China’s escalating push to have its banking behemoths backstop struggling property firms is adding to a maelstrom of woes for the $57 trillion sector.

Already stung by soaring bad loans and record low net interest margins, lenders such as Industrial and Commercial Bank of China Ltd. may soon be asked for the first time to provide unsecured loans to developers, many of whom are in default or teetering on the brink of collapsing.

The risky lifeline threatens to exacerbate an already bleak outlook. ICBC and 10 other major banks may next year need to set aside an additional $89 billion for bad real estate debt, or 21% of estimated pre-provisions profits in 2024, according to Bloomberg Intelligence. Lenders are now weighing lowering growth targets and cutting jobs among possible options, according to at least a dozen bankers who asked not to be named discussing internal matters.

“The government can’t just ask banks to step up without providing a solution to their issues,” said Shen Meng, a director at Beijing-based investment bank Chanson & Co. “Their profits may still look good on the surface, but if you take a deeper dive into their assets and bad loans, things won’t look good for long.”

China’s banks have been caught between the opposing demands of providing “national service” by supporting the property sector and distressed local governments, and their obligation to run a sound business. Boosting profits has almost become mission impossible for some.

Beijing ratcheted up pressure on the lenders even more last week to reverse the housing meltdown. Regulators are working on a draft list of firms eligible for bank support, while weighing a plan for lenders to offer developers unsecured loans for the first time. This is on top of a recent order for the banks to roll over local government debt at favorable terms to avert a crisis in that $9 trillion market.

Authorities have signaled the banks have more to give in support of a sluggish economy. The Communist Party-controlled parliament recently said the financial sector’s profits still have room to fall. A readout last week urged banks to step up funding to complete housing projects and ease the “panicked expectations” of households.

This week, the central bank pledged to press lenders to lower rates on concern that deflation has effectively pushed up borrowing costs in price-adjusted terms. The People’s Bank of China also said it will guide banks to coordinate their lending so as to smooth out volatility in credit growth between year-end and the start of the year.

The demands have been taking a toll on finances and operations. Net interest margins slumped to a record low of 1.73% as of September, data showed. That’s below a 1.8% threshold regarded as necessary to maintain reasonable profitability. Bad loans meantime have hit a new high, and a revenue growth streak since 2017 for some of the nation’s largest state banks may snap this year.

Shares of the big four state lenders including ICBC are trading near record low valuations of 0.3 times book value in Hong Kong. That’s about the same levels US banks were trading at during the global financial crisis.

Challenges Ahead

One city commercial bank is setting lower targets for the coming fiscal year, said an executive, citing difficulties in boosting loan size and revenue amid fierce competition for quality borrowers. Some small lenders have moved to slash jobs, with one planning to cut 50% of its 400 positions at their lending department this year, people said.

A branch of a big bank warned staff at its lending department to brace for a challenging year ahead, asking them to sleep in the office on the last working day of 2023 so they can get the earliest jump possible in processing new loans at the start of the year, an executive said. Lenders operating nationwide are now boosting lending to rural areas they have typically neglected, in order to meet targets on small business loans, people familiar with the matter said.

Unlike most Western banks, Chinese state-run banks are subject to government directions on how much to lend and to what sectors, especially during economic downturns. Apart from public demands, authorities often summon bank executives for impromptu meetings to give verbal instructions, known as “window guidance,” to nudge lending toward desired areas or restrict certain businesses.

These guidance sessions have become more frequent and sometimes contradictory this year, bankers said. Lenders risk being summoned by the People’s Bank of China should they miss loan targets, or punished by the National Administration of Financial Regulation for lending too aggressively, they said.

Other firms try to play ball by lending to local government financing vehicles, despite the high risk of default. About 80% of new corporate loans at one big lender’s local branch in Sichuan province this year were extended to these LGFVs, an official said, betting that they can earn interest while delaying default risk via loan extensions.

Authorities have offered some relief to the banks, guiding them to trim deposit rates three times in the past year to ease margin pressures, and slashing reserve requirements twice this year to boost their lending capacity.

Those changes won’t be enough to offset the lending rate cut and arrest a margin slide, according to Fitch Ratings Inc. Bloomberg Intelligence expects the margin squeeze to deepen into 2024 and weigh on earnings, capping the profit growth at a low-single-digit at best.

Goldman Sachs Group Inc. said China’s latest guidance for banks to step up financing for builders could push up their bad loan ratios for the sector by 21 basis points. JPMorgan Chase & Co. warned the push to extend unsecured loans “would be a risky move” and raises concerns about their national service and credit risks.

At most risk may be the nation’s myriad of regional banks, though. S&P Global Ratings warned in a recent report that those banks could incur a capital hit of 2.2 trillion yuan ($301 billion) from the debt crisis among municipalities.

The real estate support may be so risky that some analysts say the banks may push back, just as they have much of this year. Despite government exhortations since late last year for them to lend more, bank loans to property firms fell year-on-year in the third quarter — the first time that’s ever happened.

To assuage their concerns on issuing, regulators may exempt bankers from being held accountable for bad loans given the high risks involved, people familiar said last week, adding that deliberations are ongoing and subject to change.

“The government wouldn’t want material volatility in the big lenders’ operations, and it’s unlikely that banks will be asked to save the property sector or LGFVs at any cost,” said Vivian Xue, director of financial institutions at Fitch Ratings. “After all, the big banks are all owned by the central government and they’re a key source of fiscal income.”

Regulators could also guide banks to further lower deposit rates to ease their margin pressure, but that risks hurting consumers and raising a moral hazard issue, according to Shen. Another solution is for the central bank to provide zero-interest funding to commercial banks to beef up their lending capacity, he said.

Policymakers would also need to take shareholder returns into account, as about 30% of the profit of state banks go to public coffers. Should bad loans rise, banks will have to set aside more provisions, cutting into profits and constraining their ability to service the economy.

“It’s going to be a headache for regulators,” said Francis Chan, a senior analyst at Bloomberg Intelligence. “They need to make sure the banks don’t fall into a sorry state that could hurt the payout to government shareholders.”