tightening direction unchanged, but research analyst...

Deutsche Bank Markets Research

Asia

Hong Kong

Banking / Finance

Banks

Industry

Chinese banks - Financial deleveraging

Date

8 January 2018

Industry Update

Tightening direction unchanged, but holding the bottom line

A summary of recent regulations and monetary policy measures

________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong

Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be

aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider

this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE

LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. THE CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE’S REPUBLIC

OF CHINA (“THE PRC”) (EXCEPT IN COMPLIANCE WITH THE APPLICABLE LAWS AND REGULATIONS OF PRC),

EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAU.

Hans Fan, CFA

Research Analyst

(+852 ) 2203 6353

[email protected]

Jacky Zuo

Research Analyst

(+852 ) 2203 6255

[email protected]

Edward Du

Research Associate

(+852 ) 2203 6185

[email protected]

Top picks

Bank of China (3988.HK),HKD4.02 Buy

Agri. Bank of China (1288.HK),HKD3.91 Buy

Source: Deutsche Bank

Companies Featured

ICBC (1398.HK),HKD6.56 Buy

China Construction Bank (0939.HK),HKD7.61

Buy

Agri. Bank of China (1288.HK),HKD3.91 Buy

Bank of China (3988.HK),HKD4.02 Buy

Bank of Communications (3328.HK),HKD5.98

Buy

China Merchants Bank (3968.HK),HKD32.60

Hold

China CITIC Bank (0998.HK),HKD5.04 Hold

China Minsheng Bank (1988.HK),HKD8.01 Hold

CEB (6818.HK),HKD3.71 Hold

Chongqing Rural Bank (3618.HK),HKD5.81 Buy

Huishang Bank (3698.HK),HKD4.12 Sell

Bank of Chongqing (1963.HK),HKD6.41 Hold

Shanghai Pudong Bank (600000.SS),CNY12.69

Hold

Ping An Bank (000001.SZ),CNY13.30 Hold

Industrial Bank (601166.SS),CNY17.21 Sell

Bank of Beijing (601169.SS),CNY7.29 Buy

Bank of Nanjing (601009.SS),CNY7.83 Sell

Bank of Ningbo (002142.SZ),CNY18.17 Sell


We value Chinese banks using a three-

stage GGM (PV= (ROE-g)/(COE-g)), with

target prices based on 2017E book

values. Downside risks: inflation, large-

scale DES on government intervention,

over-tightening and property price

correction. Upside risks: SOE reforms

and removal or softening of GDP

targeting.

The pace of releasing new regulations has accelerated notably. Three rules were unveiled by CBRC over the weekend. The direction is clearly on the tightening side: cracking down on shadow banking and reducing wholesale funding. On the other hand, to hold the bottom line of no systemic risks, the PBOC has increased liquidity injections (by Rmb1.6tr in 2017, equivalent to 110bps RRR cuts) and announced a few pre-emptive measures, e.g. a temporary RRR cut and relaxation in the automated pledging financing facility. As such, we expect financial deleveraging to continue but the process is likely to be orderly, given the low risk of an uncontrollable “liquidity event”.

Tighter regulations: closing loopholes, but being more coordinated Since the first meeting of the Financial Stability and Development Committee on 8 Nov 2017–the “super-regulator” coordinating financial regulators–the pace of releasing new regulations has accelerated notably (Fig. 2). This weekend, the CBRC released 3 regulations targeting entrusted loans, banks’ concentration risks and shareholding management. These regulations, in general, target a crack down on shadow banking by closing loopholes and reducing regulatory arbitrage. What makes this round of tightening different from the past is that with the new committee leading, the regulations are more coordinated and most have considerable grace periods. Starting with The Asset Management Guideline (note), an overall guideline, the regulations are targeting particular sub-markets/sectors one-by-one and step-by-step. Monetary policy: higher rates but ample liquidity with pre-emptive measures PBOC has hiked OMO rates 25bps in 2017; we expect another 20-45bps in 2018, but liquidity vol. should stay ample, as we believe that, while tightening, PBOC also needs to prevent systemic risks. Indeed, in 2017, PBOC injected Rmb1.6tr liquidity mainly via MLF and PSL, equivalent in size to 100bps RRR cut or sufficient to fund 10% of banking asset expansion. Recent relaxation on automated pledged financing suggests smaller banks in temporary liquidity troubles should have access to bigger-amt funding provided by PBOC. Also temporary RRR cut during Chinese New Year may release Rmb1.5-2.0tr liquidity for 1 mo., which should smooth liquidity tightness by then. We expect relatively remote likelihood of bank run in wholesale funding market. Implications for the system and individual banks Longer term, we see most deleveraging measures as necessary to strengthen China’s financial stability, generating net positive to financial system and real economy. Near term, for financial system, we expect slower banking asset growth, modest yield curve steepening & lower actual risk-free rate. For real economy, we forecast moderate credit growth with shrinking shadow banking and hence, slower economic growth. Yet, it should come with benefit of slower build-up in leverage & better transparency. Retail banks (big 4/CMB/CRCB) should benefit from higher rates & yield curve steepening due to solid deposit franchises. Other smaller banks will experience ongoing funding and capital pressure. Our order remains BOC/ABC/CCB/ICBC/CRCB/BoCom. Catalysts: better results, introduction of CCyB and D-SIB, apt. of governor of new committee and Southbound inflow.

Distributed on: 07/01/2018 19:21:30 GMT

7T2se3r0Ot6kwoPa

8 January 2018

Banks


Deutsche Bank AG/Hong Kong

Recent regulation summary

Tightening regulations – closing loopholes, but being more coordinated

China has made containing financial risks a top priority and initiated the

financial delivering campaign. Over the past year, the financial regulators have

lifted market rates and rolled out plenty of new regulations. We highlight these

measures in the below diagram and have elaborated on the efforts in previous

reports (Financial deleveraging – Rising funding pressure, Impact Series I, II, III,

and IV, and 2018 Outlook).

Figure 1: Summary of recent financial deleveraging efforts

Other assets (6%)

Credit to interbank and PBOC

(14%)

Credit to NBFIs (12%)

Cash & deposits with PBOC (11%)

Credit to corporate (36%)

Credit to household (14%)

Credit to government (7%)

Assets(% of total)

Liabilities & equity(% of total)

Corporate & retail deposits (65%)

Borrowing from interbank and

interbank CDs (10%)

Borrowing from NBFIs (7%)

Bond issuance (7%)

Borrowing from PBOC (4%)

Other liabilities (8%)

Measures targeting liabilities

side:

- Money market hikes

(OMO/MLF/SLF)

- Lengthened MLF duration

- NCDs to be included in the

interbank funding (1Q18)

China banking system

The Guideline

on Asset

Management

Business (Dec

2017)

Comprehensive

self-assessment

required by

CBRC, so called

3-3-4 series

(April 2017)

Liquidity Risk

Management

Guideline

(Dec 2017)

Measures targeting assets

side:

- Shadow banking

tightening by CBRC (April

2017)

- Channel businesses

tightening by CSRC

(1H17)

- New rules on bank-trust

cooperation (Dec 2017)

- Broad credit requirement

in MPA to cap banks’

asset growth (1Q17)

- Entrusted Loan

Management Guideline

(January 2018)

- New rules on entrusted

bond investment

(January 2018) Measures

targeting on

general

businesses:

Establishment

of Financial

Stability and

Development

Committee

(Nov 2017)

Source: Deutsche Bank, CBRC, PBOC, Caixin

On the regulation side, since the first meeting of the Financial Stability and

Development Committee – the “super-regulator” coordinating financial

regulators – on 8 Nov 2017, the pace of releasing new regulations has

accelerated notably (Figure 2). This weekend, the CBRC released three

regulations targeting entrusted loans, banks’ concentration risks and

shareholding management. These regulations, in general, aim to crack down

on shadow banking by closing loopholes and reducing regulatory arbitrage.

8 January 2018

Banks



What makes this round of tightening different from the past is that – with the

new committee leading, these regulations are more coordinated. Starting

with The Asset Management Guideline, an overall guideline, the following

regulations are targeting particular sub-markets/sectors one-by-one and step-

by-step. Also, most regulations have considerable grace periods. So the

shocks to system liquidity should be largely manageable.

Figure 2: Tightening regulations have been released frequently post the establishment of the Financial Stability

Development Committee

March April May June July August September October November December January February

2017 2018

23 March - 12 April

3-3-4 Documents by

14-15 July

National Financial

Work Conference

14 August

Inclusion of interbank

CDs into MPS

8 November

The first meeting of Financial

Stability Developmnt

Commitee (FSDC)

17 November

Asset Management

Guideline

6 December

Liquidity Risk Management

Guidline

29 December

New Capital Rules over Asset

Management Companies

5 January

(1) Large-amount Risk Exposure

Management Guideline

(2) Circular 302 - regulations over

entrusted bond investment

6 January

Entrust Loan Manageement

Guideline over commercial banks

22 December

Guidelines over the

cooperation between banks

and trust companies

Accelerating pace of releasing regulations since FSDC's

first meeting

Source: Deutsche Bank, CBRC, PBOC

The establishment of the Financial Stability and Development Committee is

the biggest step in the financial deleveraging process, in our view. China

announced that it will set up a new and high-level committee during its fifth

National Financial Working Conference during 14-15 July 2017. This new

committee is led by one of China’s vice premiers (currently led by Premier Ma

Kai) and is set on top of the PBOC and other financial regulators. It is designed

to be the coordinating entity within the State Council on major issues related

to financial stability and financial reform and development.

We see the establishment of this new committee as a crucial step to

strengthening China’s financial regulatory framework and lowering systemic

risks. In the past, one of the key drivers to the proliferation of China’s shadow

banking has been its fragmented regulatory framework, as there has been a

lack of sufficient communication and coordination among the four financial

regulators. In some instances, there was even competition between regulators,

leading to aggressive expansion in some asset management products. A new

committee led by a more senior leader of government and set above existing

regulators should help improve regulatory coordination and curb the regulatory

arbitrage of financial institutions by closing loopholes and reducing regulatory

competition. In our view, this should contain growth and reduce the murkiness

of China’s shadow banking system.

8 January 2018

Banks



Figure 3: China’s regulatory framework is shifting towards being more coordinated, as the new committee has been

set up on top of all the current regulators

CBRC CSRC CIRC

Banks’ WMP(Rmb28tr)

Trust plans

(Rmb20tr)

Brokers’ AMPs

(Rmb18tr)

Public mutual fund

(Rmb10tr)

Fund and fund subs’ AMPs(Rmb15tr)

Private funds(Rmb9.5tr)

Insurance investment

funds(Rmb1.9tr)

PBOC

• Monetary policy• Macro-prudential assessment

China’s regulatory framework on asset management

businesses (in the past)

CBRC CSRC CIRC

Banks’ WMP(Rmb28tr)

Trust plans

(Rmb20tr)

Brokers’ AMPs

(Rmb18tr)

Public mutual fund

(Rmb10tr)

Fund and fund subs’ AMPs(Rmb15tr)

Private funds(Rmb9.5tr)

Insurance investment

funds(Rmb1.9tr)

PBOC

• Monetary policy• Macro-prudential assessment

China’s regulatory framework (at present)

Financial Stability and Development Committee

Source: Deutsche Bank, CBRC, CSRC, PBOC, CIRC

In detail, recent major regulations include:

The consultative draft for The Guideline on Asset Management

Businesses, released on 17 November 2017, targets the fast-growing

asset management sector with a total AUM of Rmb102tr (50% CAGR

during 20011-16), an essential part of shadow banking. It proposes

capping leverage, reducing duration mismatch, cutting down SPV

layers and removing implicit guarantees. We view it as a vital step in

continuing financial deleveraging. Near term, we see limited impact on

liquidity, as the regulations are largely expected, and there is a 19m

grace period. However, we see it as a long-term positive, as it raises

transparency and caps the growth in shadow banking. We expect a

divergent impact on banks, as it favors big banks while adding

pressure to smaller ones. See our report Asset Management Guideline

– Reshaping China’s shadow banking dated 20 November 2017.

8 January 2018

Banks



Figure 4: China’s asset management sector has proliferated in size and complexity in the past few years

Brokers' AM

schemes

(Rmb17.6trn)Trust investment

schemes

(Rmb17.5trn)

Public

mutual fund

(Rmb9.2trn)

Fund and fund

subsidiaries'

investment

schemes

(Rmb16.9trn)

Privatefunds

(Rmb10.2t

rn)

Retail investors (31%)

Corporates (18%)

Financial institutions (51%) Non-standard asset (36%) ~ Rmb37trn

Mutual fund (2%)

Others (11%)

Deposit and money market fund (15%)

Bond (29%)

Equity and other securities (7%)

Funding Source Underlying Asset

Bank's WMP

(Rmb29trn)

Insurance

investment

schemes (1.7trn)

Total asset management industry AUM at Rmb102trn as of end-2016; or

Rmb60-70trn if stripping out overlap.

China's asset management sector

Source: Deutsche Bank estimates, PBOC, AMAC, Trust Association, CIRC, CBRC, “Blue Book of Asset Management 2017” Note: The size of squares represents the size of AUM.

The Guideline on Liquidity Risks of Commercial Banks, released on 6

December 2017, matches the Basel III standards of liquidity

management (e.g. LCR and NSFR) and introduces new measures. We

expect this regulation to lower banks’ duration mismatch, cut off

wholesale funding and reduce investment in shadow banking assets.

As such, we see a net positive over the longer run, as it reduces

systemic liquidity risks. However, near term, the banks that are

wholesale-funded and shadow-banking-centric are likely to be subject

to NIM pressure. See our report Liquidity Risk Management Guideline –

Divergence continues dated 6 December 2017.

Figure 5: Summary of liquidity risk measures – 2017 version

Liquidity risk measures Applicable banks Calculation Minimum requirement Phase-in

period

Liquidity coverage ratio (LCR) Bank asset >= Rmb200bn High Quality Liquid Assets (HQLA) / net

cash outflows in next 30 days

90% by 2017 and 100% by 2018 2017-2018

Net stable funding ratio (NSFR) Bank asset >= Rmb200bn Stable funding available / stable

funding needed

100% NA

Liquidity ratio (LR) All banks Liquid assets / liquid liabilities 25% NA

Liquidity matching ratio (LMR) All banks Weighted funding sources / weighted

funding uses

90% by 2018 and 100% by 2019 2017-2019

High quality liquid assets (HQLA)

adequacy ratio

Bank asset < Rmb200bn HQLA / short-term cash outflows 70% by June 2018 and 100% by end-

2018

2017-2018

Loan to deposit rate (LDR) All banks Loans / deposits 75% cap removed in June 2015 NA

Source: Deutsche Bank, CBRC

Evolving MPA framework – inclusion of off-BS WMP and interbank

CDs. PBOC has introduced a macro-prudential assessment (MPA)

framework since 2016 to better monitor financial stability and

strengthen discipline in financial institutions. Among the seven

components under the MPA framework, we believe the introduction of

broader credit (including not only loans, but also bond investments,

interbank assets and shadow banking) and macro-prudential capital

8 January 2018

Banks



adequacy are particularly impactful, as these measures largely

constrain the aggressive asset expansion of smaller financial

institutions. More importantly, the MPA framework has continued to

evolve. Two major changes have been made: off-BS WMPs have been

included in broader credit since 2017 and interbank CDs will be

included in interbank liabilities, which are capped at one-third of total

liabilities, starting from 1Q18.

The Guidelines on Banks-Trust Cooperation: single-fund trusts are

generally viewed as the channel business from banks’

WMPs/proprietary investment, which came in at Rmb11.5trn as of

3Q17 (5% of system credit). The new rule stipulates that commercial

banks must take the main responsibility of fund management, usage

and risk control. It also emphasizes a proper level of capital charge

and provision charge.

The Guidelines on Entrusted Loans: as of November 2017, system

entrusted loans came in at Rmb13.9trn (6% of system credit). Major

highlights of the new rule include (1) prohibiting licensed lending

institutions as entrusted loan lender, and (2) restricting asset

management entity as entrusted loan lender, aimed at capping the

development of non-standard credit asset and containing shadow

banking expansion.

Figure 6: Single fund trust vs. yoy growth Figure 7: Industry entrusted loan vs. yoy growth

0%

20%

40%

60%

80%

100%

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Single Fund Trust AUM (Rmb bn)

YoY growth rate (RHS)

(Rmb bn)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000Entrusted loan balance

YoY growth rate

(Rmb mn)

Source: Deutsche Bank, Trust Association

Source: Deutsche Bank, PBOC

Circular 302 – regulations over entrusted bond investment: Entrusted

bond investment is essentially a financial institution moving a bond

investment off balance sheet so as to leverage up and bypass

regulations. It is conducted through an OTC repurchase transaction.

According to Caixin, entrusted bonds could account for 15% of cash

bond transactions, with an estimated balance of Rmb12trn. New rules

regulate that bond sellers with repurchase agreements need to include

those bonds sold to other financial institutions into their own capital

calculation, which basically prohibits entrusted bond investment.

Large-amount Risk Exposure Management Guideline: This renews

the regulation on commercial banks’ lending exposure to single

corporate/interbank customers, with the aim of further capping the

concentration risk. The major focus is the ceiling of single interbank

client exposure, which has been lowered to 25% of tier 1 capital vs.

the previous 50%.

8 January 2018

Banks



New capital rules over asset management companies (AMCs): On 29

December 2017, CBRC announced capital management measures for

asset management companies (AMCs), effective from 1 January 2018,

which formalize AMCs’ capital/leverage requirement at both the

company and group level. The document keeps 9%/10%/12.5% CET-

1/tier-1/CAR requirement for parent company, but lifts minimum group

leverage from 6% to 8% (before 2020).

Monetary policy: higher rates but ample liquidity with pre-emptive measures

China’s monetary policy has shifted gradually towards a tightening stance

since the beginning of 2017. PBOC has hiked rates of monetary tools three

times by 25bps in aggregate in the past 12 months. These actions have pushed

up interbank rates and bond yields, and subsequently translated gradually to

lending and the shadow banking market (Figure 8). Higher market rates

narrowed the spread earned by levered financial institutions, and in some

transactions, the spread is even negative. This forced smaller banks to de-lever.

Looking ahead, our rates strategist Liu Linan expects a hike total of 20-45bps

in OMO rates until 2018 and 7D benchmark repo fixing rate to range between

2.85-3.50% (see her note). This should further push up interbank rates, bond

yield and loan yield. However, we do not expect PBOC to hike benchmark

loan/deposit rates, which anchor the pricing for 50% of banking assets and

65% of liabilities. Leverage in the real economy remains high, and economic

growth is likely to slow modestly. Thus, we do not believe a hike in benchmark

rates is justified. However, inflation is the key risk. If PBOC was forced to hike

the rate due to heightened inflation, the market might be concerned on the

asset quality issue of the banking system.

Figure 8: Rate transmission framework in China – from PBOC liquidity facilities to shadow banking

25

34

106

49

84

O M O 7 D R A T E D R 0 0 7 1 0 Y T R E A S U R Y B O N D

Y I E L D

N E W N O N - B I L L

C O R P O R A T E L O A N R A T E

T R U S T Y I E L D

2017 YTD RATE INCREASE (BP)

PBOC injection

(OMO/MLF/SLF etc.)

Money market

(DR007/R007/GC007

etc.)

Bond market

(Treasury/corporate/

CDs etc.)

Lending market

(Corporate

loan/mortgage/bills)

Shadow banking

market

(Trust/WMP/P2P)

Total size: Rmb10.5trn Total size: Rmb12trn Total size: Rmb71trn Total size: Rmb120trn Total size: Rmb48trn

Rate transmission framework in China

Source: Deutsche Bank, WIND, CEIC, PBOC Note: interest rate data is as of late December 2017 except for non-bill corporate loan (as of Sept 2017). Each market size data is latest available data.

8 January 2018

Banks



Figure 9: After hike of 25bps in 2017, we expect PBOC to

hike OMO rate by another 20-45bps in 2018

Figure 10: Meanwhile, DR007 is likely to rise to a higher

range of 2.85-3.50%

2.25

2.50

2.40

2.602.55

2.80

2.90

2.00

2.20

2.40

2.60

2.80

3.00

3.20

3.40

3.60

3.80

4.00

Jan-1

5

Mar-

15

May-1

5

Jul-1

5

Se

p-1

5

No

v-1

5

Jan-1

6

Mar-

16

May-1

6

Jul-1

6

Sep

-16

No

v-1

6

Jan-1

7

Ap

r-1

7

Jun

-17

Au

g-1

7

Oct-

17

Dec-1

7

PBOC's reverse repo rate

7-D 14-D 28-D 63-D

(%)

up by 20-

45bps by

2018

2.93

2.00

2.20

2.40

2.60

2.80

3.00

3.20

3.40

3.60

DR007(%)

Currently PBOC keeps DR007 at 2.75-3.00%

We expect DR007 to

rise to 2.85-3.50%

Source: Deutsche Bank estimates, PBOC, WIND

Source: Deutsche Bank estimates, PBOC, WIND Note: DR007 refers to 7D benchmark repo fixing rate

However, liquidity volume should stay ample, as we believe that while

tightening, PBOC also needs to prevent systemic risks. Indeed, in 2017, the

PBOC injected Rmb1.6tr liquidity mainly via MLF and PSL (Figure 11 and 12).

This is equivalent in size to a 100bps RRR cut or sufficient to fund 10% of

banking asset expansion.

Figure 11: Changing size and composition of PBOC

balance sheet – rising liquidity injection to banks

Figure 12: PBOC’s lending to banking system is rising,

driven by MLF mainly

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

FX reserves Claims on depository corporations Other(Rmb bn)

Rapid

growth in

liquidity

provision

to banks

-1,000

1,000

3,000

5,000

7,000

9,000

11,000OMO/ Other PSL MLF

Source: Deutsche Bank, PBOC


The liquidity injection was also coupled with a few pre-emptive liquidity

measures, such as the recent relaxation on automated pledged financing and

the temporary RRR cut during Chinese New Year. So we expect a relatively

remote likelihood of a bank run in the wholesale funding market.

Relaxation in Automated Pledge Financing: automated pledge

financing will be triggered by a liquidity event of a particular financial

institution, i.e. when a financial institution runs out all reserves but still

fails to meet settlement obligations. Relaxations of the new rule

include (1) higher financing limits, i.e. the maximum financing line of

joint stock banks and other smaller city/rural banks has been lifted to

10%/15% of paid-in capital from the previous 2%/5%, (2) standardized

interest rate: this will be based on overnight SLF rates, (3) larger

scope of eligible bonds for pledge: the scope has been expanded to

local government bonds and other securities accepted by PBOC, in

8 January 2018

Banks



addition to central government bonds and policy banks financial

bonds.

Temporary RRR cut: this aims to meet the temporary liquidity demand

of banks during Chinese New Year, and facilitate the smooth operation

of the money market. According to the new rules, national commercial

banks with large cash injections can withdraw up to 2% of the deposit

reserve temporarily for up to 30 days. This temporary RRR cut would

help release Rmb1.5-2.0trn liquidity for one month per our calculation.

What are the implications for the entire system?

Over the longer run, we see most of these above-mentioned deleveraging

measures as positive and necessary steps to strengthen China’s financial

stability. In the near term, for the financial system, we expect slower banking

asset growth, modest yield curve steepening and a lower actual risk-free rate.

For the real economy, we forecast moderate credit growth with shrinking

shadow banking and hence, slower economic growth. However, it should

come with the benefit of a slower build-up in leverage and better transparency.

While some highly-levered banks and NBFIs will almost inevitably be hurt,

the financial deleveraging campaign generates net positive to the financial

system and real economy as a whole.

Impacts on the financial system Slower banking asset growth (Figure 13), with reducing interbank

liabilities and assets (Figure 13). We expect banking asset growth to

hover around the high single digits in 2018 and some smaller banks to

shrink their balance sheets further.

Figure 13: China banking asset growth is likely to slow, driven by reducing interbank businesses

15.2%

9.2%8.0%

13.0%

18.0%

23.0%

28.0%

33.0%

China banking assets yoy growth

4,269

3,519

2,897

430

340

54

(2,219)

(5,000) - 5,000

Credit to households

Credit to government

Credit to corporate

Other assets

Cash and deposits with PBOC

Credit to NBFIs

Credit to interbank and PBOC

Rmb bn

China banking balance sheet - Changes in balance during Mar-Oct 2017

Assets

3,522

1,810

1,761

1,735

793

(1,253)

(2,000) - 2,000 4,000

General deposits

Other liabilities

Borrowing from

PBOC

Borrowing from

NBFIs

Bond issuance

Borrowing from

interbank (incl.

interbank CD)

Liabilities

Source: Deutsche Bank estimates, PBOC, WIND

Shrinking asset management AUM, leading to shortened financing

chains. We believe the fast-growing shadow banking is a reflection of

lengthened financing chains, i.e. the credit would have to go through

multiple layers of SPVs from the funding providers to the ultimate

borrowers. To measure the length of financing chains, we can look at

financial assets to M2 ratio, where financial assets include all banking

assets and NBFIs’ asset management product AUM. On a stock basis,

China’s total financial assets accounted for 2.1x M2 balance,

suggesting there are slightly more than two layers to package the

8 January 2018

Banks



financing in China (Figure 14). On a flow basis (Figure 15), the layers of

SPVs to package new credit, which once surged to 4.3x in 2016, citing

every 1 dollar M2 creation, would need an incremental 4.3 dollars of

financial assets. However, post a series of tightening regulatory

treatment in 2H16, this has come down notably to only 1.1x in 2Q17.

We expect the ratio on a flow basis to fall below 0 in 2018.

Figure 14: Financial assets have grown faster than M2,

suggesting a lengthening chain of financing…

Figure 15: …but financing chains have started to shorten

since 1Q17 due to tighter regulations

1.8x

1.8x

1.9x

2.0x

2.1x 2.1x2.1x

1.6x

1.7x

1.7x

1.8x

1.8x

1.9x

1.9x

2.0x

2.0x

2.1x

2.1x

2.2x

-

50

100

150

200

250

300

350

400

2014 1H15 2015 1H16 2016 1Q17 2Q17

Rm

b t

r

Total financial assets (banking assets + NBFI AUM)

M2

Financial assets/M2 (x, RHS)

2.53x

3.93x

3.09x

4.26x

1.99x

1.10x

0.60x

1.10x

1.60x

2.10x

2.60x

3.10x

3.60x

4.10x

4.60x

1H15 2015 1H16 2016 1Q17 2Q17

Δ (banking asset + asset management plans) / ΔM2 (x)(x)

Source: Deutsche Bank, CBRC, PBOC, CSRC, AMAC

Source: Deutsche Bank, CBRC, PBOC, CSRC, AMAC

Modest yield curve steepening. China’s yield curve in the bond

market has steepened since July 2017, with the spread between 5Y

CGB and 1Y CGB expanding by nearly 50bps. Looking into 2018, we

expect the yield curve to modestly steepen from its current level. Two

main drivers: 1) tighter regulations on asset management and liquidity

risks are likely to force banks and NBFIs to unwind investment in high-

liquid assets and to trim the incremental demand for long-term bonds

and hence, will push up the long bond yield and 2) the inclusion of

interbank CDs into MPA from 1Q18 is likely to reduce the issuance of

interbank CDs, which may cap the upside of the short-term bond yield.

Figure 16: Chinese treasury yield difference in the past 10 years: (10Y – 5Y) versus (5Y – 1Y)

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

Difference: 10-year vs 5-year treasury yield Difference: 5-year vs 1-year treasury yield(%)

Sept-Dec 2008 PBOC cut benmark

lending/deposit rate and RRR to

weather the downturn in global

financial crisis

2Q-3Q13 Liquidity shock caused by

tightening restriction on banks' WMPs

invesmtent and transaction with

proprietary account, pushing market

rate hike

Oct 2010 - July 2011 PBOC lift up

benchmarkt deposit and RRR

4Q 2010 PBOC lower down RRR

by 50bps to deal with risks

arose from European bond

market

4Q2011-2Q2012 150bp

RRR cut

PBOC injected

liquidity into the

market to cool down

rising market rate

PBOC lower down RRR,

benchmark deposit rate

consecutively in June 2014- Feb

2016

High volatility in equity market,

combined with pressures of

economic growth slowdown, rising

demand of hedging, dragged long-

term yield decline

Rising market rate on

tightening regulatory on

WMPs and shadow banking

3Q17: ST

liqudiity demand

slowed down,

long term yield

up on stable

economic

outlook

???

???

Source: Deutsche Bank, CEIC, PBOC, China Bond

WMP rate to fall, leading to a lower actual risk-free rate and better

risk-pricing. In the past, banks used their own capital or asset pool

operation to provide implicit guarantees on principal and return of

WMPs, which actually lifts the risk-free rate and pushes up the social

8 January 2018

Banks



financing cost. This also deepens the moral hazard risk, as WMP

buyers generally expect implicit guarantees from banks. Post the new

regulations, we expect banks’ WMPs to transform into something

similar to close-end mutual funds. In this process, banks’ WMP yield

would gradually come down, as the WMPs invest in low-risk assets

with less duration mismatch. This should help lower the actual risk-

free rate and strengthen risk pricing and monetary policy transmission,

thus improving the capital allocation in the system.

Figure 17: WMP yield is likely to fall, driving down the actual risk-free rate

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Feb-09 Nov-09 Aug-10 May-11 Feb-12 Nov-12 Aug-13 May-14 Feb-15 Nov-15 Aug-16 May-17

DR007 3M WMP yield 10-year treasury yield Benchmark deposit rate - 1 year(%)

Source: Deutsche Bank estimates, WIND, CEIC, PBOC

Impacts on the real economy Slower credit growth, driven by shrinking shadow banking on

tighter regulations. We expect system credit growth, as measured by

total social financing adjusted for municipal bonds and equity

financing, to slow to 12-13% yoy by the end of 2018 from 14.4% yoy

now. This may add downward pressure on China’s economic growth.

Our China economists expect GDP growth to slow to 6.3% in 2018

and 2019 (see report). Credit-mix wise, we expect loan growth to

accelerate a bit towards about 14% yoy, offset by shrinking shadow

banking. Specifically, we expect banks’ WMP and various asset

management schemes issued by NBFIs to shrink in absolute balance.

Figure 18: We expect China’s credit growth to moderate

to 12-13% yoy in 2018

Figure 19: China’s credit impulse is also likely to fall

17.2%

14.4%

10%

15%

20%

25%

30%

35%

40% TSF stock yoy TSF stock (adj.) yoy

c.12-13%

in 2018E

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

TSF rolling 3 mth (SA) Average

18th NationalCongress Nov 17th National

Congress Oct 2007

19th NationalCongress Oct-Nov

2017

Source: Deutsche Bank estimates, PBOC, CBRC, WIND Note: Adjusted TSF refers to TSF plus municipal bonds minus equity financing.


Non-financial leverage continues to build, but at a slower pace. We

expect China’s debt-to-GDP ratio to increase to 294% by the end of

8 January 2018

Banks



2019 from 276%, as of September 2017. However, given slower credit

expansion, the pace of leverage build-up is slowing, as shown in

Figure 20. While the increasing leverage in China is a long-term issue,

we do believe the debt structure is much more important than the

aggregate amount of debt. As we highlighted in our report Time to

accumulate big banks dated 20 July 2017, there are indeed

incremental improvements in China’s debt structure.

Modest increase in social financing cost, which is offset by better

corporate profitability and still-low real interest rates. With the gradual

transmission of higher market rates, the average borrowing cost of the

real economy increased modestly (Figure 21). Yet, due to elevated PPI,

the real borrowing cost is actually still in negative territory, suggesting

that a debt servicing burden for corporate is not a major issue as of

now. Looking ahead, as PPI is likely to fall in 2018 (still positive), the

real borrowing cost may increase modestly.

Figure 20: Non-financial leverage is likely to rise, but at a

slower pace

Figure 21: Social financing cost increased modestly, but

the real financing cost for borrowers is low

30

15

(2)

15

18

15

23 23

7 7 8

(5)

-

5

10

15

20

25

30

35

2009 2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

% yoy change in China's debt-to-GDP ratio

5.896.25

6.37

12.6

0.4

0.7

(0.5)-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

2011 2012 2013 1H14 2014 1H15 2015 1H16 2016 1H17 3Q17

Total social financing cost Real social financing cost (minus PPI)

Source: Deutsche Bank estimates, PBOC, CBRC, CIRC, SAFE, NBS, MOF, CEIC, WIND, Chinabond.com.cn, Trustee Association of China, SAC, HKMA, media reports

Source: Deutsche Bank estimates, PBOC, CBRC, CIRC, SAFE, NBS, MOF, CEIC, WIND, Chinabond.com.cn, Trustee Association of China, SAC, HKMA, media reports Note: Total social financing cost is calculated as the weighted borrowing cost of loans, bonds and shadow banking.

Credit allocations may continue to shift towards household and

governments. In the past two years, the corporate sector has

borrowed less while government and household were leveraging up

(Figure 22). We expect this shift in leverage to continue in 2018, with

the new credit mix being 30%, 30% and 40% for government,

household and corporate, respectively. There should be notable

changes in the mix of each sector. Household credit should shift from

mortgage-centric to consumption loans (especially credit cards).

Government credit should be more in the form of municipal bonds,

which should offset a notable slowdown in PPP and LGFV borrowing.

Within corporate credit, we expect the manufacturing sector to pick

up, partly offsetting the slowdown in infrastructure and property.

8 January 2018

Banks



Figure 22: China’s new credit breakdown

55

72

57

69 7266

54

6859 62

51

3843

10

15

16

9

1720

17

15

2019

20

25

29

12

825

7

10 11

11

1217 15

2737

2622

5 2

14

1 2

17

5 5 5 1 0 3

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

11M

17

China - New credit breakdown by borrowers

Government

Household

Corporate

30%

30%

40%

Source: Deutsche Bank estimates, PBOC, CBRC, WIND

What are the implications for individual banks?

Under the backdrop of policy tightening, we prefer banks with a strong

deposit franchise, less shadow banking exposure and solid capital positions.

They could benefit from higher market rates with NIM expansion, as they are

net interbank lenders. With solid capital, these banks could maintain asset

growth. Strong retail franchises make these banks key beneficiaries of

continued household leveraging-up.

In contrast, the rest of the corporate-oriented banks will likely continuously

be subject to capital and earnings pressure. As they are mainly wholesale-

funded, they will record either weaker NIM or slower/shrinking assets, leading

to weaker PPoP growth. Fee income growth is likely under pressure given

shrinkage in WMPs and other asset management products. Asset quality may

resurface as an issue, as we expect defaults to increase in shadow banking

credit.

Funding strength, especially in the deposit franchise, continues to be

the key differentiating factor (Figure 23 and Figure 24). Banks with a

strong deposit franchise, i.e. big four, CMB and CRCB, record lower

funding costs and are able to expand NIM when market rates rise. In

contrast, wholesale-funded banks may be subject to higher funding

cost. For instance, the yield of interbank CDs, on which smaller banks

are reliant to get financing, has shot up close to historical highs,

making limited or no spread for lending or investing (Figure 26).

8 January 2018

Banks



Figure 23: Banks with strong deposit franchise should

benefit

Figure 24: Smaller banks rely more on wholesale funding

81%

53%

68%66%

8%

18%

15%

10%

3%

16%

7%

7%

7%

4%

6%

40%

50%

60%

70%

80%

90%

100%

Big-four Medium banks Small banks Banking system

Liabilities breakdown - 1Q17Other liabilities

Bond issuance

Borrowing from

PBOC

Borrowing from

NBFIs

Borrowing from

interbank (incl.

CD)

General deposits

11%

34%

22%

17%

44

3837 36 35

32 32 32 3028 28

23 22

14 1311

912

33

20

0

5

10

15

20

25

30

35

40

45

50

Wholesale funding as% of total liabilities - 3Q17(%)

Retail-oriteated

banks

Source: Deutsche Bank, WIND, PBOC, company data

Source: Deutsche Bank, company data

Figure 25: Retail-oriented banks have lower funding

cost…

Figure 26: … while smaller banks’ funding cost keep

rising, as evidenced by interbank CD yield

3.05

2.91

2.75 2.74 2.71 2.68 2.62 2.59 2.57 2.55

2.39 2.38

1.80 1.70

1.60 1.53 1.49

1.94

1.30

1.50

1.70

1.90

2.10

2.30

2.50

2.70

2.90

3.10

3.30

(%) Funding cost - 3Q17

Retail-oriteated

banks have lower

funding cost

5.295.33

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00CDs Yield - 3M CDs Yield - 6M(%)



We conducted a sensitivity test on three groups of banks: big four,

listed joint-stock banks and 179 city/rural commercial banks. The test

concludes that joint-stock banks and city commercial banks are more

vulnerable to a market rate hike due to their higher financial leverage

and heavier reliance on non-core funding (Figure 27). In particular, a

50bps market rate hike would knock off 7% and 4% earnings for JSBs

and smaller banks, respectively. In contrast, this magnitude of a

market rate hike would bring a 1.3% earning boost to the big four

banks, given their net lending position in the interbank market. Figure

30 shows the market rate hike impacts on individual banks, with ABC

as the key beneficiary, while INDB, SPDB, MSB and CITIC Bank were

the most severely hit (>9% PBT impact).

8 January 2018

Banks



Figure 27: Sensitivity – PBT impact from 50bps market

rate hike for three types of banks

Figure 28: Sensitivity – PBT impact from 50bps market

rate hike for individual banks

1.3

-7.2

-3.6

-8.0

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

Big four banks Joint-stock banks (8

banks incl.)

Smaller banks (179

city+rural banks incl.)

PBT impact comparison among different bank types upon 50bps

market interest rate hike

(%)

-15.8

-9.4

-8.2 -8.1

-6.2-5.2 -4.7 -4.2 -3.7 -3.1 -3.0 -2.9

-0.3 -0.3

0.91.9

2.7

-1.4

-20.0

-15.0

-10.0

-5.0

0.0

5.0PBT impact on banks upon 50bps market interest rate hike

2016

(%)

Source: Deutsche Bank estimates, company data, Chinabond.com.cn

Source: Deutsche Bank estimates, company data

Shadow banking exposure is another factor leading to divergent

performance. Tighter regulations are likely to impose additional capital

pressure when banks are forced to set aside sufficient capital on their

shadow banking exposure (Figure 29).

A strong capital base determines banks’ ability to weather liquidity

and asset quality shocks and to secure sustainable asset growth

(Figure 30).

Figure 29: Big banks tend to have much less exposure to

shadow banking

Figure 30: Retail-oriented banks in general have stronger

capital

3533

2926

24

20 20 19 18 18 18 17

12

53 3 2 1

2

17

8

0

5

10

15

20

25

30

35

40

(% of assets)Listed banks' exposure to shadow credit - 1H17

Off B/S NSCA in WMPs Reverse repo backed by bills/TBRs

Negligible

exposure at big-

four banks

13.4 13.0 12.7

12.0

11.2 10.8 10.5

10.0 9.8 9.5 9.4 9.3 9.3 9.2 9.1 9.0 8.6

10.4

6.0

7.0

8.0

9.0

10.0

11.0

12.0

13.0

14.0

(%) Tier-1 capital ratio - 3Q17

Retail banks also have

stronger capital base



8 January 2018

Banks



Valuation and risks

Valuation of Chinese banks

We value Chinese banks using a three-stage Gordon Growth Model (PV= (ROE-

g)/(COE-g)), with target prices based on 2018E book values.

Our valuations of the Chinese banks under our coverage assume a near-term

(2016-18E) ROE of 11.5-16.9%, a medium-term (2019-21E) ROE of 10.5-14.0%

and a terminal ROE of 8.0-12.0%, with a COE of 11.5-14.0%. In Figure 31, we

highlight our valuation comparison of the listed banks.

On our estimates, H-share/A-share listed Chinese banks are trading at 2018E

P/B of 0.79x/0.91x and 2018E P/E of 6.0x/7.0x.

Figure 31: Chinese banks’ valuation summary

Ticker Rating TP Price Upside Mkt. Cap

LC LC (%) (US$mn) 16A 17E 18E 16A 17E 18E 16A 17E 18E 16A 17E 18E 16A 17E 18E 16A 17E 18E

ICBC-H 1398.HK Buy 7.52 6.56 14.6% 325,455 7.5 6.9 6.4 1.1 0.9 0.8 4.6 4.0 3.5 15.2% 14.2% 13.8% 1.20% 1.14% 1.13% 4.0% 4.4% 4.8%

CCB-H 0939.HK Buy 8.87 7.61 16.6% 245,329 7.3 6.6 6.2 1.1 0.9 0.8 4.3 3.7 3.3 15.5% 14.6% 14.1% 1.18% 1.13% 1.11% 4.1% 4.6% 4.9%

ABC-H 1288.HK Buy 4.73 3.91 21.0% 190,759 6.3 5.6 5.2 0.9 0.8 0.7 3.6 3.1 2.7 15.1% 14.4% 14.0% 0.99% 0.94% 0.92% 4.9% 5.5% 5.9%

BOC-H 3988.HK Buy 5.25 4.02 30.6% 172,274 6.6 5.8 5.4 0.8 0.7 0.6 3.4 3.1 2.7 12.5% 12.3% 12.2% 1.05% 1.03% 1.03% 4.7% 5.4% 5.8%

BCOM-H 3328.HK Buy 7.29 5.98 21.9% 64,765 5.9 5.4 5.1 0.7 0.6 0.5 3.4 3.2 2.9 12.2% 11.4% 11.2% 0.87% 0.81% 0.79% 5.1% 5.5% 5.9%

CMB-H 3968.HK Hold 31.38 32.60 -3.7% 114,838 11.6 9.8 8.7 1.8 1.5 1.3 5.0 4.5 4.1 16.3% 16.3% 16.2% 1.09% 1.12% 1.16% 2.6% 3.1% 3.4%

CITIC Bank-H 0998.HK Hold 5.28 5.04 4.8% 43,391 5.2 4.9 4.8 0.6 0.5 0.5 2.0 1.9 1.8 12.6% 11.5% 10.8% 0.75% 0.70% 0.71% 4.8% 3.0% 3.1%

Minsheng-H 1988.HK Hold 8.68 8.01 8.4% 46,272 5.4 5.0 5.1 0.8 0.7 0.6 2.5 2.6 2.4 15.1% 13.8% 12.2% 0.94% 0.86% 0.88% 4.0% 3.0% 2.9%

CEB-H 6818.HK Hold 3.72 3.71 0.3% 31,294 5.2 4.9 4.8 0.7 0.6 0.5 2.4 2.3 2.1 13.8% 12.6% 11.5% 0.85% 0.76% 0.75% 3.0% 0.0% 0.0%

CRCB 3618.HK Buy 7.00 5.81 20.5% 6,910 6.0 5.5 4.9 0.9 0.8 0.7 3.6 3.1 2.7 16.0% 15.1% 14.6% 1.05% 1.05% 1.09% 3.9% 3.6% 4.1%

Huishang 3698.HK Sell 3.49 4.12 -15.3% 5,822 5.9 5.3 4.9 0.9 0.7 0.6 2.7 2.5 2.2 15.8% 14.6% 13.7% 0.99% 0.93% 0.93% 1.7% 1.9% 2.0%

BOCQ 1963.HK Hold 6.50 6.41 1.4% 2,563 5.1 4.4 4.1 0.7 0.6 0.6 2.5 2.3 2.1 15.5% 15.0% 14.3% 1.01% 0.98% 0.98% 5.1% 5.9% 6.3%

H-share sector mean 7.2 6.5 6.0 1.0 0.9 0.8 4.0 3.5 3.1 14.7% 14.0% 13.5% 1.08% 1.04% 1.03% 4.2% 4.5% 4.8%

ICBC-A 601398.SS Buy 6.50 6.08 6.9% 325,455 7.9 7.7 7.2 1.2 1.0 0.9 4.8 4.5 3.9 15.2% 14.2% 13.8% 1.20% 1.14% 1.13% 3.9% 4.0% 4.3%

CCB-A 601939.SS Buy 7.67 7.68 -0.1% 245,329 8.3 8.0 7.5 1.2 1.1 1.0 4.9 4.5 4.1 15.5% 14.6% 14.1% 1.18% 1.13% 1.11% 3.6% 3.8% 4.0%

ABC-A 601288.SS Hold 4.09 3.87 5.7% 190,759 7.0 6.7 6.2 1.0 0.9 0.8 4.0 3.7 3.2 15.1% 14.4% 14.0% 0.99% 0.94% 0.92% 4.4% 4.6% 4.9%

BOC-A 601988.SS Buy 4.54 3.98 14.1% 172,274 7.4 6.9 6.4 0.9 0.8 0.8 3.8 3.7 3.3 12.5% 12.3% 12.2% 1.05% 1.03% 1.03% 4.2% 4.5% 4.9%

BCOM-A 601328.SS Hold 6.30 6.28 0.3% 64,765 7.0 6.9 6.4 0.8 0.8 0.7 4.1 4.0 3.6 12.2% 11.4% 11.2% 0.87% 0.81% 0.79% 4.3% 4.4% 4.7%

CMB-A 600036.SS Hold 27.13 30.10 -9.9% 114,838 12.2 10.9 9.7 1.9 1.7 1.5 5.2 5.0 4.6 16.3% 16.3% 16.2% 1.09% 1.12% 1.16% 2.5% 2.7% 3.1%

CITIC Bank-A 601998.SS Sell 4.56 6.44 -29.2% 43,391 7.6 7.6 7.4 0.9 0.8 0.8 2.9 2.9 2.8 12.6% 11.5% 10.8% 0.75% 0.70% 0.71% 3.3% 2.0% 2.0%

Minsheng-A 600016.SS Sell 7.51 8.60 -12.7% 46,272 6.6 6.5 6.6 0.9 0.8 0.8 3.1 3.3 3.1 15.1% 13.8% 12.2% 0.94% 0.86% 0.88% 3.3% 2.3% 2.3%

SPDB 600000.SS Hold 13.61 12.69 7.2% 57,407 5.3 5.2 5.2 0.8 0.7 0.6 2.3 2.2 2.0 16.5% 14.5% 12.9% 0.94% 0.87% 0.83% 1.6% 1.6% 1.6%

Industrial Bank 601166.SS Sell 16.38 17.20 -4.8% 55,070 6.3 6.0 5.9 1.0 0.9 0.8 2.9 3.3 3.1 17.1% 15.8% 14.1% 0.89% 0.88% 0.87% 3.5% 1.7% 1.7%

CEB 601818.SS Sell 3.22 4.12 -21.8% 25,279 6.6 6.6 6.4 0.9 0.8 0.7 3.0 3.0 2.9 13.8% 12.6% 11.5% 0.85% 0.76% 0.75% 2.4% 0.0% 0.0%

Ping An Bank 000001.SZ Hold 10.89 13.30 -18.1% 35,196 10.1 9.9 9.4 1.3 1.1 1.0 3.0 3.0 2.7 13.1% 12.0% 11.4% 0.83% 0.79% 0.77% 1.2% 1.5% 1.6%

Bank of Beijing 601169.SS Buy 9.69 7.29 32.9% 23,755 6.3 7.2 6.6 0.9 1.0 0.9 3.3 3.5 3.1 14.9% 14.0% 13.8% 0.90% 0.86% 0.86% 3.4% 3.0% 3.3%

Bank of Nanjing 601009.SS Sell 6.21 7.83 -20.7% 10,236 5.9 7.5 7.1 0.9 1.1 1.0 2.5 3.9 3.5 16.2% 15.8% 14.6% 0.86% 0.79% 0.75% 3.3% 2.7% 2.8%

Bank of Ningbo 002142.SZ Sell 10.81 18.17 -40.5% 14,197 9.3 10.6 9.7 1.6 1.7 1.5 4.7 5.8 5.1 17.7% 17.7% 16.8% 0.98% 0.96% 0.94% 1.9% 1.7% 1.9%

A-share sector mean 7.8 7.5 7.0 1.1 1.0 0.9 4.1 4.0 3.6 14.7% 13.9% 13.4% 1.04% 1.00% 0.99% 3.5% 3.5% 3.7%

Div. Yield (%)ROAAROAEP/PPOPP/B (x)P/E (x)

Source: Deutsche Bank estimates, Bloomberg Finance LP; Note: market cap is sum of A and H shares; data as of 5 January 2017

Risks for Chinese banks

Key sector risks for Chinese banks CPI picks up and the PBOC is forced to hike benchmark rates: a

potential benchmark rate hike in the near term would likely be more

harmful to corporates (higher interest burden), which cannot be fully

offset by profitability recovery under better economic growth,

considering that corporates’ leverage ratio remains at a higher level, in

spite of the mild improvement recently.

Disorderly deleveraging: the government could place disorderly

deleveraging requirements on certain industries, which might

unexpectedly lead to a bank run and squeeze banks’ wholesale

funding.

8 January 2018

Banks



Over-tightening in real estate and infrastructure: If both industries

saw unfavorable credit conditions, the overall banking system might

have little chance of avoiding asset quality deterioration.

Significant property price corrections: NPL ratios usually surge

following an over-correction in property market prices, according to

historical experience. For example, Wenzhou’s NPL ratio surged

4.3ppt to 4.7% accompanying a 47% price correction in the city’s

property market.

Larger-than-expected DES size, given potentially stronger

government invention: Without strict selection criteria on the viability

of target companies, it could potentially “evergreen” the debts of

“zombie” companies, worsen capital allocation and raise investment

risk for banks.

Key upside risks for the sector:

Removal of the softening of GDP targets: In the long run, we believe

this movement will likely be meaningfully positive to banks’ RoE/RoA,

as most of the legacy NPLs are disposed within the near term (two to

three years) and banks should have notably lighter credit cost burdens

in the future.

More aggressive SOE reform to push forward privatization: SOEs are

likely to be more market-oriented, profitability might be better and

asset quality will likely recover accordingly. As of now, we are seeing

improving conditions at industrial SOEs, while non-industrial SOEs still

seem to be struggling. We are closely tracking SOEs’ profitability and

ROE.

Pick-up in private investment by further deregulation and favorable

policies: Private companies in general are more productive and

efficient than SOEs. A leading indicator could be a pick-up in private

companies’ debt growth, which is muted for now.

The authors of this report wish to acknowledge the contribution made by Vivian

Xu, an employee of Evalueserve, a third-party provider to Deutsche Bank of

offshore research support services.

8 January 2018

Banks



Appendix 1

Important Disclosures

*Other information available upon request

Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.

Analyst Certification

The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. Hans Fan

Equity rating key Equity rating dispersion and banking relationships

Buy: Based on a current 12- month view of total share-holder return (TSR = percentage change in share price from current price to projected target price plus pro-jected dividend yield ) , we recommend that investors buy the stock.

Sell: Based on a current 12-month view of total share-holder return, we recommend that investors sell the stock

Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not recommend either a Buy or Sell.

Newly issued research recommendations and target prices supersede previously published research.

57 %

33 %

10 %17 % 18 % 13 %0

100

200

300

400

500

600

Buy Hold Sell

Asia-Pacific Universe

Companies Covered Cos. w/ Banking Relationship

8 January 2018

Banks



Additional Information

The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively

"Deutsche Bank"). Though the information herein is believed to be reliable and has been obtained from public sources

believed to be reliable, Deutsche Bank makes no representation as to its accuracy or completeness. Hyperlinks to third-

party websites in this report are provided for reader convenience only. Deutsche Bank neither endorses the content nor

is responsible for the accuracy or security controls of those websites.

If you use the services of Deutsche Bank in connection with a purchase or sale of a security that is discussed in this

report, or is included or discussed in another communication (oral or written) from a Deutsche Bank analyst, Deutsche

Bank may act as principal for its own account or as agent for another person.

Deutsche Bank may consider this report in deciding to trade as principal. It may also engage in transactions, for its own

account or with customers, in a manner inconsistent with the views taken in this research report. Others within

Deutsche Bank, including strategists, sales staff and other analysts, may take views that are inconsistent with those

taken in this research report. Deutsche Bank issues a variety of research products, including fundamental analysis,

equity-linked analysis, quantitative analysis and trade ideas. Recommendations contained in one type of communication

may differ from recommendations contained in others, whether as a result of differing time horizons, methodologies,

perspectives or otherwise. Deutsche Bank and/or its affiliates may also be holding debt or equity securities of the issuers

it writes on. Analysts are paid in part based on the profitability of Deutsche Bank AG and its affiliates, which includes

investment banking, trading and principal trading revenues.

Opinions, estimates and projections constitute the current judgment of the author as of the date of this report. They do

not necessarily reflect the opinions of Deutsche Bank and are subject to change without notice. Deutsche Bank provides

liquidity for buyers and sellers of securities issued by the companies it covers. Deutsche Bank research analysts

sometimes have shorter-term trade ideas that may be inconsistent with Deutsche Bank's existing longer-term ratings.

Trade ideas for equities can be found at the SOLAR link at http://gm.db.com. A SOLAR idea represents a high-conviction

belief by an analyst that a stock will outperform or underperform the market and/or a specified sector over a time frame

of no less than two weeks and no more than six months. In addition to SOLAR ideas, analysts may occasionally discuss

with our clients, and with Deutsche Bank salespersons and traders, trading strategies or ideas that reference catalysts or

events that may have a near-term or medium-term impact on the market price of the securities discussed in this report,

which impact may be directionally counter to the analysts' current 12-month view of total return or investment return as

described herein. Deutsche Bank has no obligation to update, modify or amend this report or to otherwise notify a

recipient thereof if an opinion, forecast or estimate changes or becomes inaccurate. Coverage and the frequency of

changes in market conditions and in both general and company-specific economic prospects make it difficult to update

research at defined intervals. Updates are at the sole discretion of the coverage analyst or of the Research Department

Management, and the majority of reports are published at irregular intervals. This report is provided for informational

purposes only and does not take into account the particular investment objectives, financial situations, or needs of

individual clients. It is not an offer or a solicitation of an offer to buy or sell any financial instruments or to participate in

any particular trading strategy. Target prices are inherently imprecise and a product of the analyst’s judgment. The

financial instruments discussed in this report may not be suitable for all investors, and investors must make their own

informed investment decisions. Prices and availability of financial instruments are subject to change without notice, and

investment transactions can lead to losses as a result of price fluctuations and other factors. If a financial instrument is

denominated in a currency other than an investor's currency, a change in exchange rates may adversely affect the

investment. Past performance is not necessarily indicative of future results. Performance calculations exclude

transaction costs, unless otherwise indicated. Unless otherwise indicated, prices are current as of the end of the

previous trading session and are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is also

sourced from Deutsche Bank, subject companies, and other parties.

The Deutsche Bank Research Department is independent of other business divisions of the Bank. Details regarding

organizational arrangements and information barriers we have established to prevent and avoid conflicts of interest with

respect to our research are available on our website under Disclaimer, found on the Legal tab.

8 January 2018

Banks



Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise

to pay fixed or variable interest rates. For an investor who is long fixed-rate instruments (thus receiving these cash

flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a

loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the

loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse

macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation

(including changes in assets holding limits for different types of investors), changes in tax policies, currency

convertibility (which may constrain currency conversion, repatriation of profits and/or liquidation of positions), and

settlement issues related to local clearing houses are also important risk factors. The sensitivity of fixed-income

instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to FX

depreciation, or to specified interest rates – these are common in emerging markets. The index fixings may – by

construction – lag or mis-measure the actual move in the underlying variables they are intended to track. The choice of

the proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons

indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. Funding in a currency

that differs from the currency in which coupons are denominated carries FX risk. Options on swaps (swaptions) the risks

typical to options in addition to the risks related to rates movements.

Derivative transactions involve numerous risks including market, counterparty default and illiquidity risk. The

appropriateness of these products for use by investors depends on the investors' own circumstances, including their tax

position, their regulatory environment and the nature of their other assets and liabilities; as such, investors should take

expert legal and financial advice before entering into any transaction similar to or inspired by the contents of this

publication. The risk of loss in futures trading and options, foreign or domestic, can be substantial. As a result of the

high degree of leverage obtainable in futures and options trading, losses may be incurred that are greater than the

amount of funds initially deposited – up to theoretically unlimited losses. Trading in options involves risk and is not

suitable for all investors. Prior to buying or selling an option, investors must review the "Characteristics and Risks of

Standardized Options”, at http://www.optionsclearing.com/about/publications/character-risks.jsp. If you are unable to

access the website, please contact your Deutsche Bank representative for a copy of this important document.

Participants in foreign exchange transactions may incur risks arising from several factors, including: (i) exchange rates

can be volatile and are subject to large fluctuations; (ii) the value of currencies may be affected by numerous market

factors, including world and national economic, political and regulatory events, events in equity and debt markets and

changes in interest rates; and (iii) currencies may be subject to devaluation or government-imposed exchange controls,

which could affect the value of the currency. Investors in securities such as ADRs, whose values are affected by the

currency of an underlying security, effectively assume currency risk.

Deutsche Bank is not acting as a financial adviser, consultant or fiduciary to you or any of your agents with respect to

any information provided in this report. Deutsche Bank does not provide investment, legal, tax or accounting advice, and

is not acting as an impartial adviser. Information contained herein is being provided on the basis that the recipient will

make an independent assessment of the merits of any investment decision, and is not meant for retirement accounts or

for any specific person or account type. The information we provide is directed only to persons we believe to be

financially sophisticated, who are capable of evaluating investment risks independently, both in general and with regard

to particular transactions and investment strategies, and who understand that Deutsche Bank has financial interests in

the offering of its products and services. If this is not the case, or if you or your agent are an IRA or other retail investor

receiving this directly from us, we ask that you inform us immediately.

Unless governing law provides otherwise, all transactions should be executed through the Deutsche Bank entity in the

investor's home jurisdiction. Aside from within this report, important risk and conflict disclosures can also be found at

https://gm.db.com on each company’s research page and under the "Disclosures Lookup" and "Legal" tabs. Investors

are strongly encouraged to review this information before investing.

United States: Approved and/or distributed by Deutsche Bank Securities Incorporated, a member of FINRA, NFA and

SIPC. Analysts located outside of the United States are employed by non-US affiliates that are not subject to FINRA

regulations, including those regarding contacts with issuer companies.

Germany: Approved and/or distributed by Deutsche Bank AG, a joint stock corporation with limited liability incorporated

in the Federal Republic of Germany with its principal office in Frankfurt am Main. Deutsche Bank AG is authorized under

8 January 2018

Banks



German Banking Law and is subject to supervision by the European Central Bank and by BaFin, Germany’s Federal

Financial Supervisory Authority.

United Kingdom: Approved and/or distributed by Deutsche Bank AG acting through its London Branch at Winchester

House, 1 Great Winchester Street, London EC2N 2DB. Deutsche Bank AG in the United Kingdom is authorised by the

Prudential Regulation Authority and is subject to limited regulation by the Prudential Regulation Authority and Financial

Conduct Authority. Details about the extent of our authorisation and regulation are available on request.

Hong Kong: Distributed by Deutsche Bank AG, Hong Kong Branch or Deutsche Securities Asia Limited (save that any

research relating to futures contracts within the meaning of the Hong Kong Securities and Futures Ordinance Cap. 571

shall be distributed solely by Deutsche Securities Asia Limited). The provisions set out above in the "Additional

Information" section shall apply to the fullest extent permissible by local laws and regulations, including without

limitation the Code of Conduct for Persons Licensed or Registered with the Securities and Futures Commission. .

India: Prepared by Deutsche Equities India Private Limited (DEIPL) having CIN: U65990MH2002PTC137431 and

registered office at 14th Floor, The Capital, C-70, G Block, Bandra Kurla Complex Mumbai (India) 400051. Tel: + 91 22

7180 4444. It is registered by the Securities and Exchange Board of India (SEBI) as a Stock broker bearing registration

nos.: NSE (Capital Market Segment) - INB231196834, NSE (F&O Segment) INF231196834, NSE (Currency Derivatives

Segment) INE231196834, BSE (Capital Market Segment) INB011196830; Merchant Banker bearing SEBI Registration

no.: INM000010833 and Research Analyst bearing SEBI Registration no.: INH000001741. DEIPL may have received

administrative warnings from the SEBI for breaches of Indian regulations. The transmission of research through DEIPL is

Deutsche Bank's determination and will not make a recipient a client of DEIPL. Deutsche Bank and/or its affiliate(s) may

have debt holdings or positions in the subject company. With regard to information on associates, please refer to the

“Shareholdings” section in the Annual Report at: https://www.db.com/ir/en/annual-reports.htm.

Japan: Approved and/or distributed by Deutsche Securities Inc.(DSI). Registration number - Registered as a financial

instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No. 117. Member of associations: JSDA,

Type II Financial Instruments Firms Association and The Financial Futures Association of Japan. Commissions and risks

involved in stock transactions - for stock transactions, we charge stock commissions and consumption tax by

multiplying the transaction amount by the commission rate agreed with each customer. Stock transactions can lead to

losses as a result of share price fluctuations and other factors. Transactions in foreign stocks can lead to additional

losses stemming from foreign exchange fluctuations. We may also charge commissions and fees for certain categories

of investment advice, products and services. Recommended investment strategies, products and services carry the risk

of losses to principal and other losses as a result of changes in market and/or economic trends, and/or fluctuations in

market value. Before deciding on the purchase of financial products and/or services, customers should carefully read the

relevant disclosures, prospectuses and other documentation. "Moody's", "Standard & Poor's", and "Fitch" mentioned in

this report are not registered credit rating agencies in Japan unless Japan or "Nippon" is specifically designated in the

name of the entity. Reports on Japanese listed companies not written by analysts of DSI are written by Deutsche Bank

Group's analysts with the coverage companies specified by DSI. Some of the foreign securities stated on this report are

not disclosed according to the Financial Instruments and Exchange Law of Japan. Target prices set by Deutsche Bank's

equity analysts are based on a 12-month forecast period..

Korea: Distributed by Deutsche Securities Korea Co.

South Africa: Deutsche Bank AG Johannesburg is incorporated in the Federal Republic of Germany (Branch Register

Number in South Africa: 1998/003298/10).

Singapore: This report is issued by Deutsche Bank AG, Singapore Branch or Deutsche Securities Asia Limited, Singapore

Branch (One Raffles Quay #18-00 South Tower Singapore 048583, +65 6423 8001), which may be contacted in respect

of any matters arising from, or in connection with, this report. Where this report is issued or promulgated by Deutsche

Bank in Singapore to a person who is not an accredited investor, expert investor or institutional investor (as defined in

the applicable Singapore laws and regulations), they accept legal responsibility to such person for its contents.

Taiwan: Information on securities/investments that trade in Taiwan is for your reference only. Readers should

independently evaluate investment risks and are solely responsible for their investment decisions. Deutsche Bank

8 January 2018

Banks



research may not be distributed to the Taiwan public media or quoted or used by the Taiwan public media without

written consent. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and

is not to be construed as a recommendation to trade in such securities/instruments. Deutsche Securities Asia Limited,

Taipei Branch may not execute transactions for clients in these securities/instruments.

Qatar: Deutsche Bank AG in the Qatar Financial Centre (registered no. 00032) is regulated by the Qatar Financial Centre

Regulatory Authority. Deutsche Bank AG - QFC Branch may undertake only the financial services activities that fall

within the scope of its existing QFCRA license. Its principal place of business in the QFC: Qatar Financial Centre, Tower,

West Bay, Level 5, PO Box 14928, Doha, Qatar. This information has been distributed by Deutsche Bank AG. Related

financial products or services are only available only to Business Customers, as defined by the Qatar Financial Centre

Regulatory Authority.

Russia: The information, interpretation and opinions submitted herein are not in the context of, and do not constitute,

any appraisal or evaluation activity requiring a license in the Russian Federation.

Kingdom of Saudi Arabia: Deutsche Securities Saudi Arabia LLC Company (registered no. 07073-37) is regulated by the

Capital Market Authority. Deutsche Securities Saudi Arabia may undertake only the financial services activities that fall

within the scope of its existing CMA license. Its principal place of business in Saudi Arabia: King Fahad Road, Al Olaya

District, P.O. Box 301809, Faisaliah Tower - 17th Floor, 11372 Riyadh, Saudi Arabia.

United Arab Emirates: Deutsche Bank AG in the Dubai International Financial Centre (registered no. 00045) is regulated

by the Dubai Financial Services Authority. Deutsche Bank AG - DIFC Branch may undertake only the financial services

activities that fall within the scope of its existing DFSA license. Its principal place of business in the DIFC: Dubai

International Financial Centre, The Gate Village, Building 5, PO Box 504902, Dubai, U.A.E. This information has been

distributed by Deutsche Bank AG. Related financial products or services are available only to Professional Clients, as

defined by the Dubai Financial Services Authority.

Australia and New Zealand: This research is intended only for "wholesale clients" within the meaning of the Australian

Corporations Act and New Zealand Financial Advisors Act, respectively. Please refer to Australia-specific research

disclosures and related information at https://australia.db.com/australia/content/research-information.html Where

research refers to any particular financial product recipients of the research should consider any product disclosure

statement, prospectus or other applicable disclosure document before making any decision about whether to acquire

the product.

Additional information relative to securities, other financial products or issuers discussed in this report is available upon

request. This report may not be reproduced, distributed or published without Deutsche Bank's prior written consent.

Copyright © 2018 Deutsche Bank AG

David Folkerts-Landau Group Chief Economist and Global Head of Research

Raj Hindocha Global Chief Operating Officer

Research

Michael Spencer Head of APAC Research

Global Head of Economics

Steve Pollard Head of Americas Research

Global Head of Equity Research

Anthony Klarman Global Head of Debt Research

Paul Reynolds Head of EMEA

Equity Research

Dave Clark Head of APAC

Equity Research

Pam Finelli Global Head of

Equity Derivatives Research

Andreas Neubauer Head of Research - Germany

Spyros Mesomeris Global Head of Quantitative

and QIS Research

International locations

Deutsche Bank AG

Deutsche Bank Place

Level 16

Corner of Hunter & Phillip Streets

Sydney, NSW 2000

Australia

Tel: (61) 2 8258 1234

Deutsche Bank AG

Mainzer Landstrasse 11-17

60329 Frankfurt am Main

Germany

Tel: (49) 69 910 00

Deutsche Bank AG

Filiale Hongkong

International Commerce Centre,

1 Austin Road West,Kowloon,

Hong Kong

Tel: (852) 2203 8888

Deutsche Securities Inc.

2-11-1 Nagatacho

Sanno Park Tower

Chiyoda-ku, Tokyo 100-6171

Japan

Tel: (81) 3 5156 6770

Deutsche Bank AG London

1 Great Winchester Street

London EC2N 2EQ

United Kingdom

Tel: (44) 20 7545 8000

Deutsche Bank Securities Inc.

60 Wall Street

New York, NY 10005

United States of America

Tel: (1) 212 250 2500