Morgan Stanley believes that China's banking industry is gradually shifting from relying on loan growth to a more rational competition and loan pricing strategy. This transition is expected to help stabilize the bank's net interest income (NIM) and potentially reduce long-term risks. Morgan Stanley expects that the performance of the banking industry will outperform the overall market in the next 12 months.

On September 8th, Richard Xu and three other analysts from Morgan Stanley released a report stating that most banks have indicated a weakening expectation for various types of loan growth, including total loan growth and loans to small and medium-sized enterprises. Against this backdrop, banks will pay more attention to the quality of loans rather than the quantity, which may foster a more rational competitive environment.

The key focus areas for corporate loans are still industries supported by policies and industries with growing demand. Banks have stated that they will prioritize support for strategic emerging industries, medium- to long-term manufacturing, technology, inclusive finance, and green finance.

Some banks have outlined specific strategies: Industrial and Commercial Bank of China plans to deploy more loan resources in advance in the event of a decline in loan yields; China CITIC Bank plans to pay more attention to industries with overcapacity risks; Shanghai Pudong Development Bank has shifted more credit resources towards enterprises, especially in infrastructure, utilities, manufacturing, and wholesale industries, and will continue to focus on these areas...

Pressure on net interest margin (NIM) may decrease in the second half of the year.

Morgan Stanley points out that while the decline in the loan market's quoted interest rate (LPR) may reduce the interest income banks receive from loans, at the same time, the interest cost paid to depositors by banks is also decreasing, which helps mitigate the negative impact on NIM.

In addition, although the repricing of existing mortgage loans may increase pressure on NIM, most banks indicate that they have not yet received consultation requests from policymakers regarding adjustments in this regard. This means that there are currently no policy requirements forcing banks to lower mortgage loan rates.

The banks also stated that if necessary, they have confidence in further reducing the cost of deposits. This may be achieved by offering lower deposit rates or attracting more low-cost funds to maintain or improve the NIM.

Morgan Stanley wrote:

On the liabilities side, many banks acknowledged that controlling funding costs is a key factor for the relatively stable NIM in the second quarter of 2024. The impact of the reduction in deposit rates is gradually becoming evident, and banks are actively attracting low-cost deposits. We expect this to continue to support the NIM.

In particular, China Construction Bank stated that the decrease in deposit rates in July may offset the 10 basis point decrease in the one-year and five-year LPR in July, with limited impact on 2024. On the other hand, most banks, including China Construction Bank, Postal Savings Bank of China, CM Bank, China Citic Bank Corporation, and Shanghai Pudong Development Bank, all indicated a continued shift to more time deposits in the second quarter of 2024.

On the asset side, many banks stated that, due to more rational competition, loan yields are tending to stabilize. In addition, banks have been actively adjusting their asset portfolios, including asset categories and maturities, to offset the impact of declining loan yields.

CM Bank stated that they have not yet received any instructions from regulatory authorities, but if such policies are implemented, it is expected to have a negative impact on the banks.

Pressure on non-interest income is also expected to ease.

Morgan Stanley also believes that in the second half of this year, the pressure on the decline of non-interest income is expected to ease. For example, banks like China Construction Bank have achieved optimization of the structure of non-interest income through new business. CM Bank has implemented fee discounts to enhance customer service, while banks like Industrial and Commercial Bank of China are driving non-interest income growth through investment banking and asset management businesses.

Some banks, especially Bank of Ningbo and Bank of Beijing, have seen strong growth in retail Assets under Management (AUM), while urban banks have witnessed rapid growth in retail deposits. Despite the slowdown in deposit growth for state-owned enterprise banks, banks are overall tackling the challenges brought by rate cuts through diversification strategies.

In terms of asset quality, although some banks have experienced a decline in credit quality for small and medium-sized enterprise and retail loans, analysts are optimistic about the stability of banks' medium and long-term credit costs. Banks are also taking measures to control long-term risks by adjusting loan pricing and optimizing loan structure.

China Construction Bank, Agricultural Bank of China, and Bank of China express confidence in maintaining stable asset quality, while China Citic Bank expresses confidence in improving asset quality.

Morgan Stanley also points out that banks are looking for other assets to generate returns or liquidity, including increasing investments in bonds and allocating more assets to non-bank financial institutions, which are all beneficial for the steady recovery of the banking industry.