The US Federal Reserve’s repeated interest rate rises this year set the tone for many Asian central banks, with the notable exceptions of China and Japan – although a recent policy shift by the Bank of Japan has appeared to signal tightening is on the way there too. As a result, lenders in the region’s two biggest economies are not enjoying the kind of fatter borrowing margins seen elsewhere.

“There is significant country and bank-level divergence in performance within the region,” Attila Kincses, associate partner at consultancy McKinsey and Co, told Nikkei Asia. “China might be impacted due to market downturn. Japan may still see muted growth, as interest rates may remain lower for longer, capping increases in banking profitability.”

That also puts them at odds with global trends. Worldwide, the profitability of lenders reached a 14-year high this year, according to McKinsey’s Global Banking Annual Review released this month. Revenue hit US$6.5 trillion as higher interest rates spurred a sharp increase in net interest margins (NIM) – roughly speaking, the difference between what a bank earns from loans and what it has to pay depositors. NIM is used as a measure of a bank’s profitability.

One possible scenario McKinsey laid out for the short term was of inflationary growth, in which costs would remain higher over the next year but be kept in check by central banks keeping rates elevated. That would be good news for lenders, as rising rates lift profitability in areas like consumer finance.

But while most Asian central banks have been following the Fed’s lead higher – the US central bank last week raised rates by 50 basis points (0.5%), following a series of 75 basis point increases – the People’s Bank of China cut benchmark rates three times in recent months, reflecting its concern over a decelerating economy and a troubled property sector.

The real estate industry in Asia’s largest economy was hit by a wave of bond defaults among debt-swamped developers, leaving scores of residential property developments unfinished. That sparked a nationwide strike over mortgage payments among angry homebuyers and triggered a collapse of confidence in the sector, which accounts for about a quarter of China’s gross domestic product.

The key five-year loan prime rate – a gauge for setting mortgage loan rates – stands at 4.3%, down 35 basis points (0.35%) from the start of the year. Rate cuts alleviate debt burdens for developers and homebuyers, lowering the risks posed by bad loans for banks.

But this also squeezes net interest margins, a key metric of profitability for lenders. For mainland China’s banks, sector-wide NIM for the first nine months was 1.94%, down 13 basis points from a year ago, according to data from the Chinese financial regulator.

The Industrial and Commercial Bank of China, the country’s largest lender by assets, had a NIM of 1.98%, having dropped in line with the sector average.

China’s largest state-owned commercial banks booked growth in the low single digits in the third quarter, while the loan books of midtier commercial banks shrank, the latest S&P Global Market Intelligence data shows. China Minsheng Bank posted a year-over-year contraction of 7.65% in total net loans from July to September.

Lenders in Japan were feeling the pinch for a slightly different reason. Rate increases by the Fed caused a drop in US Treasury prices, resulting in large unrealised losses on bond holdings for Japanese banks, which over the years have increased their overseas loans and bond investments to make up for low-interest margins in their home market.

Between the end of March and the end of September, unrealised losses on foreign bonds grew more than twofold to nearly ¥4 trillion (US$29 billion) at lenders MUFG, SMFG and Mizuho. At the nation’s 98 regional banks, losses came to ¥2.3 trillion, up more than sixfold.

Like its Chinese counterpart, the Bank of Japan has kept interest rates low to avoid derailing the country’s fledgling economic recovery, though in a surprise move on Tuesday the BOJ raised its cap on 10-year government yields to 0.5% from 0.25%, a policy tweak widely interpreted by financial markets as a de facto rate hike.

In contrast, financial sectors in smaller economies like Singapore over in the 10-member Association of Southeast Asian Nations are enjoying a lift from rising interest rates.

Asean’s largest banks by assets – DBS Group Holdings, Oversea-Chinese Banking Corp and United Overseas Bank, all from Singapore or based there – take their cues from the Fed in setting their interest rates for loans.

The string of aggressive US hikes has fattened interest margins for Singaporean lenders. The largest of the trio, DBS, reported a 35% rise in net profit for the three months through September.

Net interest income for the quarter – the revenue generated from loans minus the interest paid to depositors – rose 23% for DBS from the previous quarter to 3.02 billion Singapore dollars (US$2.2 billion).

Elsewhere in Asean, however, interest rate gains come with a potential risk.

Thailand has some of the region’s highest levels of household debt relative to GDP, according to a report by financial research firm CreditSights in October, which also pointed out that floating mortgages make up the bulk of home loans issued by Thai banks.

Floating mortgages have rates that fluctuate based on the surrounding interest rate environment. Higher rates translate to higher monthly payments for borrowers, which in turn raises the possibility of a greater proportion of debts turning sour for lenders.

Bangkok Bank has 80% of its mortgage book by value pegged to floating rates, while its peer TMBThanachart Bank’s share is 90%, according to CreditSights.

“Thailand seems uniquely challenged, with high household debt … and a challenging economic outlook,” CreditSights said. “The banks are cognizant of the impact of rising interest rates on customers and are actively seeking to identify borrowers that display early warning signs of financial difficulties.”

Meanwhile, financial institutions in South Korea and India are telling a story similar to their Singaporean peers, booking fatter interest margins on higher rates.

KB Financial Group, South Korea’s top financial group by assets, said its net interest profit jumped 19% year-on-year to 8.3 trillion won (US$6.4 billion) during the first three quarters of the year.

In India, NIMs of scheduled commercial banks, or those regulated by the central bank, increased 22 basis points to 3.1% on the year in the July-September quarter – the highest in a year, according to research firm CareEdge.

But while banks across much of Asia head into the new year on a firmer footing, analysts say the higher financing costs buoying them now could also lead to trouble down the road.

In a December report, CreditSights warned that higher rates and a slowdown in business activity will gradually weaken borrowers’ ability to repay their loans. In short, banks may profit, but their customers could suffer.

“US interest rates will remain higher for longer – at least into 2024, leading to APAC central banks, excluding Japan and China, needing to be higher for longer, too,” the report said. “The lower quality or overleveraged corporates may find it difficult to refinance in either the bond or loan markets, leading to defaults.”