Daiwa has initiated coverage on China's banking sector with a constructive stance, marking its first foray into the space with a positive outlook. The brokerage has assigned a "Buy" rating to China Construction Bank (00939), an "Outperform" rating to China Merchants Bank (03968), and a "Hold" rating to ICBC (01398), signaling confidence in the industry's trajectory.

The firm asserts that the worst period of net interest margin (NIM) compression has passed, noting that after three years of margin erosion and stagnant earnings, Chinese banks are now positioned for modest yet meaningful stabilization. Daiwa projects that industry revenue will grow by 5% to 6% between 2026 and 2027, underpinned by easing pressure on funding costs and a more balanced interest rate environment.

Highlighting the scale of recent challenges, Daiwa points out that the sector's NIM has contracted by a cumulative 68 basis points since 2021. However, the outlook is improving as roughly 108 trillion yuan in high-cost legacy deposits are slated to mature this year, which is expected to trim funding costs by 21.4 basis points in 2026. On the asset side, approximately 38 trillion yuan in mortgage repricing has been fully absorbed, and the People's Bank of China has also halted cuts to the Loan Prime Rate (LPR), removing a key source of downward pressure on margins.

Looking ahead, Daiwa forecasts that the industry's NIM will stabilize at 1.40% to 1.41% during 2026-2027, translating to an annual contraction of just 1 to 2 basis points—a stark contrast to the 10 to 22 basis points witnessed each year from 2023 to 2025. This shift marks the first time since the pandemic that NIM has transitioned from a headwind to a neutral factor for the sector.

Asset quality remains under control, with the non-performing loan ratio for property exposure having peaked at 3.89% in 2023, and most legacy risks have already been provisioned for. Additionally, the dividend yield on H-shares of Chinese banks stands at approximately 5% to 6%, offering a spread of about 385 basis points over the 10-year government bond. This, combined with a core Tier-1 capital adequacy ratio buffer of 300 to 400 basis points, provides a solid foundation to sustain dividend payouts and support share prices.