Shenwan Hongyuan Group has released a research report analyzing the performance of the A-share banking sector. The report states that significant capital outflows and a market style focused on chasing high-beta opportunities have been the primary reasons for the sector's lackluster absolute and relative returns since the start of the year. Looking ahead to the next phase, the firm predicts the A-share banking sector will follow a path of "from stabilization to absolute returns, and then to relative returns," with capital flows and fundamentals acting as key variables at different stages. The firm continues to emphasize two main investment lines: 1) city commercial banks driven by profitability, and 2) joint-stock banks showing signs of a bottom reversal. The main points from Shenwan Hongyuan are as follows.

Capital Flows' Pressure on A-Share Banks is Nearing an End; Short-Term Focus on Absolute Return Catalysts

First, the "unexpected" selling pressure from capital has significantly diminished. On one hand, as of May 31st, the holdings of bank stocks by the CSI 300 and SSE 50 broad-based ETFs have decreased to approximately 48.5 billion yuan, a substantial drop from the peak of around 178.2 billion yuan in October 2025. On the other hand, in Q1 2026, several banks, including China Merchants Bank, Industrial Bank, and Everbright Bank, no longer had Central Huijin or China Securities Finance Corporation among their top ten shareholders.

Second, following the strong performance of the AI-related technology sector, it is possible that institutional funds may begin to lock in profits. Historically, during windows of extreme style rotation, the banking sector has delivered considerable excess returns.

Third, against the backdrop of an "asset shortage," bank stocks remain solid "good assets" for long-term capital such as insurance institutions and industrial capital. Insurance capital continues to increase allocations to banks: the current average dividend yield of A-share listed banks is 4.8%, higher than the yields of non-standard assets, deposits, bonds, and other assets. Furthermore, the banking sector's performance is stable, with predictable and steady dividends. Industrial capital and banks are also engaging in a "mutual attraction": since 2025, there have been numerous instances of local state-owned assets and industrial capital increasing their stakes in banks. Compared to other industries, the average ROE of listed banks, around 10%, is quite attractive. Increasing holdings in banks has become a preferred choice for many industrial entities to "revitalize idle funds and enhance asset returns."

Fundamental Stability is the Prerequisite for Sustainable Excess Returns

From a medium- to long-term perspective, stable and improving fundamentals are a prerequisite for the banking sector to achieve sustainable excess returns. The core reason for the sector's weak beta currently lies in the still-weak domestic demand within the real economy. Bank fundamentals are closely tied to changes in demand from the corporate and household sectors, which essentially reflect their willingness and capacity to add leverage. Even though a marginal recovery in bank profit statements can be expected this year, investors harbor concerns about the sustainability of fundamental improvements in banks amid a weak economic recovery.

Objectively speaking, the policy environment facing banks in 2026 is more favorable, with no further emphasis on "profit concessions" and no sustained interest rate cuts. The regulatory environment, which emphasizes preventing price-based internal competition and protecting bank net interest margins, is also more supportive. The firm reiterates that this year is one for listed banks to see revenue improvement, with the elasticity of revenue improvement being greater than that of profits, and a year for strengthening provisions, with increased impairment losses to digest non-performing assets and build up excess provisions.

Specifically within the banking sector, the stabilization of net interest margins will occur at different paces. In the short term, this depends on the pace of deposit repricing and the room for cost improvement; in the long term, it depends on the ability to serve differentiated customer groups on the asset side. The provision base determines profit stability. Banks that proactively manage risks, maintain low "NPL ratio + special mention loan ratio," and have high "loan loss provision to loan ratio" are better positioned to ensure stable ROE. Therefore, it is highly beneficial for listed banks to leverage this golden window of revenue recovery this year to re-strengthen provisions and solidify asset quality, which will aid in achieving stable and sustainable positive profit growth later.

Furthermore, if clearer signals of economic recovery emerge, such as stable and rebounding interest rates, improved production demand, domestically-driven PPI remaining in positive territory, and the sustainability of improvements in real estate volume and prices in 2026, this could truly initiate a revaluation cycle for the banking sector.

Returning to the present, in a macroeconomic environment without major fluctuations or under a scenario of weak economic recovery, alpha currently outweighs beta, emphasizing the importance of stock selection. It can be observed that year-to-date, the A-share banking sector has achieved neither absolute nor relative returns, yet within the sector, several banks have still achieved gains exceeding 10% or even 20%, predominantly city commercial banks.

Investment Analysis and Recommendations

The firm maintains a positive view on banks and reiterates two main investment lines. The first is profitability-driven city commercial banks, where credit resources translate to revenue elasticity and profit growth. The focus is on the elasticity of revenue recovery driven by net interest income, with the core being the "realization of credit resources." Top picks include Bank of Suzhou, Bank of Chongqing, and Bank of Hangzhou.

The second is joint-stock banks showing a bottom reversal. The pressure from capital flows has largely subsided, and valuations are at absolute lows. The focus is on joint-stock banks whose performance bottomed earlier but whose valuations have been more heavily suppressed. Key names are Industrial Bank, China Merchants Bank, and China CITIC Bank.

Risk Warnings

Risks include a slower-than-expected stabilization of net interest margins, weak real economic demand leading to a slower-than-expected economic recovery pace, and unexpected risk disturbances from some real estate developers and unexpected risk exposure in long-tail customer groups.