Are Distressed Small Banks Putting China’s Banking System at Risk?

It’s been 20 years since a Chinese bank failed. But recent bailouts of three regional lenders have raised concerns about systemic problems in China’s financial sector. While risks have grown for China’s smaller banks, we believe that the Chinese banking system remains robust.

In May, Chinese financial regulators took control of regional lender Baoshang Bank because of serious credit risks. While personal and small business accounts were protected, some corporate and interbank customers suffered losses. This shocked investors who had formerly believed that the government effectively guaranteed all Chinese financial institutions. The takeover briefly sparked fears of a domino effect across other small banks.

In late July, the country’s largest bank, state-owned Industrial and Commercial Bank of China (ICBC), and two other state-owned “bad banks”* rescued another regional lender, the Bank of Jinzhou. And in August, a subsidiary of China’s sovereign wealth fund** took over a third troubled regional lender, Hengfeng Bank, which is owned by the same parent company as Baoshang Bank.

It sounds like China’s banking system is in dire straits. But is it?

Assessing the Breadth of Distress

In China’s diverse banking system, the risky lenders are found in the third- and fourth-tier banks. These comprise about 20% of total banking assets in China (Display 1).