China's banks face their 'Japanification moment', S&P report warns

China's banks are edging towards their "Japanification moment", as years of yielding margins to support the economy have "left the system thin on profitability and more exposed to credit shocks", according to a new report by S&P Global Ratings.

Japanification is characterised by a prolonged period of low growth and weak profitability, similar to the state of Japan's economy after the country's asset bubble burst in the early 1990s.

While other banking systems had weathered ultra-low rates by diversifying revenue and cutting costs, "Chinese lenders may have fewer such options, leaving them more reliant on lowering credit losses to stay profitable", the report warned.

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For China's central bank, "safeguarding growth and social stability will take priority over bank profits", S&P credit analyst Ming Tan said in the report.

To stimulate growth, Beijing has cut both the one-year and five-year prime loan rates to historic lows, which further squeezed mainland banks' profitability.

At the same time, banks were directed to lend to weak borrowers and offer concessions, from the pandemic-era fee reduction policy for small businesses to lower charges levied on funds and insurance products for consumers, according to the report.

S&P's assessment reflects the tough situation for China's banks, as geopolitical tensions have discouraged them from expanding in some foreign markets.

According to the report, international expansion could slow a decline in the net interest margin (NIM) "at the expense of higher credit losses down the road for some of them." NIM measures the difference between the interest income a financial institution earns and the interest it pays out, relative to its interest-earning assets.

S&P projected NIM in China to settle at 1.27 per cent when policy rate cuts end in 2027, down from 1.52 per cent in 2024. "This assumes GDP growth stabilises by then," the report said.

Still, Chinese bank stocks have rallied since 2023 until nce 2023.

Declining government bond yields had also pushed investors, including many insurance firms, to seek better returns in bank stocks, which were generally seen as stable and offered generous dividends, according to analysts.

Ten-year Chinese government bond yields collapsed to a record low of 1.64 per cent in June from 2.64 per cent in June 2023, according to Bloomberg data. As of Wednesday, yields climbed back to 1.9 per cent.

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China's banks have led a government drive to encourage more listed companies to pay out generous dividends since last year, with the nation's six major state-controlled lenders handing out interim dividends for the first time.

Recently, however, these stocks have become less attractive. Benchmarks tracking major Chinese banks listed in Hong Kong and onshore markets have fallen by more than 10 per cent since the middle of July, while broader markets have rallied. That came after a four-year stretch during which bank shares outperformed the overall market.

People walk by office towers in the Lujiazui financial district of Shanghai. Photo: Reuters alt=People walk by office towers in the Lujiazui financial district of Shanghai. Photo: Reuters>

Investors had taken profits from their bank stock holdings after significant returns in recent years and were shifting funds into sectors such as technology, pharmaceuticals and new energy, according to May Yan, head of Asia financials research at UBS Global Research.

After the much-publicised breakthrough of Chinese artificial intelligence start-up DeepSeek early this year, "some investors are rotating out of bank stocks and into these hotspots", Yan said.

According to Kenny Wen, head of investment strategy at KGI Asia, most "dividend stocks have underperformed recently".

The MSCI China Bank Index declined to 296.22 on Thursday from its peak on July 10 this year.

Hong Kong-listed shares of Industrial and Commercial Bank of China, the world's largest bank by assets, have fallen 9 per cent since then, while those of China Construction Bank dropped about 13 per cent since peaking around the same time.

Over that period, the Hang Seng Index rose more than 10 per cent, while the Hang Seng Tech Index climbed over 20 per cent. Hong Kong-listed shares of Alibaba Group Holding, owner of the Post, closed at HK$174 on Wednesday, near a four-year high.

Quarterly net purchases of bank stocks by mainland funds through the southbound Stock Connect scheme have gathered pace since mid-2023. However, these funds have switched to insurers in recent months, according to data compiled by CGSI. Monthly net buys of southbound flows into China banks in August were the lowest since September 2024.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2025 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2025. South China Morning Post Publishers Ltd. All rights reserved.

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