China’s efforts to consolidate its small banks have led to a sharp reduction in their numbers as regulators work to reduce the potential for systemic risk from these institutions, which are often vulnerable to poor operations or exposure to risky lending.
A total of 162 small banks were merged, dissolved, or deregistered in 2024 – more than four times the number in 2023 and seven times greater than the tally in 2022, according to data from Qiye Yujingtong, a platform that tracks corporate risks. The country has about 4,000 such banks.
“Small regional banks typically have weaker funding profiles and higher risk appetite,” said Elaine Xu, director of Asia-Pacific financial institutions at Fitch Ratings. “This has translated into their higher exposure to risky sectors including property development.”
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The consolidation also aims to reduce risk from exposure to government financing platforms, analysts said. However, the effort is encountering multiple challenges, from a slowing economy to weakening government finances, they added.
The banking sector is under pressure in terms of revenue and profitability amid the slowing economy, according to Zhao Xijun, a professor of finance at Renmin University in Beijing. “This pressure is especially pronounced for small and medium-sized banks,” Zhao said.
Analysts expect the issues to persist.
“We expect small regional banks to face a larger extent of asset quality deterioration in the coming years, on top of their earnings and profitability pressure,” Xu said.
China classifies banks other than policy banks, major state-owned banks and major joint-stock banks into the small and medium-sized category. By the end of 2023, China had 3,912 such banks and rural credit co-operatives, according to the latest financial stability report from the People’s Bank of China (PBOC). Although greater in number, they are smaller in scale, accounting for around a quarter of the total assets of the country’s banking institutions.
Demonstrators protest the freezing of deposits by rural banks in Zhengzhou, Henan province, on July 10, 2022, in this image taken from a video obtained by Reuters. Photo: Reuters alt=Demonstrators protest the freezing of deposits by rural banks in Zhengzhou, Henan province, on July 10, 2022, in this image taken from a video obtained by Reuters. Photo: Reuters>
In 2019, Baoshang Bank, based in Inner Mongolia, collapsed after its controlling shareholder, Tomorrow Group, exploited weak governance to siphon off 156 billion yuan (US$21.3 billion) in unpaid loans.
Rural banks, especially those at the village level, face the highest level of risk.
These banks, which account for the majority of the 357 banks that the PBOC classifies as high risk, emerged nearly two decades ago as part of Beijing’s push to support rural development. By the end of 2023, China had 1,636 village banks, collectively accounting for less than 1 per cent of the banking sector’s total assets, according to the PBOC. Each bank held an average of about 1.4 billion yuan in assets. The banks are often controlled by a variety of small shareholders, including local rural banks, local state-owned enterprises and private enterprises.
In April 2022, savers at several rural banks in central China’s Henan and Anhui provinces were denied access to their accounts, leading many to stage protests at local banking authorities.
Beijing has been trying to reduce risk at small banks by allowing local governments to issue special bonds to replenish their capital while permitting bigger banks to merge with smaller ones.
The PBOC said in its stability report that it would accelerate efforts to reform small banks in provinces with a high concentration of risks.
“This reflects the government’s focus on maintaining financial stability,” said Nicholas Zhu, a banking analyst at Moody’s Ratings. “The central government and local governments don’t want to see a systemic banking crash.”
However, with declining revenues in recent years due to the property downturn and falling land sales, some local governments may not have the financial capacity to provide additional funding to bolster capital at these banks, said Zhao from Renmin University.
A villager works on soybean paste production in Lanxi City, in east China’s Zhejiang Province, on December 5, 2024. Photo: Xinhua alt=A villager works on soybean paste production in Lanxi City, in east China’s Zhejiang Province, on December 5, 2024. Photo: Xinhua>
Consolidation among small banks may ease the regulatory burden, allowing the watchdog to better focus its resources on the internal controls and governance of small banks, said Xu with Fitch Ratings. “But [mergers and acquisitions] alone may not permanently address the risks that small banks face, as challenges will still confront the surviving entities,” she added.
“Chinese authorities have accelerated reform of rural financial institutions in 2024, and we expect the reform process to speed up further this year,” said Ryan Tsang, managing director at S&P Global Ratings in Hong Kong. “The key question is whether the risky practices or problematic business models of the weak rural financial institutions can truly be corrected or improved within the new framework. Simply replacing a few individuals or restructuring operations is not enough to resolve deep-rooted issues.”
It will take considerable time to build a strong culture of corporate governance, he said, adding that it “is not something that can be achieved overnight”.
“You’re going to see negative headlines from time to time in different regions,” said Dong Chen, chief Asia strategist and head of Asia research at Pictet Group in Hong Kong. “That won’t be a surprise. But I wouldn’t expect it to deteriorate into systemic risk.”
However, Zhao of Renmin University believes risks remain.
“It is about confidence,” he said. “Once a financial institution encounters risks, those risks can potentially spread and cascade from one institution to another.”
