The banking sector is expected to return to fundamental-driven narratives in 2026, according to a research report released by Orient Securities Company Limited (ASX: 600958). Considering that banks remain in a concentrated deposit repricing cycle, net interest margins are expected to stabilize and recover. Structural risk exposure still awaits policy support, and banking sector revenue is projected to continue improving through 2026-2027. Meanwhile, with the pressure from stabilization fund reductions on bank stocks significantly easing, the rebalancing of market risk appetite and style is raising the probability that banks will periodically capture relative returns. Two main investment themes are recommended: first, state-owned major banks with solid fundamentals and strong defensive value; second, high-quality small and medium-sized banks with confirmed fundamentals. The key views from Orient Securities Company Limited (ASX: 600958) are as follows.
Other non-interest income supports continued revenue improvement, while impairment provisions persistently weigh on profit growth
In the first three quarters, the year-on-year growth rates of revenue, pre-provision profit, and net profit attributable to parent company for listed banks changed by +0.4pct, +1.1pct, and +0.8pct quarter-on-quarter, respectively. Breaking this down, net interest margins continued to stabilize, driving net interest income growth to remain roughly flat quarter-on-quarter. Capital market retracement was notable, with fee income growth broadly declining by 2.7pct quarter-on-quarter. The significant decline in long-end interest rates in Q3 combined with a low base from the same period last year led to a 4.9pct quarter-on-quarter improvement in other non-interest income growth. Banks continued proactive risk exposure, while income tax also dragged on profit growth to some extent, keeping profit improvement persistently weaker than revenue improvement.
Divergence across sub-sectors intensified. Only state-owned banks saw continuous improvement in net interest income, maintained high growth in other non-interest income, and benefited from converging impairment drags. After overtaking city commercial banks in revenue in the interim report, state-owned banks also surpassed them in profit growth in 2026 Q3, leading the sector. Other sub-sectors relied on other non-interest income to support revenue, driving further revenue improvement, but increased provisions kept profit growth stable or slightly declining.
Asset-side balance sheet expansion continued to slow, while deposit growth edged up
As of 2026 Q3, the year-on-year growth rates of interest-earning assets, loans, financial investments, and interbank assets for listed banks changed by -0.2pct, -0.2pct, -2.2pct, and +10.1pct compared with 2026 H1, respectively, indicating an overall slowdown in balance sheet expansion. Loan growth continued to decelerate, but the decline narrowed. With fiscal and quasi-fiscal support picking up pace marginally, the downward slope of full-year credit growth is expected to further converge. In terms of structure, the proportion of retail loans generally declined, while banks proactively reduced inefficient assets such as bill discounting. On the liability side, deposit growth edged up 0.5pct, with deposit and loan growth rates moving in opposite directions, further enriching liquidity in the banking system. Market risk appetite declined significantly in Q3, with funds flowing back from capital markets into the banking system. Interbank liability growth converged, mainly because money market rates maintained a central range of 1.35%-1.45% in Q3, potentially creating an inversion with non-bank demand deposit rates and continuously squeezing out arbitrage funds sitting idle.
Net interest margin continued its stabilizing trend, with asset yield declines persistently converging
The estimated net interest margin for 2026 Q3 was 1.33%, flat compared with 2026 H1. According to the firm's estimates, the yield on interest-earning assets declined by 22bp compared with 2025 (versus a 41bp decline in the same period last year), marking a significant convergence in the pace of decline. Interest-bearing liability costs fell by 25bp compared with 2025. In addition to support from deposit maturity repricing, interbank self-discipline gradually tightened, and interbank liability cost improvements were equally significant. As the dividend from deposit maturity repricing supporting liability cost improvement gradually fades, the divergence in net interest margin trends among banks will mainly stem from differences in asset-side yields. By sub-sector, state-owned banks and city commercial banks saw net interest margins stabilize and recover year-on-year, outperforming joint-stock banks and rural commercial banks.
Banks continued proactive and active risk exposure and disposal
As of 2026 Q3, the non-performing loan ratio for listed banks rose 0.1bp quarter-on-quarter, with the non-performing loan balance increasing by RMB 17.3 billion quarter-on-quarter. Most banks saw a slight quarter-on-quarter increase in their special mention loan ratios, and new non-performing loan formation pressure may remain stable at elevated levels. In Q3, the banking sector appeared somewhat divided in its choice between provision levels and earnings performance. Although state-owned banks maintained high impairment provisions, the drag on profits converged. High-quality city commercial banks chose to increase impairment provisions and accelerate risk clearance. Joint-stock banks continued to face relatively prominent overall asset quality pressure, with a slower pace of risk clearance. Rural commercial banks maintained stable asset quality with limited marginal changes. Fluctuations in non-performing loan indicators at individual banks may stem from concentrated supplementary provisions for three-stage expected credit loss gaps, significantly weighing on asset quality and earnings. These individual cases also reflect tightening regulatory guidance, steering banks toward more prudent and thorough risk exposure. The scissors gap between revenue and profit growth rates continued to widen, and the effectiveness of existing risk disposal is expected to gradually emerge next year.
Capital consumption pace slowed, capital adequacy ratios strengthened
Banking sector profitability improved, while the pace of capital consumption corresponding to risk-weighted assets further slowed, driving quarter-on-quarter improvements in capital adequacy ratios. The core tier-1, tier-1, and total capital adequacy ratios for listed banks rose by 7BP, 15BP, and 15BP quarter-on-quarter, respectively. Risk warnings: monetary policy tightening beyond expectations; fiscal policy falling short of expectations; risk contagion in real estate and other sectors; and risks related to estimates.