Why It's Time to Buy China Bank Stocks

China Construction Bank branch in Beijing, China
Frederick J Brown | AFP | Getty Images
China Construction Bank branch in Beijing, China

A turnaround in China's bank earnings seen in the second half of last year is likely to continue into 2013 as the economy improves further, prompting analysts to turn bullish on the sector.

For example, Japan's investment bank Nomura forecasts earnings growth to be up to 15 percent annually over 2012 to 2014 — on increasing loan demand and yields. While China's top four banks are yet to release last quarter results, full year 2012 earnings growth is expected to be between 7 percent and 22 percent, according to Nomura.

In a report released on Monday, Nomura said China's economic recovery is going to bode well for banks in the near-term, which will benefit from modest inflation and loose monetary policy.

"We turn more positive on Chinese banks in the near term given the recovery in economic growth, moderation in asset quality deterioration as well as relatively resilient margins," the report said.

Market watchers have predicted that stronger economic growth in China this year, which Chinese think tank State Information Centre of China has predicted to hit 8 percent, could bring big gains for Chinese equities.

(Read more: Will 2013 Bring More Pain or Gain for China Stocks? )

Nomura, which is overweight on China's financial stocks, has as its top picks China Construction Bank, Agricultural Bank of China, and Chongqing Rural Commercial Bank. These Hong Kong listed banks are expected to see a jump of 16 percent to 18 percent in their share prices in this year.

Backing that sentiment, Barclays released a report saying that China's banking shares listed in Hong Kong led gains in its Asia ex-Japan banks index in December, up 12.3 percent, prompting them to remain positive on the sector in the first half of this year.

"We raise our 2012-14 earnings forecasts primarily on improved bank loan pricing power and lower credit costs," Barclays said. "We expect China banks to demonstrate better NIM (net interest margin) than we estimated before, stable asset quality and reduced capital pressure."

In the first half of 2012, there were concerns that China banks' non-performing loans would balloon with a slowing economy and hurt profits. Industrial and Commercial Bank of China — the world's biggest lender by market value — posted its smallest earnings growth since the global financial crisis in the second quarter of 2012 of 11 percent, down from 29 percent a year ago. However, better-than-expected third-quarter earnings have helped the big banks recover losses.

Risks Remain

But despite the upbeat outlook for China's banking sector in the first half of 2013, analysts warn that lurking risks like shadow banking, which refers mainly to non-bank lending, still remain an issue.

"We continue to be cautious on the sector in the medium to long term due to the challenging operating environment for Chinese banks," Nomura said, adding that the China Banking Regulatory Commission's has said it will work to create more transparency in the banking system.

(Read More: Regulator Frets Over Confidence Crisis After Investment Product Fails)

By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu