Low valuation, high dividends, banks are facing the new cycle

The lagging effect of the new macroeconomic cycle is gradually becoming apparent at the banking level.

Guarding the interest spread and stabilizing assets, commercial banks are thriving proactively and facing challenges head-on.

With a dividend yield exceeding 5% and a stock price increase of over 11% within the year, the lagging effect of the new cycle on the banking sector is gradually manifesting, and bank stocks are regaining favor with investors. Since the beginning of the year, the Wind (Wang De) Banking Index has risen by more than 11%, outperforming the Shanghai Composite Index's increase of around 3%. As of the close on April 1st, the banking sector's increase ranks second among all industries.

High dividends are considered a driving factor behind the recent rise in bank stocks. Since March 15th, A-share listed banks have been successively disclosing their annual reports, with 13 listed banks together contributing over 540 billion yuan in dividends to investors, setting a new record for bank stock dividends.

Business data outside the capital market show that among the 30 banks that have disclosed their performance, 15 listed banks have seen a year-on-year decline in revenue, 4 listed banks have experienced a year-on-year decrease in net profit, and 8 listed banks have maintained double-digit growth in net profit.

"The industrial structure, sector structure, corporate structure, and quality structure that make up bank assets are a reflection of changes in the socio-economic structure," said Liu Xiaochun, Deputy Director of the Shanghai New Finance Research Institute. "In this sense, the bank's balance sheet is the barometer of China's economy."

Yu Yongding, a member of the Chinese Academy of Social Sciences, stated that since 2012, there has been a significant change in the pattern of China's macroeconomic fluctuations. The GDP (Gross Domestic Product) growth rate has been on a long-term continuous quarterly decline. The current economic slowdown and price decline have lasted for 12 years, but there are still no clear signs of reversal.

The deep-seated factors behind the economic slowdown stem from the transformation of China's economic growth model. In the pursuit of high-quality development, China is increasing its leadership in technological innovation to modernize the industrial system, accelerating the conversion of old and new drivers, promoting the transformation and upgrading of traditional industries, and vigorously developing the digital economy.The profitability growth rate and profitability of commercial banks closely follow the economic growth rate of China. From 2011 to the first quarter of 2023, the year-on-year growth rate of net profits for commercial banks fluctuated downward from 36.3% to 1.3%, while the ROE (Return on Equity) dropped from over 20% to around 10%.

In fact, the development of banks has entered a relatively mature and stable stage. At the performance briefing, Chairman of Industrial and Commercial Bank of China (ICBC), Liao Lin, stated that the future development direction is to create a modern ICBC and achieve a "five-in-one transformation."

Chairman of CITIC Bank, Fang Heying, frankly stated that they will not pursue revenue growth at the expense of scale. Whether it is "compensating for price with volume" or "compensating for volume with price," neither approach is advocated.

In October 2023, the Central Financial Work Conference first proposed to do well in five major areas: technology finance, green finance, inclusive finance, pension finance, and digital finance.

Liu Xiaochun expressed that the areas involved in the five major articles are all weak links in financial services in the past. The current policy strongly advocates for them, indicating a huge market scale. As for whether they can become high-quality markets, it depends on whether banks can provide good services through financial innovation. "This is an opportunity, but it is also full of dangers."

"If the Central Financial Work Conference is taken as a sign, China's banking industry is entering a new cycle, and it is still difficult to predict what banks will look like in the future," said Liu Xiaochun.

In reality, the development of specific banking businesses is not without pressure: the decline of net interest margins, the pressure on asset quality, and the increase in credit costs... Faced with a new cycle, commercial banks are thriving towards the sun.

Liao Lin stated that short-term challenges do not change the long-term positive trend. "We are confident in the high-quality development of China's economy, large banks including ICBC, and in dealing with the challenges we face. We have the ability to overcome difficulties and open up new situations."

Stock prices soar, and dividends are refreshed.

At the beginning of 2024, bank stocks achieved a good start.Since the beginning of the year, the Wind Bank Index has risen by over 11%, outperforming the Shanghai Composite Index, which has increased by about 3% during the same period. As of the close on April 1st, the banking sector's increase ranked second among all industries.

The share prices of the four major state-owned banks have successively hit historical records. On February 23rd, China Construction Bank touched a historical high of 7.29 yuan per share during trading, and the Bank of China closed at 4.60 yuan per share, setting a new record. On March 5th, the Agricultural Bank of China closed at 4.34 yuan per share, also a historical high. In addition, the Industrial and Commercial Bank of China has recently seen its share price at a high not seen since early 2018.

Looking at a longer timeframe, since November 2022, as the impact of the pandemic gradually receded, the share prices of the A-share banking sector have stabilized and rebounded. As of March 29th, the Wind Bank Index had increased by 25.58%, while the A-share Shanghai Composite Index rose by 5.10% during the same period.

Examining individual stock performance, from early November 2022 to the end of March 2024, the share prices of most A-share listed banks have shown an upward trend. Among them, the Agricultural Bank of China rose by 63.18%, leading the gains; the Bank of China, CITIC Bank, Bank of Communications, and Bank of Beijing all saw increases exceeding 50% within the period.

Going back further, since the beginning of 2020, the Wind Bank Index has grown by over 2%, which means that bank stock valuations have been restored to pre-pandemic levels. Over the same period, the Shanghai Composite Index fell by 0.29%, and the Shenzhen Component Index dropped by more than 8%.

Why have bank stocks gained favor since then? Several analysts believe that an important context is the market's preference for high-dividend stocks.

"In a macro environment characterized by low inflation, low growth, and low returns, the investment value of a high-dividend strategy typically increases, mainly because the related targets can provide a more stable dividend cash flow," said a report by CICC. "Most bank stocks have a dividend yield of over 5%, and their long-term returns outperform the market, making them a viable choice for a high-dividend strategy."

The dividend yield, also known as the stock earnings rate, is the ratio of the annual dividends distributed to shareholders to the share price and is one of the important indicators for measuring the investment value of a stock. With stable dividends, the higher the dividend yield, the better the financial return for investors.

As of March 29th, 2024, except for Shanghai Pudong Development Bank and Huaxia Bank, all A-share listed state-owned major banks and joint-stock banks have disclosed their 2023 annual reports and announced their annual profit distribution plans.

Wind data shows that the dividend payout ratio of the six major banks has reached 30%, meaning that 30% of the net profits attributable to the shareholders of the parent company are used to distribute cash dividends to shareholders. Among the seven joint-stock banks that have disclosed their annual reports, the dividend payout ratio exceeds 25%, with China Merchants Bank and Ping An Bank's dividend payout ratios at 33.92% and 30%, respectively.In terms of monetary value, the aforementioned 13 listed banks will bring investors a cash return of over 540 billion yuan. Among them, six state-owned major banks are expected to distribute a cash dividend of 413.341 billion yuan, while seven joint-stock banks will collectively distribute 126.907 billion yuan in cash dividends.

According to Wind statistics, based on the closing prices on March 29 and the dividend per share for 2023, the dividend yields of the aforementioned 13 listed banks range from 5.33% to 6.83%.

In comparison, the returns on major financial products are lingering at a low level.

Since the end of 2020, the yield to maturity of 10-year government bonds has continued to decline from around 3.3% to the current level of around 2.3%, breaking the new low since the statistics began in 2008. Since April 2022, the deposit挂牌利率 of major banks has been reduced at least four times. Taking ICBC as an example, by the end of 2023, the bank's deposit挂牌利率 for all terms is below 2%; data from China Wealth Management Network shows that the average yield of wealth management products in 2023 is 2.94%.

"Over the past one or two years, the yield on bonds has fallen sharply, and the investment cost-effectiveness of some high dividend stocks has relatively increased," said Liao Zhiming, Chief Analyst of the Banking Industry at China Merchants Securities. "However, the dividend yield is related to the stability of the company's dividends, performance stability, stock price fluctuations, and other factors. It cannot be simply assumed that the investment return of high dividend yield stocks is definitely better than that of bonds and wealth management."

Under the high dividend and high stock price increase, the valuation of bank stocks is still generally low among all sectors in A-shares.

Wind data shows that as of April 1, 2024, the price-to-book (PB) ratio of the 42 listed banks in A-shares is all below 1 times, and bank stocks are fully "broken net." Calculated based on the net asset value per share in 2023, the overall PB ratio of the banking sector is about 0.5 times, which is at the bottom level among the major industry sectors in A-shares.

PB is the ratio of the stock price per share to the net asset value per share, which is an important indicator to measure the investment value of stocks. "Broken net" means that the per-share price has fallen below the net asset value per share. "The per-share price of banks is lower than the net asset value per share, which is related to the market's belief that the authenticity of the quality of banks' book assets is relatively low," said CICC.

According to CICC's calculations, the average ROE of A-share listed companies at the end of 2022 is around 12%, which is basically consistent with the 11% level of bank stocks. However, the PB of A-share listed companies is 1.5 times, far higher than the level of bank stocks around 0.5 times. In terms of international comparison, the ROE and asset quality of Chinese banks are relatively good, but the PB is lower than that of the same industry in the United States (0.9 times) and Japan (0.6 times).

"The valuation of Chinese banks is systematically undervalued," said CICC. "We believe that the main reason for the undervaluation of Chinese banks is the market's concerns about asset quality and long-term profitability, as well as uncertainties related to information disclosure."In response to this, the management of commercial banks has also made numerous responses.

Previously, the president of the Bank of China, Liu Jin, has repeatedly addressed investors, stating that the overall valuation level of state-owned major banks, including the Bank of China, is significantly low and does not accurately reflect the investment value.

At the Bank of China's 2022 mid-year performance briefing, Liu Jin proposed three "not only but also" points to investors: he hopes that investors will not only look at the stock price but also at dividends; not only focus on growth in the capital market but also consider the stability of the Bank of China as a state-controlled large commercial bank; and while recognizing the market-oriented characteristics of the Bank of China as a commercial bank, they should also see the institutional advantages of socialism with Chinese characteristics.

It is worth noting that the systemic undervaluation of bank stocks has not always existed. Liao Zhiming stated that before 2010, the PB of bank stocks was clearly more than 1 times, and after 2012, the valuation of the A-share bank sector experienced a systemic downward shift, mainly due to the decline in profitability and growth potential.

Economic quality improvement, bank deceleration

In 2023, the net profit of commercial banks continued to grow overall. According to data from the National Financial Regulatory Administration (hereinafter referred to as "Financial Regulatory Administration"), commercial banks achieved a net profit of 2.38 trillion yuan in 2023, a year-on-year increase of 3.24%, with the growth rate falling by more than 2 percentage points compared to the previous year.

For the Chinese banking industry, 2012 is an important milestone.

At the end of 2012, the total assets of the banking industry reached 133 trillion yuan, more than 5 times that of a decade ago (2002); the net profit was 1.5 trillion yuan, nearly 50 times that of a decade ago. Although the net profit of the banking industry in 2013 still showed double-digit year-on-year growth, the pace gradually slowed down. By the end of 2023, the total asset scale of commercial banks exceeded 350 trillion yuan, with a net profit of 2.38 trillion yuan.

Liao Zhiming stated that from 2011 to the first quarter of 2023, the year-on-year growth rate of commercial banks' net profit fell from 36.3% to 1.3%, and the ROE dropped from over 20% to around 10%, indicating a significant decline in profitability. "It can be said that over the past decade, the profit growth rate and profitability of Chinese commercial banks have both declined significantly."

"Behind the decline in the profit growth rate of commercial banks is the slowdown in asset expansion, narrowing interest spreads, and the rise in credit costs. Bank performance mainly depends on volume, price, and credit costs. Since 2010, the growth rate of bank credit has gradually decreased from around 20% to the current level of about 11%; the net interest spread of commercial banks has fallen from 2.75% in the fourth quarter of 2012 to 1.74% in the second quarter of 2023. In addition, due to the slowdown in economic growth, the quality of bank assets has deteriorated, leading to an increase in credit costs." Liao Zhiming said.The changes in the banking industry reflect the characteristics of China's macroeconomic landscape.

In the view of Yu Yongding, the basic characteristic of China's macroeconomy from the reform and opening up until 2012 was the alternation of cold and hot phases, with high-speed growth amidst fluctuations. Since 2012, there has been a significant change in the pattern of macroeconomic fluctuations in China: the GDP growth rate has been falling on a quarterly basis for a long time. "Since 2012, the decline in economic growth and prices in this cycle has lasted for 12 years, but there is still no clear sign of reversal," said Yu Yongding.

The data listed by Yu Yongding shows that in the first quarter of 2010, China's GDP growth rate was 12.2%, and the annual rate was 10.6%. In 2011, the economic growth rate broke through 10%, reaching 9.6%; in 2012, it broke through 8%, reaching 7.9%; in 2013, the GDP growth rate was 7.7%. In summary, it has been a continuous decline, with the GDP at 6% in the fourth quarter of 2019 and 6% for the whole year. During the three years of the pandemic, the average growth rate was 4.67%. The GDP growth rate in 2023 was 5.2%.

At the same time as the continuous decline in economic growth, the PPI (Producer Price Index) has continued to show negative growth, and the CPI (Consumer Price Index) has been hovering on the edge of negative growth. After March 2012, the PPI experienced negative growth for 54 consecutive months, and after June 2019, the PPI continued to show negative growth for 23 consecutive months (with one month of positive growth), and since October 2022, the PPI has remained in negative territory.

"After May 2012, the CPI broke through 3, and the annual rate was 2.6%. The average growth rate of the CPI since then has been around 2%. In the past few months, the CPI has experienced several negative growths, with October at -0.2%, and the CPI increase in 2023 was 0.2%, which is essentially zero growth," said Yu Yongding.

The 2023 Central Economic Work Conference pointed out that to further promote the economic recovery, it is necessary to overcome some difficulties and challenges, mainly the insufficiency of effective demand, overcapacity in some industries, weak social expectations, and still many hidden risks.

On the financial level, the above challenges are particularly manifested as the insufficiency of effective credit demand.

According to a report from the Institute of Finance at the Chinese Academy of Social Sciences, the overall performance of the RMB loan structure in 2023 was poor: first, the continuous year-on-year decrease in medium and long-term loans to residents for two consecutive years reflects the still insufficient willingness of residents to leverage housing purchases; second, the continuous year-on-year decrease in medium and long-term corporate loans since the second half of 2023 reflects the still weak willingness of enterprises to expand financially. Looking at the money supply, the year-on-year growth rate of M1 (narrow money) has dropped to a historical low, and the "scissors gap" between M2 (broad money) and M1 growth rates has expanded, reflecting a decrease in the degree of capital activation.

The above changes are also reflected in the balance sheets of banks.

On the asset side, the annual reports of several banks show that the scale of personal housing loans decreased year-on-year in 2023. Taking China Construction Bank as an example, Wind data shows that by the end of 2023, the bank's balance of personal housing loans was 6.45 trillion yuan, a decrease of 94.711 billion yuan from the beginning of the year; the proportion of personal housing loans in the total loan amount decreased from 30.96% in 2022 to 27.10% in 2023.On the liability side, the scale of term deposits has increased significantly. The annual report of Industrial and Commercial Bank of China (ICBC) shows that the bank's term deposits increased by 4,176.147 billion yuan in 2023, a growth of 27.6%; demand deposits decreased by 617.111 billion yuan, a decline of 4.4%.

Driven by factors such as insufficient effective credit demand, loan interest rates have fallen. In 2023, consumer loan prices dropped into the "2" range, significantly lower than the 1-year LPR (Loan Prime Rate) of 3.45%. Annual reports from several banks show that their loan yield rates have declined year-on-year, leading to a negative growth in net interest income.

As of April 1st, among the 30 A-share listed banks that have disclosed their annual performance, 15 listed banks have seen a negative growth in revenue, including two state-owned large banks, ICBC and China Construction Bank, as well as China Merchants Bank, which ranks first among joint-stock banks; the net profits of Shanghai Pudong Development Bank, Industrial Bank, and China Everbright Bank decreased by 28.28%, 15.61%, and 8.96%, respectively.

For the full year of 2023, commercial banks achieved a cumulative net profit of 2.4 trillion yuan, a year-on-year increase of 3.2%, with adjustments made for the total value of credit impairment losses. Wind data shows that in the annual reports of 20 A-share listed banks that have published relevant data, the amount of credit impairment losses in 2023 decreased by about 63 billion yuan compared to the previous year.

Credit impairment losses are primarily a method used by banks to cope with future risks and are also an effective means for banks to regulate profit fluctuations. Typically, banks tend to provision more for impairment losses when their operations are good, and less when they are not, in order to smooth out profits.

"China's economy has entered a stage of high-quality development, where the demand for scale growth has shifted to effective improvement in quality and reasonable growth in quantity," said Zeng Gang, Director of the Shanghai Finance and Development Lab. "Bank development has also entered a relatively mature and stable stage, with the pursuit of scale generally becoming more stable and showing differentiation."

At the 2023 annual performance briefing, some bank management clearly stated that they would abandon the impulse for scale and maintain a reasonable growth in credit scale.

"We will never engage in scale impulse for the sake of revenue," said Fang Heying. "Whether it's 'compensating for price with volume' or 'compensating for volume with price,' we do not advocate either approach."

Wang Zhiheng, President of China Everbright Bank, stated that they must firmly abandon the impulse for scale and adhere to a reasonable and achievable scale pace. "In the past, we have also learned some lessons. Some of our business growth was too rapid, bringing certain risks, making our overall approach actually inappropriate," Wang Zhiheng said.

Industrial upgrading, financial support.As China's economy transitions from a phase of rapid growth to one of high-quality development, economic restructuring and industrial upgrading have become key terms in economic development. Against this backdrop, especially since 2020, top-level design has guided the financial sector to return to its roots and focus on its main business, continuously optimizing financial supply to serve the real economy and high-quality development.

The Central Financial Work Conference in 2023 further clarified that "the structure of capital supply should be optimized, with more financial resources allocated to promote scientific and technological innovation, advanced manufacturing, green development, and small and micro enterprises... to do a good job in the five major areas of technology finance, green finance, inclusive finance, pension finance, and digital finance."

"Can be summarized as 'one rise' and 'one fall'," said Li Yunze, Director of the Financial Regulatory Administration, on March 11: "'One rise' refers to the continuous improvement of the quality and efficiency of economic services, and the continuous expansion of the coverage of financial services... In 2023, the increase in RMB loans was 1.3 trillion yuan more than the previous year. The loan growth rates in some key areas such as high-tech, green and low-carbon, inclusive small and micro, and advanced manufacturing all exceeded 20%."

"'One fall' mainly refers to promoting the continuous decline of comprehensive financing costs. Currently, loan interest rates have dropped to a historical low. Last year, we also promoted the reduction of the interest rates on existing first-home mortgages, which can save homebuyers about 170 billion yuan in interest expenses per year. At the same time, we also urged the banking industry to reduce fees and give benefits, and bank handling fees have been declining for three consecutive years," Li Yunze said.

On March 15, 2024, data showed that the weighted average interest rate for new corporate loans issued in February was 3.76%, 1 basis point lower than the previous month and 11 basis points lower than the same period last year; the interest rate for new personal housing loans was 3.86%, 8 basis points lower than the previous month and 36 basis points lower than the same period last year.

Bank credit is inclined towards key areas and weak links.

Taking the Industrial and Commercial Bank of China as an example, in 2023, more than 80% of the bank's new loans were invested in the corporate sector. Among them, the growth rates of loans for manufacturing, strategic emerging industries, inclusive finance, and green finance were 27%, 54%, 44%, and 35%, respectively, which were significantly higher than the average growth rate of all loans.

By the end of 2023, the balance of manufacturing loans at the Industrial and Commercial Bank of China exceeded 3.8 trillion yuan, with an increase of more than 800 billion yuan; the balance of loans for strategic emerging industries was 2.7 trillion yuan, with an increase of nearly 95 billion yuan; the balance of green loans exceeded 5.3 trillion yuan, with an increase of nearly 1.4 trillion yuan; and the balance of inclusive loans reached 2.2 trillion yuan.

Data released by the People's Bank of China (hereinafter referred to as "the central bank") shows that by the end of 2023, the balance of long-term loans in the industrial sector was 21.83 trillion yuan, a year-on-year increase of 28%; the balance of inclusive small and micro loans was 29.4 trillion yuan, a year-on-year increase of 23.5%; the balance of green loans was 30.08 trillion yuan, a year-on-year increase of 36.5%; the balance of loans for high-tech enterprises was 13.64 trillion yuan, a year-on-year increase of 15.3%; and the balance of loans for technology-based small and medium-sized enterprises was 2.45 trillion yuan, a year-on-year increase of 21.9%.At the same time, the proportion of credit allocated to traditional sectors such as real estate and local financing platforms has gradually decreased.

The central bank's monetary policy execution report for the fourth quarter of 2023 stated that in the past few years, real estate and local financing platforms have accounted for a significant share of the annual 20 trillion yuan increase in new loans in China. With the significant transformation of China's real estate development model and the prevention and resolution of local debt risks, the demand for loans in these two areas has noticeably declined.

By the end of 2023, the balance of RMB real estate loans was 52.63 trillion yuan, a year-on-year decrease of 1%. The annual report showed that large banks such as ICBC and CCB saw a year-on-year decline in the scale of personal housing loans. Additionally, according to disclosures from Industrial Bank, the bank's local government financing platform asset scale was reduced by more than 50% in 2023.

Recently, the central bank governor Pan Gongsheng publicly stated that he would take into account the health of the banking industry's balance sheets and continue to promote a stable and slightly decreasing comprehensive financing cost for society.

In 2023, the central bank lowered the policy interest rates twice, leading to a 20 basis point decrease in the 1-year and 5-year LPR (Loan Prime Rate) respectively, and guided commercial banks to orderly reduce the interest rates on existing first-home mortgages. In February 2024, the 5-year LPR continued to decrease by 25 basis points. As of now, the 1-year and 5-year LPR are 3.45% and 3.95%, respectively, both at historical lows.

Revenue under pressure, guarding the interest spread

Affected by multiple factors such as interest rate marketization, benefiting the real economy, and reducing comprehensive financing costs, the net interest margin of Chinese commercial banks has repeatedly hit historical lows and fell below 1.7% at the end of 2023, to 1.69%.

In reality, although the total asset scale of the banking industry grew by double digits year-on-year, the decline in the net interest margin also to some extent dragged down the banks' revenue. As of April 1, 2024, according to Wind statistics, the total revenue of the 30 listed banks on the A-share market that have published data for 2023 was 213.4 billion yuan less than in 2022.

The significant narrowing of the banking industry's net interest margin comes from the dual pressure of loan pricing on the asset side and core deposits on the liability side. On the asset side, the central bank's guidance for the continuous reduction of LPR, coupled with insufficient effective credit demand, led to a year-on-year decline in the pricing of newly issued loans, driving down the average yield on loans year-on-year.

Taking the leading institution in the banking industry, China Merchants Bank, as an example, in 2023, the bank's corporate loan yield decreased by 10 basis points from the previous year to 3.75%; the retail loan yield decreased by 42 basis points to 5.02%. The overall yield on loans and advances decreased by 28 basis points to 4.26%.On the liability side of banks, although the listed interest rates for bank deposits in June, September, and December 2023 experienced multiple rounds of cuts, the cost of deposits is relatively rigid, and the structure of deposits has changed, with a surge in fixed deposits.

In 2023, ICBC's fixed deposits increased by 4,176.147 billion yuan, a growth of 27.6%; demand deposits decreased by 617.111 billion yuan, a decline of 4.4%. The interest expenditure on deposits was 589.688 billion yuan, an increase of 109.605 billion yuan from the previous year, an increase of 22.8%. "This is mainly due to a 3.8% increase in the average balance of customer deposits and a 14 basis point increase in the average interest rate," according to ICBC's annual report.

The net interest margin is the most important indicator, which is related to the survival of China's banking industry. "Before, it was about stabilizing the net interest margin, now it has become about preserving it. Although there is only one word difference, it shows the great pressure," said a person from a state-owned large bank.

Looking at the long term, the net interest margin of commercial banks was 2.20% in 2019, dropped to 2.08% in 2021, and was 1.91% in 2022. In 2023, this indicator continued to drop by 22 basis points. "The above indicator is already at the lowest value in 20 years. Regulatory authorities and the banking industry have never encountered this situation, and all parties are studying how to reduce the further narrowing of the net interest margin," said a senior regulatory official.

Affected by factors such as the reduction of mortgage loan interest rates, the debt replacement of local financing platforms, and repricing, the net interest margin of the banking industry in 2024 is still expected to narrow. At the recent 2023 bank performance conference, many bank executives also talked about the trend of the net interest margin, and the views were almost unanimous, all indicating "there is downward pressure."

"The reduction of existing mortgage loan interest rates started in September last year, and its impact will continue to be released this year. And in February 2024, the 5-year LPR decreased by 25 basis points, and its impact will also continue to be presented this year. The superposition of the above factors will lead to a continuous downward trend in loan yields in 2024," said the management of China Merchants Bank recently.

The president of a branch of a state-owned large bank said that the financial industry must adhere to its political nature, people-oriented nature, and professionalism, return to serving the real economy, and also pursue a moderate profit margin. The industry's net interest margin is expected to further drop to 1.5% in the future, and it is difficult to increase significantly in the short term. The period of the commercial bank's net interest margin defense war will be extended.

What should be the acceptable value of the bank's net interest margin?

There are different versions of calculations in the industry, and the market-recognized value is around 1.7%-1.8%. "Some views also include the non-performing rate in the calculation of the net interest margin, which is not very fair, because there is a possibility of recovery of non-performing assets," said Zhou Yiqin, a financial regulatory policy expert and founder of Guan Shuo Consulting.

CICC estimates that considering dividend distribution and the stability of capital adequacy ratio, the minimum long-term ROE level of banks is 10%-11%, and the minimum net interest margin is about 1.6%-1.8%.In order to maintain a safe margin of 1.6%-1.8%, the interest spread has been placed in a prominent position by the banking industry in 2024. On March 29, the management of Industrial Bank stated that the interest spread issue is the most important indicator they are focusing on in 2024, and they expect to keep the spread above 1.8% by the end of the year.

"Implementing a regional + industry asset layout strategy, creating regional characteristics around industries; identifying hotspots for asset deployment from new business forms and models in the process of cultivating new quality productive forces; while stabilizing the mortgage base, strengthening consumer credit and business loans to achieve adjustments in the proportion of retail loans and retail assets. For the corporate line, the most important task is to increase the proportion of low-cost settlement deposits and strive to further reduce the interest payment rate for the whole year," said the management of Industrial Bank.

Recently, the chairman of the Agricultural Bank of China, Gu Shu, also discussed the work plan regarding the net interest margin: optimizing the deposit structure; accelerating digital operations to increase settlement deposits, etc. "The analysis of the net interest margin, in addition to looking at the interest rates of deposits and loans, also needs to consider the tax-exempt effect of investment varieties. For example, last year we invested more than 500 billion yuan in government bonds, which, although the interest rate is low, is very safe and also reduces income tax expenses," he said.

In this context, stable income also has more significance. "Despite the impact of fee reductions in the bank insurance channel, the performance of the banking industry's middle income in 2023 was not good compared to the previous year, but there is still a lot of room for improvement in this indicator for Chinese banks, which can compensate for the impact of the decline in net interest margin on profits," said a banking industry person.

Data from the Financial Regulatory Administration shows that in the fourth quarter of 2023, the proportion of non-interest income (including middle income) of commercial banks was 19.93%, an increase of 1.13 percentage points compared to the same period last year.

"In the long term, there is still downward pressure on the banking industry's interest spread, and non-interest income will be the focus of banks' future income," said Zeng Gang, adding that through integrated operations and the development of light capital or non-capital-consuming businesses, it is an important means to cope with the narrowing of the interest spread and to improve the return on capital. "In this regard, large banks with multiple licenses may have more advantages," Zeng Gang added.

In addition, cost reduction and efficiency improvement, and controlling the cost-income ratio are also common means adopted by banks. Wind data shows that in 2023, the cost-income ratio of the six major banks all increased compared to the previous year. In Zeng Gang's view, reducing the cost of branch personnel through digital transformation is the most important way for banks to achieve cost reduction and efficiency improvement. "With the improvement of digitalization, banks may also become more like technology companies in the future, which may change the market's valuation logic for banks," Zeng Gang believes that in terms of the progress and capabilities of digital transformation, the space for Chinese banks in this area may be greater than that of other countries.

"We should emphasize digitalization, but not only digitalization," Liu Xiaochun emphasized that industry research capability is the foundation of the banking industry. "For example, in the past, when banks lent to textile companies, they needed to understand the company, the equipment, and the products. Some old credit officers could tell the number of yarns by touching the fabric. Now, due to factors such as the separation of loan approval systems, we have lost some of this style, and we should still strengthen the research on the industry in the future," Liu Xiaochun said.

Stabilize the lifeline, banks should be ready to fight.

"Risk prevention and control is the eternal theme of financial work, and asset quality is also the lifeline of commercial banks," said Wang Jingwu, deputy president of ICBC, at the performance release conference, stating that he will continue to strengthen comprehensive risk management and be the ballast stone for maintaining financial stability.According to the Financial Regulatory Administration, in the fourth quarter of 2023, the non-performing loan ratio of commercial banks was 1.59%, a year-on-year decrease of 4 basis points. The overall asset quality of banks remains robust, but risks in certain areas have also emerged. Based on the annual report data currently released, in 2023, the non-performing loan ratio in retail business of several banks has increased.

Industry insiders in the lending sector have revealed that, in terms of retail credit, some banks are currently more passive in asset allocation. "High-quality assets are becoming increasingly scarce. The industry has reached a point where good customers have been 'harvested' almost once, and we can only explore further down. However, from the perspective of bank risk control, the risks are relatively high."

"To be realistic, the current situation is still unclear. In the retail sector, adjustments in product structure and improvements in customer repayment capabilities will take time. This year's asset quality, including retail performance, is still under pressure," said the management of Ping An Bank at the performance briefing.

By the end of 2023, the non-performing loan ratio of personal loans at Ping An Bank was 1.37%, an increase of 0.05 percentage points from the previous year. Among them, the non-performing loan ratio for credit cards was 2.77%, an increase of 0.09 percentage points year-on-year; the non-performing loan ratio for consumer loans was 1.23%, an increase of 0.15 percentage points year-on-year.

Regarding the future development of retail business, Zhang Zhaohui, Assistant President of Ping An Bank, pointed out that in terms of development strategy, the first priority is to control risks well. Different pricing strategies should be adopted for different customer groups, while optimizing costs, including risk costs, funding costs, and customer acquisition costs. For example, gradually reducing prices for high-risk, high-pricing customer groups, increasing the proportion of medium and low-risk customer groups, managing in a portfolio manner, and implementing a "one bank, one policy" risk policy.

In terms of corporate business, the non-performing loan ratio in the real estate industry is also quite prominent. Annual reports from several listed banks show that in 2023, the non-performing loan ratio in the real estate industry exceeded 5%, not only far exceeding other industries but also showing an upward trend.

Lu Jiajun, Chairman of Industrial Bank, stated at the performance briefing that due to the superposition of domestic cyclical and structural contradictions, and facing some issues in the economic recovery, some industries have excess capacity, insufficient effective demand, weak social expectations, and more hidden risks, especially in real estate, government financing platforms, and small and medium-sized enterprises, where operational issues are more prominent.

Looking forward to 2024, Miao Jianmin, Chairman of China Merchants Bank, said that the difficulty of bank profit growth continues to increase, and the banking industry continues to face challenges such as narrowing interest spreads, declining fee rates, overcoming the decline in risk appetite, and insufficient effective credit demand. At the same time, the risk environment is complex and severe, and strong regulation has become the new normal, putting higher demands on bank operation and management.

At the performance briefing, several banks also stated that they are strengthening their industry research capabilities.

CITIC Bank said that in recent years, it has strengthened industry research and, based on in-depth industry research, formulated credit policies, credit approval standards, marketing guidelines, and resource allocation policies.China Everbright Bank stated that in 2023, the bank has established a collaborative industry research team across its head office and branches, setting up strategic industry teams at both levels. They have focused on supporting eight major industries, including green finance, digital economy, and consumer goods, with an emphasis on three key areas: technology innovation finance, green finance, and advanced manufacturing.

In practice, many banks have integrated industry research capabilities into their risk control processes, aiming to ensure the quality of assets. It is understood that the real estate industry is also within the scope of research.

In January of this year, the Ministry of Housing and Urban-Rural Development and the Financial Regulatory Authority jointly issued the "Notice on Establishing a Coordination Mechanism for Urban Real Estate Financing," requiring cities at the prefecture-level and above to establish a coordination mechanism for real estate financing, to build a communication platform between the government, banks, and enterprises, and to promote precise docking between real estate companies and financial institutions.

At the press conference held by the State Council Information Office that month, Deputy Director of the Financial Regulatory Authority Xiao Yuanqi said that in recent times, the Financial Regulatory Authority has actively cooperated with industry regulatory departments and local governments to implement comprehensive policies from both the supply and demand sides of the real estate market, continuously increasing financial support.

For banks, "how to support corporate financing while ensuring the stability of asset quality" has always been a question they have to face. In the current economic transition and when some industries have more prominent operational issues, it poses a challenge to the banks' asset quality management capabilities.

A banking industry insider admitted, "Policies encourage banks to support reasonable financing needs of enterprises, but who is responsible for the bad loans that are made? Therefore, overall, we are very cautious, increasing management efforts from access, process management, to post-loan collection. In terms of real estate, we will focus more on economically developed areas such as first and second-tier cities."

It is worth mentioning that for the risks in the real estate market in 2024, senior executives of several listed banks have given optimistic forecasts. In the view of industry insiders, policy support has already shown certain effects in promoting the stable development of the real estate market.

"We insist on controlling the direction of investment and optimizing the increase, fully supporting the stable and healthy development of the market, and supporting the reasonable financing needs of real estate enterprises of different ownerships equally, actively serving the construction of the 'three major projects,' and promoting the construction of a new model of real estate development," said Wang Jingwu, who also stated that by the end of 2023, the non-performing loan ratio of the real estate industry within the territory of ICBC had decreased by 0.77 percentage points compared to the beginning of the year.

With the decline in credit demand from the real estate and local financing platforms, optimizing asset structure and finding new high-quality assets is also an essential part of industry research.

Zeng Gang believes that the five major financial articles represent the opportunities for the future of the banking industry. "This is not only the direction encouraged by policies but also contains huge business opportunities."Recently, the management of several banks has indicated that five major articles (technology finance, green finance, inclusive finance, elderly care finance, and digital finance) will be the key areas for future investment by banks.

To this end, ICBC has recently established a General Technology Finance Center, a Digital Inclusive Center, and a Leading Group for Serving the "Five Major Articles" to advance related work.

Agricultural Bank of China stated that it aims to achieve a growth of more than 1.3 trillion yuan in county-level loans by 2024; inclusive finance sector loans are expected to grow by more than 800 billion yuan; and it will continue to maintain a significantly higher growth rate in manufacturing loans, strategic emerging industry loans, and technology enterprise loans compared to the overall bank.

Economic recovery is the cornerstone of the improvement of bank indicators. Several industry insiders interviewed have expressed that as the effects of national macroeconomic regulation gradually take effect, the upward trend of the economy is further consolidated and strengthened, social expectations will further improve, risk resolution in key areas will gradually achieve results, and the repayment ability of residents and enterprises is expected to steadily increase. This will have a positive impact on bank profitability and asset formation.