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| Net Interest Margin Compression and Risk-Taking of Rural Financial Institutions |
| ZHAO Yaxiong, PENG Derong, WANG Xiuhua
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| College of Finance and Statistics, Hunan University; School of Finance, Jiangxi University of Finance and Economics) |
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Abstract A reasonable net interest margin (NIM) is a crucial guarantee for the stable operation of commercial banks, especially for rural financial institutions (RFIs). However, data show that the NIM of RFIs has narrowed to a historical low level, with the NIM of some rural commercial banks even falling below 1%, increasingly exposing potential risks to their safety. Furthermore, RFIs face limited channels for capital replenishment. Their core business consists of rural deposit and loan services, and are prohibited from cross-regional operations, making the deposit-loan spread their primary and single source of profit. Therefore, NIM compression may impact the operations of RFIs more significantly.
Based on this background, this paper first compares the typical differences in NIM compression between RFIs and large and medium-Sized banks (LMBs), discussing whether and through what inherent mechanisms NIM compression affects the risk of RFIs compared to LMBs. Secondly, it verifies effective pathways for RFIs to cope with the risks arising from NIM compression. This paper provides empirical evidence for the necessity of maintaining reasonable NIM to prevent financial risks in commercial banks and offers insights for preventing risks in RFIs.
The conclusions of this paper are as follows: NIM compression significantly increases the risk of RFIs. The mechanism lies in the fact that NIM compression increases pressure on the asset side and restricts the equity side, leading to a decline in the risk disposal capacity and risk resilience of RFIs. Further analysis finds that promoting diversified operations to increase non-interest income and controlling operational management costs are effective pathways for RFIs to alleviate the impact of NIM compression. Adjusting the loan structure based on customers does not help them effectively cope with the risk; instead, it may squeeze out personal loans and undermine their core mission of serving small entities.
The contributions of this paper are mainly reflected in the following aspects: First, it examines the risks of RFIs based on the typical fact of NIM compression, providing an important supplement to the existing literature on commercial bank risks. RFIs have distinct particularities, yet previous research has focused more on LMBs. Investigating the impact of NIM compression on the risk of RFIs adds an important perspective to current financial risk research. Second, it analyzes the inherent mechanism through which NIM compression increases the risk of RFIs from the perspectives of asset-side pressure, equity-side constraints, and liability-side adaptation. This paper argues that NIM compression leaves RFIs without sufficient provision coverage and loss reserves to guard against bad debt impacts, and also restricts their internal capital replenishment, significantly reducing their risk resilience. However, NIM compression does not drive RFIs to pursue high-risk investment returns. Third, it provides references for the operational strategies and pathways of RFIs in responding to NIM compression risks. This paper finds that diversified operations and reducing operational and management costs are effective pathways for RFIs to cope with NIM compression risks. However, adjusting the loan structure based on customers does not effectively address NIM compression; instead, it causes RFIs to deviate from their positioning of supporting small entities.
Based on the above empirical conclusions, to mitigate the risks associated with NIM compression in RFIs, this paper provides the following implications: First, guide and assist RFIs in maintaining reasonable NIM through structural monetary policy tools. The guiding role of structural monetary policy can be strengthened by flexibly using tools such as relending programs supporting agriculture and small businesses, and rediscounting to precisely reduce the liability costs of RFIs. Second, implement differentiated measures for preventing and resolving risks from NIM compression. RFIs can be appropriately encouraged to replenish capital through market-based methods in multiple channels, such as supporting the issuance of secondary capital bonds and special bonds, or conducting compliant mergers, acquisitions, and equity investments in accordance with the law. Third, strengthen business capacity and prevent RFIs from deviating from their focus on agriculture and small entities through enhanced supervision. Prudently guide RFIs to adjust their loan businesses and explore business growth points among long-tail customers; accelerate the transformation of intermediary businesses to broaden non-interest income channels.
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Received: 03 December 2024
Published: 27 February 2026
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