Big banks' profitability on the mend

The profitability prospects of China's big banks have improved in the first quarter of this year after the country's economy picked up steam during the period while smaller banks will see greater capital and liquidity pressure amid tightened regulation, analysts said.

Industrial and Commercial Bank of China Ltd, the world's largest lender by assets, reported net profit of 75.8 billion yuan ($11 billion) in the first quarter, up by 1.5 percent year-on-year, according to the bank's stock exchange filings. It was the bank's strongest quarterly profit growth in two years.

The ICBC's domestic rival Agricultural Bank of China Ltd reported 1.87 percent profit growth while China Construction Bank Ltd saw 3.03 percent profit growth in the first quarter.

While the outstanding value of non-performing loans at the country's biggest lenders continued to rise, they saw declining NPL ratio in the first quarter, indicating improved asset quality as the government has encouraged banks to dispose of bad loans through programs such as the debt-for-equity swaps.

The average NPL ratio among the country's banks dropped to 1.74 percent at the end of March from a seven-year high of 1.76 percent in September, Bloomberg cited data from the Chinese banking regulator.

Analysts said that there is likely to be a performance divergence among the banks starting from the first quarter as tightened regulation to curb financial risks and reduce leverage in the economy began to take effect.

The stricter regulation to curb risks and excess liquidity has led to higher interbank interest rates and shrinking net interest margins at banks.

Smaller banks will be mostly affected as they tend to be more reliant on wholesale funding facilities and are most vulnerable to liquidity squeezes, analysts with global ratings agency Fitch wrote in a research note.

"We expect smaller banks' margins will erode further in 2017 but larger banks, typically net providers of market liquidity, may see margins stabilize or slightly increase," they said.

Yulia Wan, an analyst at Moody's Investors Service, said in a report that smaller banks will face greater liquidity constraints due to their faster rate of asset growth and their reliance on wholesale funds, which will make them more vulnerable to financial market volatility.