Investment Topics January 6, 2025 111

Sustained Growth of Bank Expansion

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In the contemporary banking sector, the negative pressure on interest margins has spotlighted the positive implications of scale on profitability and capital replenishment, illuminating the sustainability of growth. Over the past two years, the performance of the banking industry has exhibited a marked divergence, with scale emerging as a pivotal factor influencing this performance disparity. Against a backdrop of a sluggish domestic economic recovery and weak growth momentum, commercial banks are expected to experience a gradual decline in net interest margins, making scale growth a primary positive driver of profitability for these institutions.

Currently, net interest margins are continually contracting, primarily due to a rapid decline in interest rates on the asset side that outpaces reductions on the liability side. This phenomenon occurs in an environment characterized by weak demand for real financing, combined with governmental directives encouraging banks to pass on benefits to customers. It reflects a broader trend where the real economy is entrenched in a cycle of diminishing return on investment, complicating efforts for a robust resurgence.

As net interest margins continue to shrink, the expansion of scale becomes a significant contributor to profitability growth in banks. The pressing question, therefore, is: how sustainable and viable is this scale expansion for commercial banks in the future?

According to research by Dongxing Securities, an analysis of profit drivers for listed banks during the first quarter of 2023 and into 2024 reveals that, compared to the contributions made by reserve replenishment and non-interest incomes, scale expansion is a more robust force propelling profitability growth. This trend indicates that the support from reserves is weakening.

Under the assumption of a continuing sluggish recovery in the domestic economy with ineffective growth momentum, a gradual decrease in net interest margins is expected. Consequently, scale growth will persist as a key positive influence on the profitability of commercial banks.

Scale expansion is also a critical metric for assessing a bank's growth potential. From an operational perspective, growth in scale—which primarily aligns with the growth of credit—reflects a bank's proactive efforts to attract customers and subsequently facilitate effective credit allocations within its own risk control frameworks. In an environment where credit demand is weak, the rate of scale expansion often mirrors a bank's robust capability to deploy credit effectively. However, it's essential to recognize that different banks possess varying risk appetites and target markets, preventing a blanket categorization of performance based solely on scale.

From a financial standpoint, while scale expansion does consume capital and has implications for capital adequacy levels, if such growth leads to increased profitability, it can facilitate endogenous capital replenishment, provided that dividend ratios remain relatively stable. This creates a foundation for banks to further expand their balance sheets.

In essence, if banks can transition from expanding scale to enhancing profits, subsequently bolstering their capital reserves, and using those reserves to support further growth, it establishes a stable positive feedback loop. Should this cycle become established, it can be interpreted as an indicator of sustainable growth potential for the bank in question.

The pace of balance sheet expansion has emerged as a central explanatory factor for the performance divergences among listed banks. Since 2022, profitability growth among various categories of listed banks has continued to decline. Notably, the profitability growth rate for joint-stock banks plummeted from 14.6% in 2021 to -3% in 2023, marking a significant contraction.

Analyzing quantity and price metrics shows that the downward trend in net interest margins is a common industry challenge, with slight variations in the reduction rates across different types of listed banks. Between 2022 and 2023, state-owned banks, joint-stock banks, urban commercial banks, and (listed) rural commercial banks saw net interest margins decrease by 25 basis points, 24 basis points, 19 basis points, and 8 basis points, respectively.

The differentiated scale expansion rates offer a more convincing explanation for the varied profitability outcomes among banks. Over the past two years, the compound growth rates of scale for state-owned banks, joint-stock banks, urban commercial banks, and rural commercial banks were 13.2%, 7.6%, 12.7%, and 9.7%, respectively, with joint-stock banks experiencing notably slower growth. An examination of profit-driving factors in 2022 and 2023 reveals that the sluggish scale growth in joint-stock banks is a substantial contributor to their declining profitability.

Since 2022, deposit growth has remained robust, having a limited negative impact on balance sheet expansion. Industry data since 2022 shows a marked acceleration in deposit growth. In early 2023, for instance, the growth rate for deposits reached 12.6%, surpassing that of loans. By the end of 2023, deposit growth continued to stay above 10%, a notable improvement compared to previous periods when deposit growth lagged behind loan growth. While varying growth rates for deposits across different bank types are observed, these disparities are largely influenced by the diverging rates of loan growth, which in turn affect deposit retention.

In the context of a gloomy property market and pessimistic income expectations, the demand for medium- and long-term loans among residents has remained tepid. From the standpoint of bank balance sheet expansion, new loans primarily skew towards corporate financing, with evident signs of weak demand in retail sectors producing negative growth. Moreover, subdued financing needs in real estate development and its associated sectors have further constrained the demand for corporate loans.

In conclusion, the scale of expansion itself serves as a barometer for a bank's growth capacity. Within an environment marked by considerable pressure on sectoral profit margins, the positive impact of scale on profitability and capital replenishment accentuates the sustainability of growth. The last two years have witnessed significant performance disparities in the banking sector, with public banks exhibiting substantial declines in profitability, underscoring that scale differentiation remains a crucial factor driving these performance variations.

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