China’s banking sector is facing dual pressure. Its profits are shrinking due to weak loan demand as well as a more accommodative monetary policy. At the same time, it is expected to increase lending to carbon-intensive industries as part of the country’s green transition efforts, which could lead to even lower returns.

The industry’s profitability, measured by its net interest margin ( NIM ), has been sliding for the last few years, reaching 1.52% in 2024 and further dropping by 12 basis points to 1.4% in the second quarter of 2025, according to Fitch Ratings.

Weak credit demand from households, especially with regard to property-related mortgages, and the central bank’s downward adjustment of the benchmark rates are two factors driving down the NIM. This is adversely impacting banks’ return on assets and return on equity.

On the investment side, rising allocation to government bonds has emerged as a key driver of asset growth among major banks. According to data from Natixis, investments in government bonds accounted for approximately 16% of these banks’ total assets in 2024, and continue to grow in 2025.  

An important theme of government debt issuance is green bonds. Local governments have become the dominant issuers of green bonds in the first half of 2025, according to Natixis. However, it also notes that most government bonds are not green-labelled, which raises questions about the efficiency of the green fund allocation.

Meanwhile, banks’ disbursement of green loans is also growing, reaching 44% of the loan books in the first half of 2025.

Considering that China is currently falling behind on its decarbonization target set in the 14th Five-Year Plan, it is likely that the government will ramp up its decarbonization efforts in the coming 15th Five-Year Plan.

As the government’s most effective channel for transmitting policy changes, banks are required to increase their lending to carbon-intensive industrial sectors, such as steel and cement, to speed up the energy transition.

However, financing the green transition for these sectors means a lower return on capital for banks because these industries are also struggling with low profit levels. Facing an already thin NIM, Chinese banks now face the extra pressure of contributing to meeting the government’s decarbonization ambition, which could lead to an increase in credit risks.