Consolidation in China's rural banking sector will take a long time but likely pay off. China still has thousands of rural financial institutions, which make up 14% of the banking system total assets. Many of them are more susceptible to shock and deposits runs than larger peers, and improvement of the sector could reduce vulnerabilities in the financial system.
| Most of China's weakest financial institutions (323 out of 337) are rural ones | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| People's Bank of China rating of financial institutions (scale 1 to 10 and D) as of 2Q 2023…. | ||||||||||
| ….these weak rural FIs accounted for less than 1% of the system total assets | ||||||||||
| Number of FIs | Green zone | Yellow zone | Red zone | |||||||
| (1 to 5) | (6 to 7) | (8 to 10 and D) | ||||||||
| Large banks* | 24 | 23 | 1 | 0 | ||||||
| (%) | 95.8 | 4.2 | 0 | |||||||
| City commercial banks§ | 122 | 82 | 26 | 14 | ||||||
| (%) | 67.2 | 21.3 | 11.5 | |||||||
| Rural financial institutions± | 3,783 | 1,770 | 1,690 | 323 | ||||||
| (%) | 46.8 | 44.7 | 8.5 | |||||||
| Private banks and others | 21 | 16 | 5 | 0 | ||||||
| (%) | 76.2 | 23.8 | 0 | |||||||
| Foreign banks | 42 | 40 | 2 | 0 | ||||||
| (%) | 95.2 | 4.8 | 0 | |||||||
| Total | 3,992 | 1,931 | 1,724 | 337 | ||||||
| (%) | 48 | 43 | 8 | |||||||
| Total assets (%) | 100 | 90.7 | 7.6 | 1.7 | ||||||
| Note: The ratings span 11 levels, from 1 (safest) to 10 (riskiest) and level D ( in bankruptcy). *Large banks include three policy banks, six state-owned commercial banks, 12 joint-stock commercial banks and three other banks. §Three city commercial banks are grouped into major banks group. ± Rural financial institutions include 1,608 rural commercial banks, 23 rural cooperative banks, 509 rural credit cooperatives and 1,643 village and township banks. Sources: People's Bank of China, National Financial Regulatory Administration, S&P Global Ratings. | ||||||||||
What's happening
China is launching further reforms for the country's 3,800 rural financial institutions. Liaoning Rural Commercial Bank will absorb 36 rural banks in Liaoning province under a plan approved on June 20, 2024 by the National Financial Regulatory Administration. This provincial level bank was set up in September 2023 to consolidate 31 rural financial institutions. According to a 2021 report by the People's Bank of China, Liaoning was one of the regions with higher numbers of high-risk financial institutions.
Why it matters
Strengthening rural institutions would improve overall confidence in China's banking system. Individually, most of the rural financial institutions are insignificant and unlikely to pose a systemic risk to Chinese banking sector. Collectively, stress cases are more common for weak rural financial institutions. Frequent occurrences could weaken the public's confidence in Chinese financial system and may cause regional stress from time to time.
…and deepen risk-management culture. Chinese authorities will push hard on rural financial institutions reform and clean up to strengthen Chinese financial system stability.
The process could take up to a decade. We reckon that it would take four to five years to substantially clean up the high-risk rural financial institutions, and it would take another few years to reorganize these lenders and institutionalize changes in corporate governance, management structure and risk culture.
What comes next
Authorities will prioritize riskier institutions for capital injections and balance sheet cleanup.
Regions with a relatively high level of risky assets, a high number of risky financial institutions, and/or tight liquidity will be prioritized. We expect the authorities to form new institutions to take over weak lenders or encourage the stronger ones to absorb weaker players.
Authorities could also close selected financial institution as in two bankruptcy cases in 2022: that of Liaoyang Rural Commercial Bank, and Liaoning Taizihe Village and Township Bank.
The cleanup process will likely involve write-offs and/or disposal of nonperforming assets on the bank balance sheets and capital injections from local governments, local state-owned enterprises, or other strategic investors. Holders of capital instruments of a failed bank are likely to bear losses, and institutional creditors could also see some haircuts.
Rural Bank Consolidation Is Nothing New
China has been reforming its rural financial institutions for years. The number of such institutions has reduced by about 90% in the last two decades from over 38,000 at the end of 2001. Close to 3,800 rural financial institutions are still in operations today.
This reform is part of a systematic exercise to bolster financial system that started with the state-owned commercial banks, then moved onto joint stock commercial banks and others (see table on page 1). The six state-owned commercial banks and the 12 joint stock commercial banks accounted for about 60% of the banking sector total assets as of May 2024.
This report does not constitute a rating action.
| Primary Credit Analyst: | Ryan Tsang, CFA, Hong Kong + 852 2533 3532; ryan.tsang@spglobal.com |
| Secondary Contacts: | Ming Tan, CFA, Singapore + 65 6216 1095; ming.tan@spglobal.com |
| Xi Cheng, Shanghai + 852 2533 3582; xi.cheng@spglobal.com | |
| Phyllis Liu, CFA, FRM, Hong Kong +852 2532 8036; phyllis.liu@spglobal.com | |
| Yiran Zhong, Hong Kong 25333582; yiran.zhong@spglobal.com |
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