A comprehensive restructuring process is taking place in China, focusing on small-scale institutions of the banking system.
As economic growth slowed down, capital inadequacy, low asset quality and management problems became more evident, especially in rural banks, and the Beijing administration accelerated the merger and liquidation process.
According to Fitch Ratings data, 670 banks will exit the system in 2025 alone. This number corresponds to approximately one quarter of the banks in the country.
The model followed by Beijing is based on creating larger institutions with higher capital and easier central control, instead of many small banks.
SMALL AND RURAL BANKS ARE THE WEAKEST LINK
At the center of the restructuring are small and rural commercial banks.
According to Fitch, these institutions are among the most fragile parts of the Chinese financial system. Especially in banks operating in less developed regions, capital inadequacy, low profitability and problematic loans come to the fore.
While the asset profitability of rural banks decreased to 0.45 percent in the first half of the year, the rate of non-performing loans increased to 2.8 percent.
The fact that the non-performing loan rate in the overall Chinese banking sector is at 1.5 percent shows that the deterioration in small banks is above the sector average.
REAL ESTATE LOANS ARE CHALLENGING BALANCE SHEETS
The structure of their loan portfolios also affects the problems faced by small banks.
The loans provided by these institutions to small businesses as well as real estate developers and local government financing instruments are among the main risk areas in the balance sheets.
The long-standing real estate crisis in China and the increasing debt burden of local governments puts pressure on the balance sheets of banks, especially those operating on a local scale.
Fitch states that bank mergers can contribute to strengthening supervision and increasing transparency in the financial system. However, structural problems in small banks are not expected to disappear in a short time through mergers alone.
THE RISK IS ON A LOCAL SCALE FOR NOW
Despite the problems in small banks, the possibility of risks spreading to the entire Chinese financial system is considered limited.
The fact that these banks operate mainly on a local scale and have limited connections with large financial institutions reduces the risk of a possible crisis spreading to other banks.
However, if economic growth slows down further and problem loans increase, the pressure on small banks is likely to increase.
IN THE SAME PERIOD WITH THE ECONOMIC SLOWDOWN
It is also noteworthy that the restructuring in the banking sector accelerated at a time when the Chinese economy was losing momentum.
The world's second largest economy grew by 4.3 percent on an annual basis in the second quarter of the year. This rate was the lowest growth performance recorded since 2022.
The increase in industrial profits also fell to 4.2 percent in August, the lowest level of the year.
When the slowdown in economic growth, the problems in the real estate sector and the debt burden of local governments are evaluated together, Beijing's move to gather hundreds of small banks under the umbrella of larger institutions stands out as a restructuring step to control the vulnerabilities in the financial system before they grow further.
