What does China’s banking data tell us about the economy and the sector consequences?

In our ninth flagship Natixis China Banking Monitor Series 2025, we continue to analyze core issues in China's banking sector to draw macroeconomic and sector implications. The interlinked relationship between the economy and banks is crucial as China faces structural challenges. We begin the note by examining what Chinese financial data reveals about the economy. We further analyze the current income sources of Chinese banks, followed by the challenges from the macro environment.What does China’s banking data tell us about the economy?Although there has been moderate policy support to stabilize the economy, the improvement is limited in consumer sentiment. It is a structural trend that households have been piling up savings and reducing investment since 2015. Household credit growth has decelerated, indicating limited incentives to leverage.The government has relaxed policies on real estate, but the rebound so far has been limited. Mortgage and real estate development loan growth remain weak. It means that it is unlikely to see any recovery in real estate investment anytime soon, with the baseline scenario being an L-shaped recovery only.As a result, China is walking a tightrope in cutting interest rates to support the economy and finding ways to cushion banks' profitability. Banks play a pivotal role in absorbing the fiscal deficit through buying and swapping bonds with lower yields and longer maturity. These purchases have reduced the credit spreads for LGFVs.In the next five-year plan, Chinese banks will be expected to bear an even larger burden of government objectives, which means that their profitability might be pushed down further. This includes accepting a lower return on their assets (including treasury bonds and local-government bonds). This is particularly relevant now given the government push for infrastructure as a core part of the fiscal stimulus. They will also need to continue to offer preferential loans to SMEs and tech companies, with potential consequences for asset quality, especially for the former.Declining profitability buffered by lower deposit rates and proprietary investmentWe expect banks to face weaker profitability structurally and net interest margins to slip from about 1.52% in 2024 to 1.49% in 2025. Asset growth had been sluggish until recently, supported by government bonds, but this support is unlikely to change the broader picture of lower return on assets (ROA).Chinese banks face a sharp decline in loan interest income due to faster benchmark interest rate cuts and the repricing of existing lending. Still, proprietary investment income and lower funding costs have provided some buffers. Falling yields have lifted bond prices, resulting in unrealized gains under other comprehensive income (OCI). Between 2023 and H1 2025, such unrealized gains increased by 2.6 times and form 20% of net income, giving banks room to release profits in the future.Chinese banks have long faced declining lending rates, while deposit costs have remained relatively stable. The trend shifted in 2025 as the government aimed to support consumption, making it the first year in which both lending and deposit rates declined concurrently. At the same time, slower growth in time deposits has reduced reliance on higher-cost funding, further easing interest expenses.Challenges in asset quality and capitalDespite a seeming stable picture balanced by multiple sources of income and regulatory relief, we expect more challenges, especially from asset quality and capital needs in 2026 and beyond. Although the stressed loan ratio (special mention and non-performing loans) is estimated to fall from 3.88% in 2022 to 3.66% in 2025, the pressure on asset quality is greater than it appears. If we add back write-offs and restructured loans, the adjusted stressed loan ratio would have increased from 4.53% to 4.83%, indicating banks are absorbing the cost of decelerating growth and credit risks.Beyond restructuring, the fast loan growth to households and small and micro enterprises points to a potential worsening in asset quality, especially if the business cycle deteriorates. The household NPL ratio increased from 0.9% in 2022 to 1.33% in H1 2025, especially driven by non-mortgage loans, reaching nearly 2%. The share of loans to small and micro enterprises has also increased from 19% to 22% of total assets, but such lending can traditionally be 2.6 times riskier than lending to big corporates.Despite weaker profitability, the capital adequacy ratios for Chinese banks have improved, mainly due to changes in regulatory requirements, local government debt swap and state-led capital injections. The new capital regulations effective as of 1 January 2024 imply a reduction of risk-weighted asset to total asset falling from 62% in 2023 to 60% in 2025, reflecting the lower pressure on banks.At the same time, the local government debt swap has helped banks lower the risk weight on assets and improve their capital ratio by 19 bps in 2024. The government has injected RMB 520 billion into state-owned commercial banks, resulting in a 23-basis-point increase in the system-wide solvency ratio. A similar level of support is expected in 2025 and 2026, but the longer-term problem remains in the lack of organic capital generation.More responsibilities at the expense of profitabilityChina’s banking data continues to highlight challenges from slowing nominal growth and structural macroeconomic problems. Amid these headwinds, banks are likely to shoulder more responsibility at the expense of profitability. Still, given their pivotal role in policy transmission, the government will support the sector through moderately lower funding costs, additional liquidity injections, recapitalization, and regulatory adjustments to keep profit growth marginally positive. However, bank profitability will likely decline over time in the support to reshuffle resources in the economy.