China steps up aid for regional banks as economic risks mount

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Chinese provinces pumped a record Rmb218.3bn ($31bn) of capital into fragile regional banks last year using special-purpose bonds, in a sign of concern at the risks within one of the world’s most important financial systems.

Sales of bonds that are used to boost the capital buffers of regional lenders more than tripled in 2023 from the previous year, according to data from Chinese financial data provider Wind.

The bonds, which are sold by local governments and whose proceeds can only be used to put capital into banks, are also being used to hasten mergers of weak lenders in China’s indebted regions, which are struggling to cope with a long-running property sector crisis. The bonds were introduced in 2020 to help banks through the Covid pandemic.

The acceleration of funds being channelled to regional banks underlines Chinese authorities’ concern over their systemic importance at a time when the economy has slowed.

Regional lenders including urban and rural commercial banks “hold 25 per cent of China’s banking system assets”, said Yulia Wan, analyst with Moody’s Investors Service, who added that risks to banks were set to rise over the next 12 months from exposure to sectors including manufacturing, retail, property, construction and local government financing.

The risks are “substantial for some regional banks, trust companies and asset managers”, she said.

Regional lenders have been harder hit than bigger peers by interest and deposit rate cuts meant to shore up sluggish economic growth.

Lower interest rates generally reduce banks’ profits by narrowing the gap between the amount they pay on deposits and what they charge on loans.

“There has been a significant fall in the net interest margin of small and medium-sized banks last year, resulting in a severe weakening of their capital replenishment capabilities,” said Ming Ming, chief economist at Citic Securities.

The net interest margin at listed urban commercial banks stood at 1.6 per cent at the end of September, a historic low.

“When interest rates are lower, banks usually increase loan offerings to boost their revenues. But amid weak demand and fierce competition among banks for good clients, the profit margin at regional lenders has been squeezed even further,” said Ming.

The provinces of north-eastern Liaoning and central Henan have been the top issuers of the Rmb476bn in special-purpose bonds sold since 2020.

Liaoning has been working for years to merge three of its troubled banks while Henan is wrestling with the aftermath of a rural banking scandal that involved the loss of about Rmb40bn in savings.

The acceleration of the special bond sales has coincided with a jump in the number of regional bank mergers. More than 20 so-called village banks, which mainly serve farmers, in central Sichuan, western Xinjiang and northern Hebei provinces have been merged or absorbed by larger banks in 2023, according to regulatory filings from the National Administration of Financial Regulation.

China has a national network of more than 4,000 banks, but fears over their health have mounted since relatively unknown Baoshang Bank was forced into a state takeover in 2021.

Regulators have become more vocal about the need for sector-wide consolidation, pushing for capital injections and state purchases of stakes in distressed regional lenders.

The central bank has also created a separate financial stability fund to provide emergency liquidity to curb contagion risks if weak banks fail. However, analysts have warned that the fund, which raised Rmb64.6bn in a first tranche in 2022, may be too weak for a proper safety net.

“Bond sales have helped supplement regional banks’ capital but have not fundamentally changed their weak capital positions,” said Wan at Moody’s.

She added that the special bond sales only accounted for about 0.9 per cent of the risk-weighted assets of regional banks at the end of 2022.