China’s ambitious small bank consolidation drive has accelerated over the past year, but recent data shows that mergers of regional banks and rural lenders may be creating new financial risks. While Beijing aims to strengthen the country’s $8 trillion small banking sector, profit declines, shrinking capital buffers, and rising non-performing loans are testing the effectiveness of the consolidation strategy.
Surge in Bank Mergers
China has canceled at least 350 banking licenses in 2025 as of November, up from 198 in 2024, according to China International Capital Corp. The consolidation primarily targets over 3,600 rural banks and credit cooperatives, which collectively account for approximately 14% of China’s $58 trillion banking industry.
These smaller banks are heavily reliant on provincial government backing and are often funded through short-term interbank borrowings, creating potential vulnerabilities to domestic financial instability if some fail.
Profit Declines and Capital Erosion
A Reuters review of 20 regional banks that absorbed smaller troubled lenders in 2024 revealed that:
- 13 banks reported lower profit growth, profit declines, or outright losses through mid-2025
- 14 banks saw their capital adequacy ratios deteriorate post-merger
Experts warn that mergers alone cannot resolve underlying financial weaknesses. Xiaoxi Zhang, a China finance analyst at Gavekal Dragonomics, stated:
“Unless bad debts are recognized and written off, mergers merely dilute risk rather than eliminate it. Local governments often step in to rescue failing banks, creating a cycle of moral hazard.”
Challenges from the Property Sector and Slow Growth
Many small banks are burdened by non-performing loans, particularly due to a property sector liquidity crisis and slowing economic growth. Case in point:
- Shanxi Bank posted a more than 90% drop in profit in 2024 after absorbing four high-risk rural lenders
- Bank of Dongguan reported an 8.2% net profit decline after taking over two local rural banks
Non-performing loan ratios for rural and city commercial banks remained elevated at 2.82% and 1.84%, respectively, by September 2025, well above the 1.22% level at large state banks.
Moral Hazard and Regulatory Pressure
The consolidation drive has also introduced a moral hazard, as some weaker institutions anticipate government bailouts. Meanwhile, healthier regional banks are forced to absorb troubled lenders under regulatory guidance, straining profit margins and capital buffers.
A loan officer at a city commercial bank in Jiangsu province noted:
“During acquisitions, we often discover bad debts at village banks are far worse than initial assessments.”
Regulators have historically relied on large state banks to rescue struggling smaller peers to maintain financial stability, but this strategy has limits as the sector faces rising asset quality risks.
Government Oversight and Policy Direction
The National Financial Regulatory Administration (NFRA) aims to “steadily and systematically promote mergers and reorganisations of small and medium-sized financial institutions while reducing quantity and improving quality,” according to NFRA head Li Yunze.
Despite these efforts, smaller lenders remain the weakest link in China’s financial stability, facing challenges such as:
- Poor asset quality
- Low capital bases
- Governance issues
- Exposure to underdeveloped regional economies
Some banks have resorted to property sales following loan defaults to manage liquidity pressures, while regulators continue to monitor risks closely.
Conclusion
China’s small bank mergers reflect a strategic attempt to strengthen the banking system, yet declining profits, deteriorating capital ratios, and moral hazard indicate that financial risks remain high. Without addressing the root causes of bad loans and improving governance, the consolidation may stabilize bank numbers but not systemic risk, leaving the sector vulnerable to shocks.
Leave a Reply