China Banks Report Interpretation

Overview

This 2Q26 wrap reviews China banks’ earnings, margins, balance-sheet growth, asset quality and capital returns. Morgan Stanley finds the strongest improvement at SOE banks, while mid-sized banks show a much wider split between resilient operators and banks still absorbing legacy-credit costs.

Core views

Morgan Stanley’s central conclusion is that SOE banks led the sector’s 2Q26 improvement. Higher net-interest income, still-solid investment gains and cost discipline lifted SOE-bank revenue growth to 9.2% YoY and pre-provision operating profit growth to 13.0% YoY, versus 2.7% and 4.0%, respectively, for the rest of the banks. SOE-bank profit growth accelerated to 5.9% YoY, while the all-bank average slipped to -0.2%. The report attributes the stronger outcome to pricing rather than balance-sheet volume: earning-asset growth at covered SOE banks slowed to 7.6% YoY from 9.6% in 1Q26, yet average sector NII growth accelerated to 9.0% YoY from 7.9% in 1Q26 and 3.7% in 4Q25; SOE banks delivered 9.9% NII growth. Margins improved modestly for a second consecutive quarter. Average NIM rose about 1bp QoQ for both SOE banks and joint-stock banks, supported by stabilizing loan yields and further falling deposit costs. The biggest QoQ NIM gains were 8.0bps at Minsheng, 6.8bps at Huaxia, 5.4bps at Chengdu and 4.3bps at ABC. Loan-yield pressure persisted but eased: average covered-bank loan yield declined 11bps HoH in 1H26, compared with a 22bp decline in 2H25, while SOE-bank loan yield fell 6bps to 2.77%. Deposit costs declined 14bps HoH on average, and SOE interbank funding costs fell about 13bps. Management commentary points to further NIM stabilization in 2H26 at CITIC and ABC, while BOC expects stabilization and recovery aided by FX spreads. Non-interest revenue was less uniform. Fee-income growth slowed to 3.6% YoY from 6.9% in 1Q26 as bank-card fees remained a drag, although wealth-management-related fees held up. ABC and CCB reported fee-income declines of 28% and 12% YoY, respectively, partly because of high prior-year bases; Industrial and CMB grew fees by 9.8% and 7.2%, while Ningbo grew 25%. SOE banks’ non-interest income rose 8.4% YoY, supported in part by large bond portfolios with lower historical costs and appreciation in some early-stage technology investments, compared with a -4.9% all-bank average. Management teams also identified wealth management, capital markets, investment and trading, FX and cross-border services as growth areas. The report stresses an increasing earnings divergence among mid-sized banks. Ningbo continued to lead the group in revenue and profit growth and ROE, and remains Morgan Stanley’s Top Pick. SPDB, Hangzhou and Ningbo reported solid 8-14% YoY profit growth, while Minsheng, Industrial, Huaxia and Everbright faced weaker results as they caught up on provisions and write-offs. Morgan Stanley sees improving underlying operations at Minsheng because NII growth rebounded, NIM improved and PPOP remained healthy despite pressure from its legacy loan book. It also sees improving trends at CMB, where more rational loan growth, stronger wealth-related fees and 15% YoY retail-AUM growth offset weaker bank-card fees. Balance-sheet expansion became more measured. Covered banks’ loan growth slowed to 6.1% YoY in 2Q26 from 6.9% in 1Q26, and quarterly loan growth slowed to 0.7% from 3.9%. Retail loan balances generally declined HoH amid household deleveraging and asset-quality pressure, while BOC, ABC and PSBC still achieved more than 8% YoY loan growth. Deposits increased only 0.7% QoQ on average, but CMB, BoCom, Industrial, Ningbo and Chengdu gained share. Morgan Stanley views slower expansion and lower RWA growth—about 1.3% QoQ in 2Q26 versus around 2% in 2Q25—as more rational and sustainable rather than simply negative for growth. Asset quality remains the key offset to the earnings improvement. The end of Covid-era forbearance on property and retail loans, together with the removal of inclusive-loan window guidance, has pushed banks to recognize and digest risks more actively. Average annualized NPL formation rose 4.9bps YoY in 1H26, average overdue-loan ratios rose 9.3bps HoH, and credit costs increased about 7bps YoY on average. Retail credit quality, including credit cards, is the principal pressure. Everbright’s NPL formation rose 60bps YoY to 1.8%; Huaxia’s increased 31bps YoY, and Minsheng continued to digest property risk. By contrast, CCB, ABC, PSBC and CITIC had formation increases below 5bps HoH among larger banks, while city banks generally showed lower NPL formation YoY. Overall NPL ratios remained broadly stable, but lower-coverage banks such as Everbright, Huaxia and Minsheng had less room to release provisions, making profits more exposed. Capital and shareholder returns are the report’s final positive theme. SOE banks and CMB maintained CET1 ratios of 10-14%, while total capital adequacy ratios rose 31.5bps QoQ on average despite a modest interim-dividend-related CET1 decline. Payout ratios rose about 1ppt across SOE banks; ICBC, CCB, BOC and ABC moved to roughly 31%, supporting about 8% DPS growth for SOE banks and CITIC. Morgan Stanley argues that stable capital, slower RWA growth and gradually higher payouts should make growth more sustainable and support further group re-rating, although profit-growth dispersion will continue to shape investor preferences.

Analysis framework

Morgan Stanley compares covered banks’ 2Q26 and 1H26 results across revenue, NII, NIM, fees, investment income, costs, PPOP, net profit, ROE and ROA. It then links balance-sheet growth and funding costs to margin trends, evaluates asset quality through NPL formation, overdue loans, special-mention loans, coverage and credit costs, and assesses capital and payout ratios as indicators of sustainability and shareholder return. The report uses cross-bank comparisons and management guidance to identify likely 2H26 developments.

Methodology notes

• Financial-sector metricsNet Interest Margin (NIM) Analysis

  NIM analysis

  The report tracks changes in loan yields, deposit costs, interbank funding costs and NIM to explain the acceleration in net-interest income despite slower asset growth.

• Financial-sector metricsProvision Coverage and Asset Quality

  Asset-quality and provision-coverage analysis

  The report uses NPL formation, overdue and special-mention loans, NPL coverage, loan-loss reserves and credit costs to assess the scale and earnings effect of risk digestion.

• Industry AnalysisVolume-price decomposition

  Volume-versus-pricing analysis

  The report contrasts slowing loan and earning-asset growth with improving NII growth to show that margin and pricing changes mattered more than volume in 2Q26.

• Valuation methodsPB valuation

  Valuation comparables using P/B alongside P/E, dividend yield, ROE and ROA

  The valuation table compares covered A- and H-share banks on forward valuation and profitability measures; it supports the report’s sector re-rating discussion.

Asset mapping & comparison

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

• Bank of Ningbo (002142.SZ)

  Morgan Stanley’s Top Pick and a leading mid-sized-bank performer.

  Strengths

  Led the group in revenue and profit growth as well as ROE; maintained rapid fee-income growth.

  Comparison

  Reported 18% YoY PPOP growth, ahead of other smaller banks.

  Risks

  Ongoing sector-wide retail-credit pressure and risk digestion.

• SOE banks

  Primary positive earnings theme in the sector review.

  Strengths

  Accelerating NII, revenue, PPOP and net-profit growth; rising payout ratios and stable capital.

  Weaknesses

  Loan and earning-asset growth slowed; retail credit remains a sector risk.

  Comparison

  Revenue growth of 9.2% and PPOP growth of 13.0% exceeded the rest of the banks’ 2.7% and 4.0%.

  Risks

  Continued loan-yield pressure and higher credit costs.

• China Minsheng Bank

  Turnaround and risk-digestion case.

  Strengths

  NII growth rebounded, NIM improved and PPOP growth remained healthy, indicating improved core operations and client base.

  Weaknesses

  Legacy-loan write-offs and provisions pressured profits.

  Comparison

  Its profit performance remained weaker than resilient peers despite improved core operating indicators.

  Risks

  Further property-risk digestion and provisioning needs.

• China Merchants Bank

  Improving mid-sized-bank trend.

  Strengths

  More rational loan growth, stronger wealth-related fees and 15% YoY retail-AUM growth.

  Weaknesses

  Bank-card fee pressure persisted.

  Comparison

  Fee income grew 7.2% YoY, behind Industrial’s 9.8% but ahead of many peers.

  Risks

  Retail asset-quality pressure and slower loan growth.

Key data

• SOE-bank revenue growth9.2% YoY in 2Q26Versus 2.7% YoY for the rest of the banks.
• SOE-bank PPOP growth13.0% YoY in 2Q26Versus 6.8% YoY for all banks on average.
• SOE-bank net-profit growth5.9% YoY in 2Q26The all-bank average was -0.2%.
• Average NII growth9.0% YoY in 2Q26Up from 7.9% in 1Q26; SOE banks grew 9.9%.
• Average NIM changeabout +1bp QoQ in 2Q26Observed for both SOE banks and joint-stock banks.
• Covered-bank loan growth6.1% YoY in 2Q26Down from 6.9% YoY in 1Q26.
• Average annualized NPL formation+4.9bps YoY in 1H26Reflecting continued retail-credit pressure and risk digestion.
• Average payout ratio at SOE banksabout 31%Up roughly 1ppt, supporting about 8% DPS growth for SOE banks and CITIC.

Impact & implications

Morgan Stanley sees a more constructive sector setup in stronger SOE-bank earnings, modest margin stabilization, improving capital returns and slower, more disciplined balance-sheet expansion. The report expects the benefits to be uneven: banks with stronger operating franchises and lower provisioning pressure are better positioned, while retail-credit stress and limited provision-coverage flexibility may continue to weigh on weaker mid-sized banks.

Risks

• Retail asset quality remains the main sector pressure, particularly in credit cards and other consumer loans.
• The end of forbearance programs is increasing NPL recognition, write-offs, provisions and credit costs at some banks.
• Banks with lower provision coverage, including Everbright, Huaxia and Minsheng, have less flexibility to absorb additional credit stress without profit pressure.
• Loan-yield pressure and slower balance-sheet growth could constrain earnings if funding-cost reductions do not continue.

What to watch

• Whether NIM stabilizes further in 2H26 as loan yields, deposit costs and FX spreads evolve.
• Retail NPL formation, overdue loans, credit-card risk and the pace of provision catch-up.
• Fee-income recovery, particularly wealth-management and capital-markets-related revenue versus continuing bank-card-fee weakness.
• The pace of payout-ratio increases, RWA growth and capital-ratio trends as indicators of sustainable shareholder returns.
• Whether mid-sized-bank operating improvement translates into profits after credit-cost effects.