Dec 12 (Reuters) - Many of China's newly merged small banks have seen profits fall and capital buffers shrink over the past year, a Reuters review of data showed, testing Beijing's record consolidation drive designed to avert risks in its $8 trillion small banking sector. China's bank consolidation has accelerated, with at least 350 banking licences cancelled in 2025 as of November, up from 198 in 2024, according to a report by Chinese investment bank China International Capital Corp. The consolidation mainly targets a sprawling network of more than 3,600 rural banks and credit cooperatives that account for about 14% of the country's $58 trillion banking sector, according to official data. These small banks are mainly backed by indebted provincial governments and are largely funded via short-term money market and interbank borrowings, potentially jeopardising domestic financial stability in the event some of them fail. A Reuters review of publicly available financial reports shows among 20 small-sized regional banks that absorbed smaller troubled lenders in 2024, 13 reported either lower profit growth, a profit decline or losses through mid-2025. Fourteen saw their capital adequacy ratios deteriorate post-merger, the data showed. The data review highlights the challenges Beijing faces in bolstering the balance sheets of its unwieldy small banks, most of which have been reeling from a property sector liquidity crisis and slowing economic growth. "Unless bad debts are recognised and written off, mergers and acquisitions alone cannot reduce the number of bad debts - they can only dilute bad debt risk," said Xiaoxi Zhang, China finance analyst at Gavekal Dragonomics. "Local banks generally belong to local governments, so if the merged and restructured bank still cannot absorb the bad debts, it's highly likely that the local government will provide rescue assistance again," she said. The People's Bank of China declined to comment. China's financial regulator, the National Financial Regulatory Administration (NFRA), did not respond to a request for comment. WEAK LINK IN FINANCIAL STABILITY China will "steadily and systematically promote mergers and reorganisations of small and medium-sized financial institutions while reducing quantity and improving quality," NFRA head Li Yunze said at a financial conference in October. At least 290 rural Chinese banks and rural cooperatives were merged into larger regional lenders in 2024, Reuters reported in February based on calculations of regulatory and company filings over the preceding 12 months. The smaller lenders are widely considered the weak link in China's financial stability, plagued by poor asset quality, low capital bases and governance issues, particularly in the country's less-developed regions. Underscoring the challenges, regional lender Shanxi Bank, backed by the northern Shanxi province's department of finance, posted a more than 90% drop in 2024 profit after absorbing four rural lenders that state-owned local media described as "high-risk village banks". Shanxi Bank's non-performing loan ratio jumped to 2.5% in 2024 from 1.74% a year earlier, according to its financial report released in April. Bank of Dongguan, a regional lender based in southern China's Guangdong province, reported its net profits fell 8.2% in 2024 after taking over two local rural lenders during the year. The bank's non-performing loan ratio rose to 1.01% at end-2024 from 0.93% a year earlier, according to its annual report released in April. Reuters' calls to Shanxi's provincial government seeking comment went unanswered. Shanxi Bank and Bank of Dongguan did not respond to requests for comment. 'WAITING TO BE RESCUED' In some cases, healthier banks have been told they must comply with regulatory guidance to buy small lenders on local government lists of troubled banks, though they are allowed to choose among given options as they attempt to protect their profit margins and capital buffers, said a loan officer at a city commercial bank in Jiangsu province. "During actual acquisitions, we often discover bad debts at many village banks are worse than initial assessments," said the loan officer, who requested anonymity due to the sensitivity of the matter. Despite the consolidation drive over the last couple of years, asset quality risks also remain elevated at regional lenders relative to larger peers. Bad loan ratios at city and rural commercial banks were at 1.84% and 2.82%, respectively, by end-September 2025, far exceeding the 1.22% level reported by large state banks and national joint-stock banks, official data showed. Regulators in China have in the past tapped the big state banks to bail out smaller and struggling peers to ensure financial stability. As asset quality deteriorates, rural lenders in some regions across China have stepped up property sales following defaults on business loans and mortgages, according to JD.com's online asset trading platform. The consolidation drive has also created moral hazard, as "weak institutions are just lying down waiting to be rescued", while healthier banks are dragged down by their problems, said a state-owned bank branch head on condition of anonymity. (Reporting by Reuters Staff; Editing by Jamie Freed) (The article has been published through a syndicated feed. Except for the headline, the content has been published verbatim. Liability lies with original publisher.)
