Debt Resolution: Key for Banks & Real Economy
In recent years, the banking sector in China has encountered a plethora of challenges and opportunities, particularly in the context of economic transformation and evolving market conditions. As of the third quarter of 2024, the performance reports of 42 listed banks have been fully released, painting a clear picture of the current state and development trends of China's banking industry.
From the financial reports of these banks, it was observed that for the first three quarters of 2024, the banking industry overall achieved a revenue of 4.28 trillion yuan, marking a slight decline of 1.05% year-on-year; however, the net profit attributable to equity holders reached 1.66 trillion yuan, showing a growth of 1.43% compared to the previous year. This data illustrates that despite a dip in revenue, the profitability of the banks continues to grow, highlighting the sector's robust adaptability to shifts in revenue structures and cost management.
But why are we discussing banks specifically? One significant reason is that the banking sector constitutes approximately 16% of the Shanghai Composite Index, making it a pivotal player in the capital markets.
Financial institutions are often considered the lifeblood of the real economy, serving as a critical force driving socioeconomic development. In China, the financial sector is predominantly led by banking institutions, whose assets make up over 90% of the total assets held by financial entities. By providing financial support, banks enable the real economy to accelerate its growth, showcasing their significant role in facilitating various enterprises. Hence, robust financial statements from banks translate into greater loan disbursements and support for the real sector.
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Recent data indicates a revival in the performance of state-owned banks as reflected in their quarterly reports. In contrast to their mid-year reports showing a marginal profit decline of about 1%, their third-quarter profits have nearly all reverted to positive growth, alongside an increase in operating revenue compared to the mid-year figures.
An interesting aspect worth noting is that in 2024, the Loan Prime Rate (LPR) declined by 30 basis points, with a 25 basis point reduction noted specifically in the third quarter. A crucial factor contributing to banks' profitability is the net interest margin, which is the difference between lending rates and deposit rates.
Generally, when interest rates decline, the narrowing of this margin can lead to reduced bank profits. However, with a significant drop of 25 basis points in the third quarter and synchronous adjustments of both lending and deposit rates by the central bank, banks maintained a stable margin. Since 2022, the one-year LPR and the one-year deposit rate have maintained a consistent 2% spread, meaning that when loan rates decrease, deposit rates follow suit, thereby cushioning banks from significant profit erosion.
At present, the one-year deposit rate hovers around 1%, thus theoretically allowing for a further interest rate cut of up to 100 basis points without altering the interest margin. This stability implies that banks' financial reports are largely secure as long as there isn't substantial downward pressure on the interest margin.
Furthermore, in the event of interest rate cuts, banks might experience some short-term benefits due to the nature of their deposit-related activities. Funds garnered from deposits are not only utilized for loans but can also be invested in other vehicles, such as bonds, despite not being allowed to invest directly in equities.
Two significant concerns currently dominating the market's attention regarding banks include capital injections and debt resolution.
After several years, the Ministry of Finance has reissued special treasury bonds to recapitalize major state-owned banks. Unlike previous instances aimed specifically at risk mitigation, this round of capital infusion focuses on fostering expansion, aiming to bolster the core Tier 1 capital of the big state-owned banks. This strategy is intended to better support the implementation of national policies and enhance support for the real economy, essentially preparing for potential future challenges.
This basic principle resembles any business venture; the larger the initial capital, the more significant the potential for business expansion. Following capital injections, banks are equipped to issue more loans to customers.
Concerning debt resolution, market apprehensions regarding banks' valuations are partially attributed to fears surrounding non-performing assets. Data from Tonghuashun iFinD indicates that as of the end of the third quarter, the non-performing loan ratio for the 42 A-share listed banks fell to 1.25%. Given that 28% of loans issued by listed banks were allocated to local government financing projects by the end of June, and with a non-performing rate of 1.13%, this ratio does not seem excessively alarming. Moreover, with the anticipated annual burden of at least 800 billion yuan for debt resolution over the next five years, there is hope for significant alleviation in the difficulties associated with non-performing loans in local investment projects. This approach directly addresses a critical issue within the banking sector.
To effectively propel financing costs downward in the real economy, it is of utmost importance to continuously enhance financial services, resolving the bottlenecks and challenges that hinder capital flow into the real economy. The banking sector's stability and performance are therefore intrinsically linked to the Shanghai Composite Index and the real economy, effectively serving as key indicators.
Investment, when discussing the banking sector, leads one to consider the importance of understanding effective business models.
Typically, a successful business model boasts a robust economic moat, long-term sustainability, and scalability, combined with high customer loyalty and stability amid fluctuating economic conditions. Such characteristics elevate businesses above their competition and create long-term value for investors.
In essence, investment is akin to casting a vote for a company's business model. A stable, efficient, and innovative model can generate enduring value for a firm while offering investors consistent returns. Investors should aim to identify enterprises with long-term growth potential or those they can collaborate with, mirroring the decade-long investment strategy focused on cultivating promising opportunities.
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