In the intricate world of banking, the management of bond holdings has become a vital aspect that can significantly affect overall revenue streamsSpecifically, banks divide their bond holdings into two distinct categories: the trading portfolio and the investment portfolioAs of early 2024, the trading portfolio accounted for approximately 4% of interest-earning assets, while the investment portfolio represented around 24.7%. The income generated from these portfolios was also notably different, contributing 3.7% and 14% respectively to total revenueThese figures underscore the varying influences that market conditions and policy decisions have on the banks' earnings derived from these two types of asset management strategies.

From January to July 2024, a notable trend emerged as government bond rates consistently decreased

To illustrate, the yield on a benchmark 10-year government bond fell from 2.56% at the beginning of the year, dropping by 41 basis points to 2.15% by JulyHowever, this downward trend was disrupted in August when major state-owned banks began offloading their government bond holdingsThis move was met with immediate reaction from the Traders Association, which publicly called out four rural banks in Jiangsu for their involvement in trading government bondsAs a consequence, government bond yields began to rise once again.

Given that financial investments constitute a crucial component of banking operations, the increase in government bond yields can have direct repercussions on revenueConsequently, a thorough analysis of these fluctuations—and their implications for the banks' earnings—has become increasingly importantThis analysis necessitates a closer look at both the trading and investment portfolios, as adjustments to the bond market can considerably impact earnings.

Delving deeper, the position of trading portfolios within commercial banks can be seen as a reflection of strategic decision-making in asset management

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By the first quarter of 2024, listed banks held trading financial assets amounting to 11.7 trillion yuan, which constituted 4.1% of the total interest-earning assets of these banksNotably, urban commercial banks exhibited a higher proportion, standing at 11.3%, followed by joint-stock commercial banks at 6.6%, rural banks at 6%, and state-owned enterprises at 2.2%. The predominance of urban commercial banks highlights their proactive engagement in trading activities compared to other segments.

The trading portfolio is primarily composed of financial investments measured at fair value, with changes reflected in current earningsSince 2019, the value of trading assets held by listed banks has risen at a compound annual growth rate of 6.5%. A closer inspection reveals that banks such as Nanjing Bank, Jiangsu Bank, Changsha Bank, and Ningbo Bank maintained higher proportions of trading assets—over 12% of total assets—emphasizing their strategic focus on trading endeavors.

Analysis of the income from trading portfolios between 2019 and 2023 reveals that this income accounted for an average of 3.7% of total revenue, with urban commercial banks and rural banks showing noticeably higher proportions

The primary earnings from trading portfolios derive from gains realized through fluctuations in the fair value of trading financial assets and trade price differences, minus the costs associated with liabilitiesIn terms of sub-segments, urban commercial banks reported a 6.6% income share, while rural banks followed closely at 5.7%, and joint-stock banks at 4.5%. State-owned banks lagged behind with only 2.5% of their revenue stemming from trading activities.

Urban and rural commercial banks, due to their relatively smaller investment portfolios, experienced greater flexibility and opportunities to realize trading gainsThe first quarter of 2024 showcased a bullish bond market, positively impacting the revenue contributions from trading portfoliosExamining individual cases, small urban and rural banks in Jiangsu and Zhejiang provinces reported particularly high net income proportions—over 10%—from their trading activities, evidencing their susceptibility to fluctuations in the bond market.

Between 2019 and 2023, the average net profit margin from listed banks' trading portfolios was approximately 1.68%. State-owned banks and rural banks yielded higher returns primarily due to lower costs of liabilities and the ability to capitalize from agile trading strategies

Specifically, state-owned banks achieved a leading profit margin of 2.02%, with rural banks at 1.87%, while joint-stock banks and urban commercial banks fell behind at 1.27% and 1.15%, respectively.

On an individual basis, banks with higher net profit margins were predominantly small rural banks in Jiangsu and Zhejiang provincesFor instance, Zijin Bank, Zhangjiagang Bank, and SuNong Bank reported average returns exceeding 4%, with their numbers reflecting the practical implications of their asset choicesNotably, Zijin Bank's high returns can be attributed to its substantial allocation to trusts and asset management plans, indicating a distinctive appetite for risk.

In a broader context, the asset allocation strategy within the trading portfolios indicates a remarkable preference towards fund investments, which constituted 48.1% of these investments, primarily focusing on medium to long-term pure bond funds

By the end of 2023, nearly half of banks' trading portfolios were invested in such funds, while financial bonds made up 21% of their investmentsOther investments, such as government bonds and corporate bonds, accounted for 9.1% and 6.9% respectively, revealing a pattern of cautious diversification.

Several key factors explain the high allocation toward fund investmentsFirst, liquidity plays a pivotal role as banks must manage cash flow effectively, thus favoring high liquidity products that can be easily liquidatedMoreover, tax savings further incentivize fund investments, as banks benefit from favorable tax treatment when investing in funds, particularly compared to direct holdingsThe administrative advantages, potential leverage benefits, and relationship-building with fund companies reveal a multi-faceted rationale behind this strategy.

Different bank types exhibit varied preferences in asset allocation; for instance, joint-stock banks and urban commercial banks hold fund investments at approximately 55% while engaging more directly in bond investments at around 30%. Conversely, state-owned and rural banks possess a slightly lower proportion of fund investments, focusing more on direct bond investments, particularly financial bonds exceeding 30% of their portfolio.

The earnings and yields from trading portfolios are closely linked to interest rates

With more than 50% of bank trading portfolio assets invested in funds, it is evident that fluctuations in fund performance will significantly impact trading incomeBanks, however, typically obscure their specific fund holdings; yet, in some instances, banks also serve as stakeholders or custodians for certain fund management companies, leading to periodic disclosures that could serve as benchmarks for analyzing fund performance within bank portfolios.

An analysis of related party fund holdings reveals that the predominant investments made by banks focus on medium to long-term pure bond funds, constituting 84.9% of banks' holdingsThe bond investments within these funds account for 76.74% of the total assets, reflecting an ingrained preference for bond-based securitiesWithin this, government bonds, interbank certificates, and financial bonds dominate, showcasing a conscious steering towards stable returns in uncertain market conditions

Over recent years, the proportion traversing between government bonds and corporate bonds has fluctuated, demonstrating banks' adaptability toward market exigencies.

As observed from the 2023 bond underwriting data, banks and securities companies played significant roles, with banks accounting for 52% and securities firms 48%. However, banks predominantly focused on government bonds, underwriting 38.5% of their total bond issuances, further reflecting their commitment to secure stable liabilities through government bond financing.

The prevailing trend indicates a profound shift toward government bonds within banks' investment strategiesEnhanced by fluctuations in macroeconomic indicators and stringent regulatory oversight, banks have increasingly gravitated toward stable government bonds, often pivoting away from non-standard asset classes altogether