Guosen: The net interest margin of the banking industry may bottom out in 2026. Valuation repair in the sector can be expected.

Guosen released a research report stating that the significant convergence of China's banking sector's net interest margin decline in 2026 will likely mark the end of this cycle of net interest margin decline. This is in stark contrast to the previous two years when the industry's net interest margin generally declined, with uncertain bottom lines. The bank predicts that the fundamental improvement of the banking sector will drive the valuation premium recovery of high-quality individual stocks. Guosen's main points are as follows: Resident confidence is the core variable of fund flow, and financial product performance is not the key driver. This trend can be fully confirmed in the asset allocation trend of Japanese residents. In 1995, Japan's deposit interest rates experienced a significant decline. The average interest rate for 3-4 year fixed-term deposits plummeted from 3.39% at the beginning of the year to 0.94% at the end of the year, gradually approaching zero after the ASIA FINANCIAL crisis in 1997. However, this did not trigger a shift in deposits, with funds instead concentrating on low-risk assets such as cash, deposits, insurance, and pension funds, which was primarily due to the severe lack of resident confidence. At that time, the Japanese economy was in continuous decline following the burst of the real estate bubble, combined with the concentrated exposure of bad loans in the banking sector, highlighting the vulnerability of the financial system. Residents had a pessimistic outlook on employment and income, leading to a core demand for precautionary savings. Even though the stock market rebounded by 35% in the second half of 1995, residents allocated only 9% of their funds to equities and funds in the fiscal year 1995, while the proportion allocated to deposits, insurance, and pension funds were 53.2% and 47.2%, respectively. This trend did not shift fundamentally until 2003-2004 when Japan's economy achieved substantial recovery after the burst of the bubble. Resident confidence gradually improved, and there were clear signs of a shift in deposits that had been consistently high-growth prior to this. From 2004 to 2007, funds began to shift towards high-risk assets such as debt securities, equities, and investment funds, with this trend strengthening. This confirmed the driving role of confidence recovery in asset allocation. However, this pattern was disrupted again after the 2008 financial crisis. Under the impact of the crisis, resident confidence collapsed again, and funds significantly flowed back into low-risk assets such as cash and deposits. Additionally, there was a decrease in the proportion allocated to insurance assets, while the proportion allocated to pension and retirement equities significantly increased. From the conservative allocation during the period of low-interest rates from 1995 to 2003, to the rebound in risk appetite after the recovery from 2004 to 2007, and then the retraction after the crisis in 2008, the flow of assets of Japanese residents always revolved around fluctuations in "confidence", fully confirming that resident confidence is the core variable that determines fund flow. Although Japanese residents did not shift out of deposits, the significant convergence of term interest rate differentials led to an increase in the activation trend of resident deposits. The proportion of transferable deposits held by Japanese residents continued to increase, from only 11.4% at the end of fiscal year 1994 to 33.7% at the end of fiscal year 2003, and this trend continued to rise, reaching 65% at the end of fiscal year 2024. In addition, the proportion of deposits held by financial institutions for less than one year also continued to rise, reaching 90.5% at the end of fiscal year 2024. Investment advice: The bank recommends a configuration strategy of "stable foundation + aggressive combination" with a focus on recommending China Merchants Bank, CITIC BANK, Bank Of Ningbo, Bank Of Changsha, and Chongqing Rural Commercial Bank. Risk warning: Slow growth below expectations, increasing downward pressure on the asset quality of banks. The banking sector is heavily regulated, and if subsequent policies are unfavorable to the short-term fundamentals of banks, it will impact short-term valuations. International political turmoil and increased uncertainty overseas should be monitored, as changes in the international situation may affect risk appetite.