SHANGHAI, (Reuters) – Beijing’s directive to help virus-hit areas has caused China’s banks sector to lag behind a wider market rally. Investors fear that a cash injection by lenders could increase bad loans and reduce already thin margins.

China’s recent easing of monetary policy conditions has caused stocks to rebound and is in direct contradiction with its own.

The COVID-19 rules in Shanghai and Beijing were eased over the past month. Blue chip index CSI300 climbed nearly 8% while the tech-oriented STAR 50 Index jumped almost 18%.

However, the CSI300 Bank Index, which tracks the “Big Four” state banks and other lenders, including local government-controlled Shanghai Pudong Development Bank, has lost 0.7% over the same period amid concerns over the financial health of lenders.

China Banking and Insurance Regulatory Commission, (CBIRC), last week urged banks and financial institutions to increase support for companies that are affected by COVID. This would allow them to tolerate bad loans more.

Gary Ng, a Natixis economist said that Chinese lenders are facing “an increasing apparent tradeoff between being profitable and supporting economic growth.” Banks will have to sacrifice their profitability to support the economy, according to Gary Ng of Natixis economist.

He said that the net interest margin of banks fell from 2.1% to 2.04% during 2020 to 2.04% in quarter one. It will be further squeezed.

The People’s Bank of China (PBOC), in late May, urged banks “raise their political standing” through the implementation of stimulus measures. They also called for an incentive mechanism to allow loan officers to be “willing” or “daring to lend small businesses.

These regulators are addressing signs that risk-averse banks may be investing in short-term, low-risk financial instruments to push yields towards zero.

Low Value

Xie Ching, a Shanghai Jianwen Investment Management Co fund manager, believes that monetary easing can be a double-edged weapon for banks.

Credit expansion can increase revenues but profitability will drop if lending rates are slashed without corresponding cuts to deposit rates,” Xie stated.

The market is expecting write-offs for non-performing loans because of the banks’ low valuations, he said.

China-listed lenders trade at 5.18x earnings and 0.65x book value. This makes banking one of the most affordable sectors in China. Consumer staples, however, trade at an earnings multiple 38.4.

Chinese banks also tend to be cheaper than global banks, which average 9.74x earnings and 1.03x book value in the Refinitiv Global Banks Price Returns Index.

Some investors believe that pessimism about Chinese banks has been overdone.

Dong Baozhen (fund manager at Lingtong Investment), stated that the current bank valuation is too low to price in large-scale sector bankruptcy. He regarded such an outcome unlikely.

He said that despite recent recovery, China’s tech stock bubble was bursting and that money would eventually move into lower-valued bank shares.