Morgan Stanley believes that domestic bank stocks, having undergone seasonal adjustments in the third quarter, will present significant investment opportunities in the fourth quarter and the first quarter of next year.

On October 20, Morgan Stanley's Asia Pacific analyst team published a report indicating that domestic bank stocks are nearing the completion of a cyclical bottom in the third quarter. This marks the first time China’s financial system has achieved a "natural cyclical bottom" without large-scale stimulus measures—evidenced by the rebound in M1 growth and improved profitability of industrial enterprises occurring without major policy interventions.

The report analyzes that upcoming dividend distributions, stabilized interest rates, the support of 500 billion RMB of structural financial policy tools, and a more sustainable policy approach will all contribute to a revaluation of bank stocks.

Analysts point out that the previous reliance on strong stimulus for investment logic has become ineffective. The new focus should shift towards high-quality banks that can achieve profitability earlier and rebound more robustly in a “natural clearance” environment.

Historical First: A "Natural Cycle Bottom" Without Major Stimulus

Morgan Stanley emphasizes that China's financial system is undergoing an unprecedented transformation: achieving a "natural cyclical bottom" without large-scale stimuli and further monetary easing. This suggests that the risk clearance in the financial system is nearing its end, and the industry is shifting from a risk control model pursued over the past decade to a development-focused model. Several indicators validate this assessment:

Credit growth is better aligned with economic growth: By September 2025, the growth rate of social financing slowed to 8.7%, and loan growth decelerated to 6.4%. This moderate growth aligns better with nominal GDP growth, supporting the stability of bank asset yields.

(As of September, the growth rate of social financing slowed to 8.7%.)

Improvement in corporate liquidity and confidence: Meanwhile, M1 (narrow money) and the growth rate of corporate demand deposits have been accelerating since early 2025. Historically, this has been a positive signal for improved corporate liquidity and operational confidence, indicating easing risks.

(Since early 2025, corporate deposits have continuously increased, especially demand deposits.)

Optimizing supply-side structures brings results: Guided by "anti-involution" policies, capital expenditure growth in manufacturing has slowed (from 6.2% in July to 4.0% in September), and credit flows have become more rational. This effectively alleviates the overcapacity issues faced by certain industries. The gap between fixed asset investments in manufacturing and industrial added value has narrowed by September. Consequently, despite short-term macro growth slowdowns, profits in industrial enterprises are showing gradual improvements, and the year-on-year decline in PPI is consistently narrowing.

(The PPI index remains stable month-on-month.)

Farewell to "Extreme Ups and Downs": China's Banking Sector Enters a New Era of Steady Development

The report suggests that China’s financial industry has entered a relatively benign long-term operational environment, with ongoing revaluation of bank stocks. Three core drivers underlie this:

Continuous digestion of high-risk assets: Market-driven controls over the inflow of funds into overcapacity industries are leading to a steady decline in high-risk asset scale. Morgan Stanley predicts that the proportion of high-risk assets to total credit will decrease from 9.2% in 2024 to around 3% in the coming years. This will significantly reduce risk premiums in Chinese financial stocks.

(Changes in high-risk assets.)

Moderate and stable credit demand: Policies no longer pursue extreme fluctuations in credit. Driven by technological innovation and industrial upgrades, credit demand is expected to maintain a moderate annual growth rate of 5-6% (slightly above the nominal GDP growth forecast of around 4%), which is sufficient to support banks in achieving reasonable asset yields and stable net interest margins.

Shift of household wealth towards bank stocks: With stringent regulations on shadow banking and the cooling of the real estate bubble, alternative investment options for households are declining. The substantial and still-growing household financial assets (reaching 297 trillion RMB by the end of Q2 2025) will continue to provide strong inflows for bank stocks.

Four Key Support Factors for the Fourth Quarter Market

The report identifies four critical factors that will collectively support the performance of bank stocks in the fourth quarter:

Dividend-driven capital inflows: Banks typically distribute mid-term dividends in late December and early January, attracting capital inflows. Especially considering the strong growth of residents' financial assets since 2022 (with a year-on-year increase of 12% to 297 trillion RMB by Q2 2025) and robust insurance product sales, demand for allocation from institutions such as insurance funds will be significant.

(The year-on-year growth rate of household financial assets accelerated to 12% in Q2 2025, up from 10.8% in Q1.)

Fundamentals approaching a turning point: The operational pressures on banks are easing. The upcoming Q3 2025 reports are expected to show that the pressure on net interest margin (NIM) has moderated (with a quarter-on-quarter decline of only a few basis points), while fee income continues to rebound with the increased activity in the capital markets. This will serve as an important indicator of which banks can achieve profit recovery first.

Policy support for "bank-friendly" initiatives: The new 500 billion RMB structural financial policy tool (with 289 billion already deployed as of October 17) aims to supplement project capital and support credit demand, without pressuring banks’ loan yields like past “flood irrigation” policies. This measure reduces the risks of economic decline and further interest rate cuts.

Stabilizing interest rate environment: If the loan prime rate (LPR) remains steady for the remainder of 2025, it will be another critical catalyst for bank stocks. Thus far in 2025, both the one-year and five-year LPR have been cut by merely 10 basis points, significantly lower than the reductions of 35 and 60 basis points in 2024. A stable LPR signals steadiness in loan and financial asset yields, alleviating market concerns regarding ongoing margin pressure.

(Since 2025, both the one-year and five-year lending benchmark rates have been cut by 10 basis points.)

Analysts indicate that under the current environment, bank stocks that demonstrate superior profit rebound potential and robust dividend paying capabilities will be prime choices for capturing opportunities in this “new era.” (Ranking of dividend yields for Chinese banking H-shares and A-shares.)