China’s banking system represents the world’s largest banking landscape by assets and has come under growing strain because of an overall property market slump and mounting local government debt. In 2024, banks in China experienced an unprecedented rate of collapse due to a turning point in the country’s economy.
In June 2024, multiple small banks faced a savings and loan crisis, as 40 of them were absorbed by larger financial institutions, and their financial products and services were discontinued. Included in this list is the Jiangxi Bank of China, which went under in July 2024. According to a report made by The Economist, this rate of bank closures was faster and more damaging than the severe period of the S&L crisis that happened in the mid-1980s in the US.
Rural banks represent an important part of the economy, as they focus on developing and maintaining customer demands, while bigger banks prioritise providing money to companies and government entities. As property prices have fallen, developers and households alike have stopped taking loans and mortgages, which ultimately meant less lending and cash for banks. Furthermore, regional and local financial institutions needed to respect LGFVs, the Local Government Financing Vehicles, a practice that put a further strain on the small banks’ balance sheets, especially since the land and property prices have fallen and the value of these banks' assets has declined.
According to The Economist, there were roughly 3.800 lenders in rural China that were struggling because of an overstock of bad loans, holding a total of USD 7.5 trillion in assets. This represented approximately 13% of the entire banking system. In addition, some of them even admitted that more than 40% of their portfolios and suites of services were represented by non-performing loans.
Included in the 40 small banks that had to close their operations are 36 institutions that were in Liaoning Province and were absorbed into Liaoning Rural Commercial Bank, which was set up by the country’s regulators in September 2024 in order to manage banks that were not meeting the regulatory requirements and laws of the local industry. Five similar institutions were developed in the same year to serve the same purpose.
In the past, the local governments could buy up any non-performing assets from the small banks’ balance sheets in order to shift the risk from the small institutions to them. One of the main reasons why this couldn’t take place anymore is that local governments couldn’t borrow as easily as they used to, as the capital was growing worried about them having debt burdens. This made them launch new measures that limit the overall sums that small banks can borrow from bigger entities.
Alongside this strategy, local governments’ balance sheets also have been strained by the property crisis, which has become worrisome after they took on massive debts, some even reaching billions of dollars, in the process of trying to meet the development targets set by the capital. This became such a big problem that Beijing had to bail some of the institutions out, as well as ban others from borrowing more money, in an initiative that was meant to unwind a decade-long investment binge.
In the meantime, the biggest banks of China continued their development process in a quick manner, a strategy that consolidated the failing institutions while also drastically expanding their market cap. This happened as the Chinese economy faced multiple challenges, including consumer confidence and client process, sharp downturns in residential construction and sales, as well as the overall declining population and debt as a percentage of GDP. China’s major state-owned banks also remained better capitalised and more stable but faced profit pressure and narrowing margins amid a slowing economy.
In response to the challenges faced by the country’s banking system, authorities have tried to combine the process of merging or closing dangerous banks and swapping risky debts with the initiative of monetary easing and selective fiscal support. These efforts aimed to keep credit flowing securely and maintain confidence in financial institutions without the need for a complete reversal of deleveraging in the property and local government sectors.
Since April 2024, the People’s Bank of China has issued multiple warnings against plummeting yields in long-dated government bonds, aimed at making financial institutions more aware of the severity of the situation. As lower borrowing costs can be welcomed in an economy that is struggling to recover from a property crash, this initiative triggered worries among China’s policymakers, who feared a crisis similar to the collapse of SVB in March 2023, as it represented the biggest US bank failure since the global financial crisis.
Small and medium-sized banks were the ones believed to be particularly susceptible to interest rate risks, as once rates began to rise, they incurred huge losses and faced the risk of bankruptcy. Reflecting the growing concern over banks’ exposure to government debt, Chinese authorities took an unusual step in August 2024, beginning to publicly name and shame banks that purchased government bonds in an effort to discourage further buying.
In June 2024, the Chinese Communist Party (CCP) issued a notice for a 30-year retrospective tax payment aimed at significantly increasing income confiscation. Meanwhile, financially troubled local governments also took advantage of the situation, as they led multiple private SMEs to declare bankruptcy. In addition, China reduced its short and long-term interest rates to stimulate economic growth just days after a major Communist Party leadership meeting.
Despite authorities’ extensive stabilisation efforts, multiple systemic risks continue to loom over China’s overall banking sector. These include a prolonged real estate slump, local government debt crisis, hidden bad debts and shadow banking, erosion of confidence, as well as economic slowdown and credit demand.
Recently, a profitability indicator at China’s biggest lenders has fallen to its lowest levels on record, according to the Financial Times. In the news article, China’s six largest banks by assets have all recently posted their lowest-ever net interest margins, as a slowing economy and an official push to boost credit are currently weighing on the country’s banking sector. The average marking across the six state-run lenders was 1.48 % at the end of 2024, compared with 1.6% in 2023. In addition, the government has also cut interest rates, with the one-year loan prime rate at 3.1%, down from 3.35% in September 2024. Four of the six banks (Bank of China, Bank of Communications, Postal Savings Bank of China, and China Construction Bank) mentioned that they plan to raise USD 72 billion, with the finance ministry making a rare direct investment amid concerns over profitability in the region.
Considering the overall situation of the Chinese banking system, the key systemic threats lie between the property downturn and local government debts. A successful navigation of these problems is expected to involve restructuring bad debts, recapitalising banks and institutions when needed, as well as reviving credit demands using economic reforms.
According to The Economist, one of the main methods by which this financial crisis can be solved is through the use of stable but marginal capital restructuring. In 2023, approximately USD 29.8 billion flowed to local banks, representing an equivalent of 1% of their risk-weighted assets. However, more funds were disbursed in the more severely affected provinces, such as the case of Liaoning Province in northeastern China, which injected 17% of its special bond revenue into its banks from December 2020 to May 2024. Furthermore, the regulatory authorities of the country also pushed for mergers to develop more, as they lacked the mechanisms needed to allow banks to fail and exit the market.
According to S&P Global, the process of finding stability in China’s financial crisis can be estimated to be completed in ten years. This process also means that the country could plan to move away from the fragmented regional banking strategy towards a centralised model. Although this model can reduce further bank failures, it could also harm the economy and the overall deflation crisis. Moreover, switching from smaller banks to larger banks could also reduce household purchasing power while also potentially increasing the country’s export capacity.
The Chinese banking system is currently contending with the aftermath of a credit crisis that threatens its growth and structural strains. The major banks in the country remain solid but less profitable, while scores of local and regional lenders have been absorbed under bigger institutions to avert a crisis. Although the system will likely avoid a hard crash through multiple state improvements, the overall trade-off is lower in growth and profitability across the sector in the foreseeable future.
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