China's small bank mergers shrink sector but raise financial risks

Many of China’s newly merged small banks have reported falling profits and shrinking capital buffers over the past year, according to a Reuters review of data, putting pressure on Beijing’s record consolidation drive aimed at reducing risks in the country’s $8 trillion small banking sector.

Bank consolidation in China has accelerated, with at least 350 banking licenses canceled in 2025 as of November, up from 198 in 2024, according to a report by Chinese investment bank China International Capital Corp.

The consolidation effort mainly targets a vast network of more than 3,600 rural banks and credit cooperatives, which account for about 14% of China’s $58 trillion banking sector, based on official data.

These smaller lenders are largely backed by heavily indebted provincial governments and depend on short-term money market and interbank borrowing for funding. This structure raises concerns about domestic financial stability if some of these institutions were to fail.

A Reuters review of publicly available financial reports shows that among 20 small regional banks that absorbed troubled lenders in 2024, 13 reported weaker profit growth, profit declines, or outright losses through mid-2025. Fourteen of those banks also saw their capital adequacy ratios deteriorate after the mergers.

The findings highlight the challenges facing Beijing as it seeks to strengthen the balance sheets of smaller lenders, many of which have been hit hard by the property sector’s liquidity crisis and slowing economic growth.

“Unless bad debts are recognized and written off, mergers and acquisitions alone cannot reduce the number of bad loans — they can only dilute the risk,” said Xiaoxi Zhang, a China finance analyst at Gavekal Dragonomics.

“Local banks generally belong to local governments, so if a merged and restructured bank still cannot absorb bad debts, it is highly likely the local government will once again step in with rescue assistance,” she added.

The People’s Bank of China declined to comment, while the National Financial Regulatory Administration (NFRA) did not respond to a request for comment.

Weak link in financial stability

China will “steadily and systematically promote mergers and reorganizations of small and medium-sized financial institutions while reducing quantity and improving quality,” NFRA head Li Yunze said at a financial conference in October.

At least 290 rural banks and cooperatives were merged into larger regional lenders in 2024, Reuters reported in February, based on regulatory filings and company disclosures over the previous 12 months.

Small lenders are widely viewed as the weakest link in China’s financial system, struggling with poor asset quality, thin capital bases, and governance problems, especially in less-developed regions.

Regional lender Shanxi Bank, backed by the Shanxi provincial finance department, reported a more than 90% drop in profit in 2024 after absorbing four rural lenders described by state media as “high-risk village banks.”

The bank’s non-performing loan ratio rose to 2.5% in 2024 from 1.74% a year earlier, according to its April financial report.

Meanwhile, Bank of Dongguan in Guangdong province said its net profit fell 8.2% in 2024 after taking over two rural lenders. Its non-performing loan ratio increased to 1.01% at the end of 2024 from 0.93% a year earlier, based on its annual report.

Requests for comment from Shanxi’s provincial government went unanswered, while Shanxi Bank and Bank of Dongguan did not respond.

‘Waiting to be rescued’

In some cases, healthier banks have been instructed to follow regulatory guidance to acquire troubled lenders listed by local governments, though they are allowed to choose among several options, according to a loan officer at a city commercial bank in Jiangsu province.

“During actual acquisitions, we often find that bad debts at village banks are much worse than initial assessments,” said the loan officer, who declined to be named due to the sensitivity of the issue.

Despite years of consolidation, asset quality risks remain higher at regional lenders compared with larger banks. As of the end of September 2025, bad loan ratios at city and rural commercial banks stood at 1.84% and 2.82%, respectively, well above the 1.22% level reported by large state-owned and national joint-stock banks, official data showed.

Chinese regulators have previously relied on major state-owned banks to rescue struggling smaller lenders to preserve financial stability.

As asset quality continues to deteriorate, some rural banks have stepped up property sales following defaults on business loans and mortgages, according to JD.com’s online asset trading platform.

The consolidation drive has also created moral hazard, with “weak institutions lying down and waiting to be rescued,” while stronger banks are weighed down by the burden of absorbing troubled peers, said a branch head at a state-owned bank, who spoke on condition of anonymity.

-Reporting by Reuters Staff; Editing by Jamie Freed/Reuters