China Oversees Largest Wave of Rural Bank Mergers

(Reuters) – China managed its largest-ever rural bank mergers last year, as a Reuters review of official data showed. However, analysts caution that Beijing’s efforts to mitigate risks in the small banking sector could lead to more complications in the future.

Context of the Mergers

Many of the approximately 4,000 small Chinese banks rely on heavily indebted provincial governments and are primarily funded through short-term money market and interbank borrowings, raising concerns about financial stability if several banks were to fail.

These smaller banks have been adversely affected by sluggish loan growth and increasing bad loans due to a crisis in the property sector and ongoing economic downturns in the world’s second-largest economy.

In 2024, at least 290 rural Chinese banks and cooperatives were merged into larger regional lenders, highlighting the severity of the challenges facing this critical segment of China’s financial system. This represents the most significant consolidation since the transformation of small rural banks from socialist-style cooperatives in the early 2000s.

Financial Stability Challenges

China’s rural banking sector comprises around 3,700 institutions with a combined 57 trillion yuan (approximately $7.8 trillion) in assets, which is roughly double the size of Australia’s banking sector and one-third the size of the United States’.

Despite undergoing years of cleanup, the banking system’s health remains precarious amid a weakening economy, according to Jason Bedford, a former Asia analyst known for his research on the Chinese banking sector.

However, these mergers often result in the formation of “larger troubled banks” by merging insolvent entities.

The Issue of Bad Loans

Over the past decade, many small banks aggressively lent to property developers and local government financing vehicles, which made them particularly vulnerable to post-COVID economic shifts. As of the last quarter of the previous year, the bad loan ratio for rural commercial banks stood at 3.04%, almost double the overall banking sector’s rate of 1.56%.

In a significant merger case last year, Liaoning province established Liaoning Rural Commercial Bank with 20.8 billion yuan in registered capital in September 2023, which then absorbed 36 struggling local rural lenders, many grappling with rising bad loans.

Recent Consolidation Examples

Additionally, Lanzhou Bank in northwestern Gansu province received regulatory approval to acquire two rural banks in December, marking another step in the ongoing consolidation process. As of the end of 2023, Lanzhou Bank reported a total of 453 billion yuan in assets and a bad loan ratio of 1.73%.

Reform Efforts

The merger initiative is part of reforms initiated by Chinese regulators in 2022 aimed at overhauling the rural banking sector and addressing difficulties faced by smaller lenders. This followed various scandals, some resulting in depositors losing money and leading to public protests.

Ten more small banks in Liaoning are expected to merge into Liaoshen Bank, which was established in June 2021. However, the institution has inherited significant amounts of bad assets, resulting in its bad loan ratio peaking at 4.67% in 2022 and 4.53% in 2023.

The central bank reported that some rural institutions transformed into shareholders’ ‘cash machines,’ straying from their primary role of supporting agriculture and small businesses.

Due to the vast number of small regional banks, the banking regulator struggles to monitor all effectively. Christopher Beddor, deputy research director at Gavekal Dragonomics, noted that although consolidating banks may facilitate better regulatory oversight, significant issues like bad asset management will persist, indicating that many existing problems remain unresolved.