BEIJING, Sept 26 (Reuters) - Faced with shrinking profit margins, some Chinese banks are turning away from funding big infrastructure projects to focus on smaller clients who they can charge higher interest rates, bankers say, a fundamental shift in business strategy.
Funding big state-owned firms and big government infrastructure projects is the traditional lifeblood of China's government-controlled banks, whose profits enjoy additional protection from the country's managed interest rate system.
But the cushy set-up for banks changed this year when China started freeing up its interest rates market to force banks to compete harder for clients and reduce their guaranteed profits.
The changes made doing business with big state clients less lucrative for banks as those powerful borrowers pay minimum interest rates at a time when banks are being pressured by slowing profit growth as the economy cools.
"Interest rates for loans to big clients are low, but capital usage is high. It's not worth it," said a senior executive at Bank of China , the country's fourth biggest bank.
The banker declined to be identified because he is not authorised to speak to the media.
That some banks are shying away from infrastructure deals is not surprising: banks were burnt in 2008/09 when they lent 10.7 trillion yuan to local Chinese governments to build roads and railways, only to find most loans could not be repaid on time and must be restructured.
Still, it remains to be seen if banks, majority owned by the government and which lend at its beck and call, will enjoy much success in pulling away from state-directed infrastructure projects, especially as the government is accelerating $150 billion in spending on roads and railways this year to revive an economy trapped in its worst slowdown in three years.
Indeed, a banker from Bank of Communications said his bank would accord a higher credit rating to infrastructure projects endorsed by Beijing.
"But we will not lend to infrastructure projects in a big way," the banker said. "The funding of some projects should not be borne by banks. Those who wish to borrow do not meet our criteria, while those we want to lend to can sell bonds or have no need for loans."
Of China's five largest banks, only Construction Bank of China and Bank of Communications have faster growth rates in mid- to long-term infrastructure loans, interviews with half a dozen bankers showed.
Other banks are busy expanding their off-balance sheet businesses to boost fee income and make up for narrowing net interest margins, a banker at a joint-stock Chinese bank said.
The government squeezed banks' net interest margins in two moves this year when it liberalised the rates market by allowing banks to fix deposit rates at 110 percent of benchmark rates, and borrowing rates at 70 percent of the benchmark level.
The twin moves narrowed the net interest margin to as slim as 9 basis points, from 240 basis points previously.
Adding to profit pressures, big state borrowers usually pay benchmark interest rates, while smaller, private firms can pay up to four time more as they are seen to be more credit risky.
Authorities set the floor for lending rates and ceiling for deposit rates to shield its banks, insolvent as recently as a decade ago, from intense competition.
A second banker from Bank of China said the bank issued a lot of infrastructure loans in 2008-09, and so the pace of lending must slow this year to avoid a surge in bad debt.
"Based on internal calculations, it's a little hard for our 2012 profit growth to meet the target set at the start of the year," said the banker from the Bank of China, which posted its weakest quarterly profit in three years in August.
"We don't have huge pricing power among the big four banks, and rates charged for loans to big projects are usually set at the benchmark level and are not lucrative," he said, adding the bank will focus on controlling costs in the fourth quarter. (Editing by Robert Birsel)