China’s Bank Consolidation Campaign Struggles as Profits Sink and Capital Buffers Thin

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Summary:

China’s aggressive consolidation of its small banking sector is showing early signs of strain, as newly merged regional banks report falling profits and weakening capital ratios...

Record Consolidation Push Meets Mounting Financial Stress

In 2025, China accelerated its unprecedented drive to consolidate its fragmented small banking sector, with over 350 banking licenses revoked by November up sharply from 198 the year prior. This wave of mergers primarily targets the country’s 3,600-plus rural banks and credit cooperatives, which account for about 14% of China’s $58 trillion banking industry. Despite these aggressive moves, newly formed entities appear financially strained, as a Reuters review of 20 regional banks involved in 2024 mergers revealed that 13 saw declining profits or outright losses by mid-2025. Additionally, 14 of these lenders reported deterioration in their capital adequacy ratios.

The results signal that consolidation, while aimed at reducing systemic risk, may be exposing deeper structural issues within China’s small-bank landscape particularly in regions burdened by overleveraged local governments and lingering fallout from the country’s property sector crisis.

Asset Quality Concerns Persist Despite Mergers

At the heart of Beijing’s financial stability concerns lies the vulnerability of rural and city commercial banks, which are disproportionately reliant on short-term interbank borrowing and often lack robust governance or diversified revenue streams. In many cases, regional governments pressured relatively healthier city lenders to absorb “high-risk” rural banks, hoping that scale and integration would stabilize the system. However, data shows the opposite has often occurred: banks that acquired distressed peers are now seeing their own balance sheets weaken.

For instance, Shanxi Bank, backed by the Shanxi provincial government, reported a dramatic 90% profit plunge in 2024 after absorbing four rural banks, alongside a spike in its non-performing loan (NPL) ratio from 1.74% to 2.5%. Similarly, Bank of Dongguan’s profit fell 8.2% after its own acquisitions, and its NPL ratio rose from 0.93% to 1.01%. These figures suggest that the integration process not only failed to restore profitability but may have transferred risk from smaller institutions to mid-sized regional banks.

Structural Fragility and Moral Hazard Undermine Reform Goals

Financial analysts warn that unless underlying bad debts are properly recognized and written off, mergers merely spread risk rather than eliminate it. Xiaoxi Zhang of Gavekal Dragonomics emphasizes that bad loans must be resolved transparently, as bundling troubled assets without restructuring does not strengthen the system’s foundations.

Moreover, local governments who often control or support these banks may be forced to intervene repeatedly, leading to a vicious cycle of public bailouts. Such interventions risk creating moral hazard, with weak institutions relying on state rescues while stronger banks are dragged into distressed asset pools. As one state-owned bank executive noted, many smaller lenders are “just lying down waiting to be rescued.”

The risk is compounded by the fact that rural and city commercial banks remain far more fragile than their national peers. By September 2025, rural banks reported an average NPL ratio of 2.82%, city commercial banks at 1.84%, both substantially higher than the 1.22% reported by national state-owned banks and joint-stock banks.

Policy Ambiguity and Political Tension Cloud Long-Term Impact

While China’s top financial regulator, NFRA chief Li Yunze, has reaffirmed Beijing’s intent to continue systematic restructuring of small and medium-sized financial institutions, clear success metrics remain absent. Despite large-scale consolidations in 2024, including the merger of 290 rural lenders into regional banks, asset quality issues persist. Political pressure for rapid stabilization may have led to premature integrations without adequate risk pricing or restructuring mechanisms.

Additionally, anecdotal evidence suggests that acquiring banks were often given limited discretion, being “guided” to acquire specific troubled banks from local government-approved lists. A loan officer from Jiangsu confirmed that many acquirers discovered significantly worse asset conditions than originally disclosed, undermining the credibility of regulatory risk assessments.

A Costly Band-Aid for a Systemic Wound

China’s sweeping bank consolidation campaign was designed to eliminate fragmentation and mitigate systemic risk. Yet, early evidence indicates that while the quantity of banks has decreased, the quality of financial health has not proportionally improved. The mergers, rather than curing the sector’s ailments, may have merely delayed them pushing distressed assets further up the institutional ladder without resolving their root causes.

The correlation between forced consolidations and worsening balance sheets points to a structural mismatch: cosmetic changes in the number of institutions cannot substitute for deeper capital reform, debt resolution, and governance overhaul. Until Beijing confronts these core vulnerabilities particularly in rural and underdeveloped regions the threat of financial instability will remain, regardless of how many banking licenses are revoked.

Source: Reuters

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