China’s Small Bank Consolidation Struggles as Profits Fall and Risks Persist

China’s aggressive push to consolidate its vast network of small banks is facing mounting challenges, as many newly merged lenders report falling profits and weakening capital buffers, according to a Reuters review of financial data. The consolidation drive, designed to reduce systemic financial risks in China’s $8 trillion small banking sector, has accelerated sharply, with at least 350 banking licences cancelled in 2025 by November, compared with 198 in 2024, data from China International Capital Corp shows.

The effort primarily targets more than 3,600 rural banks and credit cooperatives, which account for roughly 14% of China’s $58 trillion banking system. These institutions are often backed by heavily indebted local governments and rely heavily on short-term interbank and money market funding, increasing their vulnerability during periods of economic stress or financial shocks.

Despite the policy push, consolidation has not delivered immediate financial relief. Among 20 small regional banks that absorbed weaker lenders in 2024, 13 reported slower profit growth, outright profit declines, or losses by mid-2025. Fourteen also saw their capital adequacy ratios deteriorate after mergers, highlighting the difficulty of repairing balance sheets through consolidation alone.

Analysts warn that mergers without proper recognition and write-offs of bad debts merely spread risk rather than eliminate it. Many small banks continue to struggle with poor asset quality due to China’s prolonged property sector downturn and slowing economic growth. In some cases, stronger regional banks have been instructed to acquire troubled rural lenders, only to discover that bad loans were significantly worse than initially assessed.

Official data show non-performing loan ratios at rural and city commercial banks remain far higher than those at large state-owned banks, underscoring ongoing financial stability concerns. Meanwhile, the consolidation drive has raised fears of moral hazard, as weaker institutions expect rescues while healthier banks bear increasing burdens. As China presses ahead with banking reforms, the performance of its small banks remains a critical test for the country’s broader financial stability.