Mainland bank shares have rallied by nearly 50 per cent over the past two months, driven higher by signs of recovery in the world's second-largest economy.
The CSI China Mainland Banks Index ended the day up 4 per cent yesterday at 4,716.6 points - an increase of 49 per cent from 3,163 points on December 3.
Investor expectations of better bank earnings and rising share prices in the sector have been improving since the release of data that showed the mainland economy expanded by 7.9 per cent year on year in the fourth quarter of last year, quickening from a 7.6 per cent growth in the third quarter.
"The improving macro-outlook is shoring up loan demand and yields, while moderating non-performing loan risk and lowering credit risk," said Lucy Feng, an analyst at Nomura Securities.
Double-digit profit growth announced by four lenders in the past few weeks added to the optimism. In result snapshots before the release of their full earnings reports in March, Shanghai Pudong Development Bank, China Everbright Bank, China Minsheng Banking Corp, and Industrial Bank said their net earnings would be up between 25 and 36 per cent year on year for 2012.
Minsheng shares soared nearly 9 per cent yesterday in Shanghai trading, to close at a historic high of 11.23 yuan.
"In 2013, just hold on to your bank shares," China International Capital Corp told clients in a note on Thursday. "Wait for further share price increases when fund managers build larger positions."
But while banks represent a bright spot in terms of 2013 profits, compared to a variety of industries from shipbuilders struggling amid external weakness to steel makers with overcapacity problems, challenges still lie ahead for the sector.
While listed mainland banks posted an average 29 per cent profit growth in 2011, the pace is estimated to have slowed significantly to 17.2 per cent last year before slumping further to 7 to 8 per cent this year, said analysts at Bank of Communications in a recent report.
Nomura expects Bank of China and Bank of Communications to see the slowest increase in net earnings growth among Hong Kong-listed mainland lenders this year, with growth of just 2 per cent from last year.
"Banks' profit prospects are dimmed by China's initiatives of interest-rate liberalisation, as well as measures to reduce credit-card transaction fees which would impact their fee businesses," said Guo Tianyong, a professor at the Central University of Finance and Economics in Beijing.
The mainland for the first time allowed banks to raise deposit rates up to 10 per cent higher than benchmark rates last year, in an important step to deregulate interest rates. A further widening of the rates is expected in the second half of this year, which will in turn squeeze banks' margins.
Beijing's efforts to boost domestic consumption and help retailers cut costs will also weigh on banks' profits as transaction fees on card payments will be cut by an average of 23 to 24 per cent from February 25 this year. Shanghai's Orient Securities estimates the cut will lower mainland-listed banks' profit growth by 1.05 percentage points.
Also, banks are unlikely to be relieved of risks. Default risk from local government financing vehicles with poor solvency and companies in overcapacity industries will continue to weigh on lenders' asset quality.
To make things worse, wealth management products, trust products, and other off-balance sheet products which have boomed over the last year will test lenders' risk-management capabilities.
"The continued lack of transparency makes the risks for these products on the banking system even more worrisome," said May Yan, an analyst at Barclays Capital.