China accelerates its banking sector reform, closing 670 small and rural credit institutions considered the most vulnerable in the system

China is accelerating reform of its banking sector by closing 670 small and rural credit institutions, considered the most vulnerable component of the financial system. The measure comes amid deteriorating asset quality, rising non-performing loans, and a slowing economy.

According to a Fitch Ratings analysis, authorities are intensifying mergers and dissolutions to create fewer but larger and better-capitalized banks. The agency warns that small and rural commercial banks face governance problems, low capitalization, and high exposure to small companies, property developers, and financing vehicles of local governments.

The return on assets of rural banks fell to 0.45% in the first half of the year, from 0.56% in 2021. At the same time, the proportion of non-performing loans reached 2.8%, compared with 1.5% for the banking sector as a whole.

The consolidation process aims to improve supervision, reduce regulatory arbitrage, and increase transparency. Fitch estimates that the risk of contagion for the system as a whole is limited, because small banks’ activity is predominantly local, while their links with other financial institutions are limited.