businesses.

The S&P's '' from August 2024 projects that the sector's return on average assets will decline to 0.55% in 2026 from 0.70% in 2023. The report also suggests that polarization within the Chinese banking sector could intensify, with banks in lower-tier cities facing greater pressure from property-sector weakness and fiscal strains in debt-laden regions.

While in the Asia-Pacific region by assets, the growing pressures on profitability and asset quality are a significant concern for investors and regulators alike. The S&P report serves as a stark warning of the potential for a prolonged period of stagnation if these systemic risks are not addressed.