From "Buy Buy Buy" to Budgeting: Bond Market Fluctuations Drive Banks' "Smart Allocation"

Wu Yang, China Securities Journal

After experiencing wide fluctuations in the bond market in 2025, the investment logic of commercial banks is undergoing profound changes. Faced with narrowing coupon yields and increased interest rate volatility, small and medium-sized banks, previously considered major players in bond allocation, are generally adopting defensive strategies focused on shortening durations and locking in coupon payments. A person from the financial markets department of a western regional rural commercial bank told China Securities Journal that since 2026, the bank has “reduced tradable positions in trading portfolios and tightened risk indicators,” and during certain periods, “not adding new bond holdings.”

This strategic adjustment reflects the cautious approach many banks are taking amid current market uncertainties. Meanwhile, some small and medium-sized banks have begun exploring quantitative trading systems to assist investment decisions, attempting to find proactive optimization opportunities within passive defense through “smart allocation.” Industry insiders say that in the current low-interest-rate, high-volatility environment, balancing returns and risks and building a resilient investment portfolio has become a key challenge for most banks’ asset allocation.

Shift Toward Defense

“Under current market conditions, bond allocation has become more challenging,” said the head of a northern regional bank’s financial markets department. “Currently, market coupon rates are low, and even slightly higher coupon durations need to be extended.” Therefore, the bank’s strategy is to strictly limit long-term trading positions, focus mainly on short-term products, and use leverage to earn interest spreads. During a bond bull market, some banks preferred trading for gains. However, the 2025 market forced institutions to reconsider the balance between risk and return.

The general manager of a Tianjin rural commercial bank’s financial markets department revealed that their duration strategy has not changed significantly, but trading volume has decreased markedly year-on-year. “In 2025, after taking profits early, we mostly held a flat position until the fourth quarter before re-entering the market, and we stopped holding interest rate bonds, instead focusing more on loans, interbank certificates of deposit, and other assets,” he described this approach as “adapting to changing circumstances with unchanged strategies.” Although somewhat passive in operation, it helped preserve earlier gains. Reflecting on 2025, he said that in the first half of the year, market sentiment was overly exuberant, yields fell too quickly, and chasing higher yields was no longer worth the risk, so they took profits and exited the market.

A person from a western regional rural commercial bank’s financial markets department predicted this year’s market trend: “The bond market may be in a state of oscillation with a top on the upside and a bottom on the downside. After last year’s adjustment, many institutions are likely to adopt a more conservative stance.” He disclosed that the main change in their operations this year has been reducing tradable positions and strictly controlling risk indicators, with no new bond holdings. This strategy helps avoid unnecessary losses when the market direction is unclear.

Additionally, Hangzhou Bank recently disclosed in its investor relations activity record that, in response to bond market fluctuations, the bank has adopted prudent measures such as maintaining investment portfolio duration and scale limits, conducting regular reviews, optimizing portfolio structure, disposing of inefficient assets, and prudently utilizing various interest rate derivatives.

Wind data shows that last year, the bond market weakened with volatility, with the 10-year government bond yield rising from a low of 1.59% to 1.87% at year-end. As of March 2, 2026, the yield on the active 10-year government bond (250016.IB) was 1.7910%.

Major Banks “Buy, Buy, Buy” and Small and Medium Banks “Seek Hedging”

The shift toward defensive strategies among banks has deep structural reasons. Yang Yewei, Chief Fixed Income Analyst at Guosheng Securities, explained that during the bond market recovery earlier this year, allocative institutions were the main source of increased holdings. The sustained increase in bond holdings by banks is driven by the rapid growth of deposits over the past few months, while loan growth has slowed, widening the gap between deposit and loan growth. Deposits are the bank’s funding source, and loans are the main use of funds. The widening gap indicates banks need to find other ways to deploy funds. Besides loans, investments in bonds, interbank lending, and central bank deposits are key channels. This suggests that the increasing deposit-loan gap may lead banks to continue increasing bond allocations.

However, responses vary significantly among different types of institutions. Guosheng Securities’ research report states that, based on credit and deposit data, over the past three months, large banks increased bond holdings by 2.86 trillion yuan, making them the main force in bond accumulation. Yang Yewei believes that overall, banks have accelerated bond purchases in recent months, surpassing bond supply, and their continued buying has been a major stabilizing force in the bond market.

Faced with limited investment tools, some relatively flexible small and medium-sized banks are exploring more complex strategies. The aforementioned head of a northern regional bank’s financial markets department said that last year, some flexible institutions used securities lending to short-sell as a hedge. However, for most small and medium-sized banks, lacking derivatives trading qualifications makes such strategies difficult to implement. For example, accounting issues pose a significant challenge, as they involve extensive system upgrades.

He explained that with low trading volumes, bearing high system upgrade costs is not cost-effective for small institutions. Their risk control systems and accounting procedures are closely aligned with traditional trading strategies, and introducing new hedging tools would require large-scale system modifications, which are a heavy burden for small banks.

From Experience-Driven to Quantitative Assistance

When traditional defensive strategies fail to generate excess returns and market segmentation further compresses the space for small and medium banks to operate, some banks are turning to fintech, attempting to build quantitative trading systems for interest rate bonds to assist decision-making.

“This year, we plan to develop a quantitative trading system for interest rate bonds. Based on last year’s market changes, we really need quantitative methods,” said the person from a western regional rural commercial bank’s financial markets department. “We want to use the system as a decision support tool. But building such a system is costly, so we prefer small-scale investments. Last year’s volatility caught many traders relying on experience off guard, while a quantitative system can detect subtle trading signals through models.”

According to reports, several small and medium-sized banks have been trying to build or pilot such systems this year. This trend reflects that, in a market environment characterized by narrowing spreads and increased volatility, some banks are seeking breakthroughs through digital tools.

However, the path of technological transformation is not smooth. The Tianjin rural commercial bank’s financial markets department head said that some institutions failed to successfully build quantitative systems, partly because current interest rate ranges are too narrow, and partly because the industry remains in a wait-and-see and learning phase. He further explained that building a quantitative system involves not only technical issues but also the accumulation of trading strategies, risk control models, and personnel training—a comprehensive project.

Looking ahead, Yang Jiefeng, Chief Fixed Income Analyst at Southwest Securities, believes that, considering the divergence in institutional behavior, profit-taking pressures, supply expectations, and credit injection, the upside for the 10-year government bond yield may be limited, and the market is likely to fluctuate to rebalance forces. As a key component of the 10-year government bond allocation, the marginal change in large banks’ holdings will directly impact market resilience.

Tan Yiming, Chief Fixed Income Analyst at Tianfeng Securities, offers a perspective from an institutional behavior standpoint. He states that the bond market remains in a volatile phase, with short-term instruments being more predictable than long-term and ultra-long-term ones. He recommends focusing on the value of coupon assets. The recent market movements are fundamentally driven by the weakening of the allocation power of banks, which have been the main force, and the reallocation of household assets may be a key factor to watch in the next phase of bond market trends.

(Edited by Qian Xiaorui)