China Financials: Anti-involution and deleveraging policies reinforce Morgan Stanley’s constructive China financials view

Overview

This China Financials report interprets two September policy developments as evidence that policymakers are prioritizing supply-side capacity rationalization and sustainable deleveraging over leverage-led demand stimulus. Morgan Stanley sees that path reducing systemic financial risks and underpinning brokers, insurers and banks in 2H26 and toward 2027.

Core views

Morgan Stanley argues that China is doubling down on a more sustainable response to overcapacity: restraining irrational investment and destructive price competition rather than re-leveraging to lift near-term domestic demand. The NDRC and SAMR’s cost-accounting notice gives regulators a framework to establish firms’ production costs using audited records, industry averages where needed, and capacity-utilization adjustments. The report emphasizes that this does not set product prices or prohibit normal competition; instead, it makes disorderly below-cost pricing more enforceable and could improve margins, investment discipline, and the exit or restructuring of inefficient capacity. A second policy—the September 10 State Council circular on delayed SME payments—strengthens implementation of a longstanding objective. It encourages payment terms within 60 days, promotes cash payment, monitors large companies with unusually high payables, tightens disclosure and enforcement, and requires central SOEs to pay SMEs entirely in cash. Morgan Stanley believes this can curb shadow leverage at large corporates, improve SME cash flow without additional borrowing, and reduce incentives for debt-funded capacity expansion. The report notes that repeated earlier arrears-clearing campaigns indicate prior implementation gaps, making the latest specific payment and monitoring requirements significant. The institution sees evidence that anti-involution measures since mid-2024 are already moderating capacity formation. Manufacturing medium- to long-term loan growth fell from more than 30% in 2023 to 6.6% by end-2025 as policy support was reduced. Industrial investment growth has run below demand growth since September 2025, and the gap between nominal manufacturing-output growth and capex growth moved from +5.5% at end-2024 to negative territory. By July 2026, 85% of manufacturing subsectors by liabilities had slowed capex growth versus 1H24, while 37% had improving profitability; electrical equipment was highlighted as an early-cycle beneficiary, whereas slower capex moderation continued to weigh on auto-sector profitability. Overall manufacturing-firm YTD profit growth was 18.8% year on year in July 2026. Morgan Stanley links more controlled capacity expansion and strong exports to greater scope for financial deleveraging. It expects stricter LGFV financing discipline, higher return and cash-flow requirements for projects funded by local special bonds, and continued household deleveraging to create near-term credit-demand pressure but accelerate long-term risk reduction. Household debt-to-GDP had declined to 60.5% in 2025 from 63.6% in 2020, but the report still sees a need to normalize consumer and personal operating loans. It considers household credit growth broadly in line with disposable-income growth, or 3-4%, a reasonable medium-term trajectory. The report also notes that high-risk assets across the financial system fell from Rmb62tn, or 30.2% of total financial assets, in 2017 to Rmb21tn, or less than 5%, in 2025; TSF growth is currently 7.2%, with around 6% described as a more sustainable medium-term level. For financial equities, Morgan Stanley expects lower risk premia, healthier financial asset yields and a more market-led credit cycle. It forecasts a gradual 50bp recovery in financial asset yields over the next three years, with 70-80bp potential in a bull case. For banks, this should stabilize NIMs and allow a modest recovery from 2026, while lower credit costs support profit recovery despite retail asset-quality pressure. Covered banks’ long-term ROE is expected to stabilize around 9%. The report notes that H-share banks were up 17.4% year to date versus a flat HSI, while A-share banks rose 4.3% against CSI 300’s -1.5%. The report sees brokers as underappreciated beneficiaries of a positive capital-markets loop. A-share average daily turnover was above Rmb2.6tn year to date, doubling year on year; 2025 ADT had already exceeded the prior 2021 bull-cycle peak by around 50%. Equity’s share of household financial assets recovered to an estimated 10.5% in 2025 from 9.3% in 2024, but remained 1-2 percentage points below its 13.3% 2021 level. Mutual-fund AUM reached Rmb40tn by August from more than Rmb36tn at the start of the year, hybrid-fund launches rose 2.5x year on year from January to July, and private-fund AUM added Rmb5tn over 12 months. Morgan Stanley expects prolonged capital-market activity to expand leading brokers’ ROE. For insurers, Morgan Stanley remains constructive after strong 1H26 results, citing resilient savings-product demand, better agency and bancassurance business quality, stronger agent productivity, expense discipline, and gradually higher allocations to high-dividend assets. It acknowledges a difficult 3Q26 comparison base and near-term disruption from tighter bancassurance regulation, but expects sales momentum to improve later in 3Q26 and in 4Q26. Across banks, the report identifies Bank of Ningbo as its Top Pick for double-digit loan and profit growth, market-share gains and stronger products and services; it also highlights Industrial Bank’s 6.2% A-share dividend yield, CITIC Bank-H’s 5.6% yield and healthy profit growth, and CCB-H and BOC-H for stable profit growth with capital-injection dilution already reflected.

Analysis framework

The report begins with the content and enforcement implications of the new policies, then tests their direction against credit, capex, profitability and leverage data. It connects supply-side rationalization to LGFV and household deleveraging, and then traces the expected effects through financial asset yields, bank NIM and credit costs, capital-market activity, and insurance operating fundamentals.

Methodology notes

• Industry AnalysisSupply-demand framework

  Supply-side capacity rationalization versus leverage-led demand stimulus

  Morgan Stanley assesses anti-involution measures by their ability to limit excess capacity, reduce destructive pricing, and bring investment growth into better alignment with industrial demand.

• Financial-sector metricsNet Interest Margin (NIM) Analysis

  Bank asset-yield, NIM, credit-cost and ROE transmission

  The report links lower financial risks and recovering asset yields to NIM stabilization, lower credit costs, profit recovery and longer-term bank ROE.

• Valuation methodsDDM (Dividend Discount Model)

  Three-stage dividend discount model

  For banks, Morgan Stanley uses probability-weighted base, bull and bear dividend-discount scenarios, with assumptions for discount rates, ROE and dividend payout.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Bank of Ningbo Co. Ltd (002142.SZ)

  Top Pick among covered banks

  Strengths

  Double-digit loan and profit growth, continuing market-share gains, and superior products and services.

  Comparison

  Identified as Morgan Stanley’s Top Pick.

  Risks

  Potential leadership change, higher SME and retail defaults, and pricing pressure from destructive competition.

• Industrial Bank Co. Ltd (601166.SH)

  Covered bank

  Strengths

  6.2% dividend yield, described as attractive among covered A-share banks.

  Comparison

  Highlighted for dividend yield versus the A-share coverage universe.

• China CITIC Bank Corporation Limited (00998.HK)

  Covered bank

  Strengths

  5.6% dividend yield and healthy profit growth.

  Comparison

  Highlighted among preferred H-share bank exposures.

  Risks

  Asset-quality deterioration if economic trends worsen and weaker-than-expected fee income.

• China Construction Bank Corp. (00939.HK)

  Covered bank

  Strengths

  Stable profit growth with capital-injection dilution already reflected.

  Comparison

  Preferred among SOE banks alongside BOC-H.

  Risks

  Macro slowdown, accelerated deposit-rate deregulation, and potentially higher SME credit risk as inclusive-finance lending expands.

• Bank of China Limited (03988.HK)

  Covered bank

  Strengths

  Stable profit growth with capital-injection dilution already reflected.

  Comparison

  Preferred among SOE banks alongside CCB-H.

  Risks

  Social responsibilities and weaker overseas economic conditions could pressure credit quality and asset yields.

Key data

• Manufacturing medium- to long-term loan growth>30% in 2023 to 6.6% by end-2025The report views the deceleration as reducing credit support for capex expansion.
• Manufacturing subsectors with slower capex growth85%By liabilities, relative to 1H24, as of July 2026.
• Manufacturing subsectors with improving profitability37%By liabilities, as of July 2026.
• Manufacturing firms’ YTD profit growth18.8% YoYJuly 2026.
• High-risk financial assetsRmb62tn / 30.2% in 2017 to Rmb21tn / less than 5% in 2025The report’s measure of progress in financial-system clean-up.
• Financial asset yield recovery forecast50bp over three years; 70-80bp in bull caseExpected to support bank NIM and profitability.
• A-share average daily turnover>Rmb2.6tn2026 YTD, doubling year on year.

Impact & implications

Morgan Stanley expects policy-led capacity rationalization and deleveraging to reduce financial risks more durably than demand stimulus. It argues that this should improve the operating backdrop for financial assets: brokers benefit from market activity and institutionalization, insurers from resilient savings demand and better business quality, and banks from recovering asset yields, stabilizing NIMs and lower credit costs.

Risks

• Bank asset quality could weaken if economic conditions deteriorate, including through SME and retail lending.
• Destructive market competition could create pricing pressure.
• A macro slowdown, accelerated deposit-rate deregulation, or weaker fee income could weigh on bank earnings.
• For insurers, tighter bancassurance regulation and a difficult 3Q26 comparison base may disrupt near-term growth.

What to watch

• Implementation and enforcement of the cost-accounting and SME-payment rules, including adoption of 60-day cash-payment practices.
• The pace of industrial capex moderation, profitability improvement and financial-risk reduction.
• LGFV financing discipline, special-bond project return requirements and household credit normalization.
• Whether bancassurance channels adapt to new regulations and regain growth momentum.
• Early progress of insurers’ 2027 sales campaigns.