China's Record Mergers in $8 Trillion Small Banking Sector Raise Future Risks

China's banking sector, valued at approximately $8 trillion, is witnessing a wave of mergers and consolidations, with around 70 rural banks having already undergone mergers since 2023. This trend, driven by various factors, raises concerns about future risks and impacts on local economies and communities. This article explores the primary drivers behind these mergers, their effects on the financial landscape, and the challenges faced by surviving banks.



Primary Drivers Behind the Mergers

1. Oversupply and small asset size: The oversupply of rural financial institutions, with total assets that are too small, leaves them vulnerable to local market risks. As of December 2023, there were 3,796 rural financial institutions, with an average asset value of RMB15b per institution, which is just 3% of the average asset value of city commercial banks (Huang, BBVA Research).
2. Aggressive lending practices and inadequate risk management: Many small banks have engaged in aggressive lending practices, leading to high non-performing loan (NPL) ratios. Some institutions have reported NPL ratios as high as 40%, significantly above the industry average of 1.6% (Huang, BBVA Research).
3. Exposure to real estate and local government financing: Small banks have heavily lent to developers and local governments, making them vulnerable to fluctuations in the real estate sector and China's slowing economic growth (Huang, BBVA Research).
4. Regulatory pressure and clean-up process: The Chinese government is pursuing consolidations alongside regulatory reform to clean up the banking sector. This is evident in the consolidation of the Liaoning Rural Commercial Bank, and analysts believe this trend will continue (Tsang, S&P Global Ratings).

Impacts on the Financial Landscape

Mergers and closures of rural financial institutions can reduce the number of institutions, address operational disorder, and improve risk management capabilities. However, they may also lead to job losses and regional economic impacts if branches close, as well as government capital injections to absorb losses (Tsang, S&P Global Ratings).

Challenges Faced by Surviving Banks

After the consolidation process, surviving banks face several key challenges, including job losses, regional economic impacts, and the need to manage risks within the banking system. To enhance their efficiency and risk management capabilities, these banks can focus on the following strategies:

1. Strengthened Supervision: With fewer, larger institutions, regulators can allocate more resources to oversee these systemically important banks, helping to identify and mitigate risks more effectively (Huang, 2025).
2. Improved Financial Health: Consolidation can lead to increased efficiency and better risk management capabilities for surviving banks by increasing asset scales and enhancing risk management systems and personnel (Huang, 2025; Tsang, 2025).
3. Centralization of Operations: Transforming village banks into bank branches can centralize operations, leading to improved efficiency and better risk management (Huang, 2025).
4. Capital Injections: To ensure the financial stability of surviving banks, capital injections from local governments, local state-owned enterprises, and investors may be necessary (Tsang, 2025).
5. Enhanced Corporate Governance and Management Structure: Consolidation provides an opportunity to improve corporate governance and management structures, further enhancing risk management capabilities (Tsang, 2025).

By implementing these strategies, surviving banks can enhance their efficiency and risk management capabilities, ensuring long-term success and contributing to China's financial stability.

In conclusion, China's record mergers in the $8 trillion small banking sector raise future risks and present challenges for surviving banks. However, with proper management and regulatory oversight, these banks can enhance their efficiency and risk management capabilities, ensuring long-term success and contributing to China's financial stability.