China’s provinces asked to bail out risk-fraught regional banks
Local government debt and state control of credit could rise once again as a consequence.
China’s top economists and bankers remain highly concerned about the potential for the ailing health of regional lenders to trigger a financial crisis.
They’ve called for local governments to help bail them out, by issuing special bonds to fund capital injections for unsteady balance sheets.
While the move would bolster China’s beleaguered smaller banks, it could also compound long-standing problems with the financial system.
These include the immense leverage burden of local governments, as well as the collusion between regional officials and lenders which has historically been a source of debilitating debt risk.
Leading pundits argue, however, that increasing local government influence over regional banks via bailouts will prove advantageous for the Chinese economy, by enhancing the state’s ability to control credit allocation and tightening the coordination of fiscal and financial policy.
China’s smaller banks still source of crisis anxiety
Liu Ya (刘亚), a representative to the National People’s Congress and party secretary for the Beijing branch of China Export-Import Bank, voiced concern about the capital health of smaller lenders at the Two Sessions congressional event held in March.
“Capital is a reflection of the operating strength of banks,” she said during an interview at the sidelines of the Two Sessions.
“For small and medium-banks, it is of the utmost importance when it comes to stable and healthy development, absorbing losses and the prevention of risk,”
Prominent financial commentator Mo Kaiwei (莫开伟) echoed Liu’s concerns in a follow-up opinion piece entitled “China’s Small and Medium-sized Banks Urgently Need the Establishment of Long-term Effective Mechanisms for Capital Supplementation” (“莫开伟：我国中小银行亟需构建资本补充长效机制).
“High-risk institutions are concentrated in the small and medium-sized banking system, and their lack of sufficient capital buffers could readily trigger regional financial risk,” Mo writes.
“It is very clear that expanding support for capital supplementation by smaller banks has become an extremely urgent task.”
As of the end of 2025, the core tier-1 capital adequacy ratios for all categories of Chinese banks were safely above the regulatory baseline.
They stood at 17.56% for the large-scale commercial banks and 13.43% for the joint-stock banks - the traditional mainstays of the Chinese banking sector.
For municipal commercial banks and rural commercial banks - considered smaller lenders, the figures stood at 12.63% and 12.22% respectively.
Mo points out, however, that some of the smaller municipal and rural commercial banks have “already seen their capital adequacy ratios fall to quite low levels, with some posting on-quarter declines.”
He further notes that the bad debt levels for certain regional lenders have reached perilous heights, while the Chinese banking sector as a whole still faces headwinds which will continue to diminish the health of their balance sheets.
“At present, China’s small and medium-sized banks suffer from constraining factors such as low profit levels and high non-performing asset ratios,” Mo writes.
“On top of this, China’s economic growth is slowing, with the trends of financial risk prevention, crack downs on malfeasance and strict regulation still ongoing.
“The return of corresponding operations to balance sheets will further accelerate the erosion of capital at smaller banks, affecting their capital adequacy ratios to varying degrees.”
Smaller regional banks have remained an acute source of concern for China’s financial authorities for much of the past decade - despite ownership by the state and tight oversight by regulatory agencies.
In 2019 Yi Gang, the then-governor of China’s central bank highlighted problems with asset quality at China’s smaller lenders, stating that a rise in NPLs comprised the greatest threat to the stability of the banking sector.
The summer of that year saw the failure of three regional lenders - Inner Mongolia’s Baoshang Bank, Bank of Jinzhou in Liaoning and Shandong’s Hengfeng Bank.
In May 2019 the Chinese central bank and the China Banking and Insurance Regulatory Commission (CBIRC) made the bold move of taking over Baoshang Bank - the first such nationalisation of a Chinese commercial lenders in more than two decades.
The episode marked the end of implicit government guarantees for Chinese financial institutions, with creditors to the trio of capsized banks left to eat their losses.
It also ushered in a wave of mergers and takeovers of China’s smaller regional lenders, in a bid to shore up the sector’s overall health.
Local governments asked to borrow to save their banks
Because smaller banks tend to be China’s most vulnerable and risk-fraught financial institutions, they also suffer from the disadvantage of finding it far harder than larger lenders to boost their capital levels.
Mo points out that it’s much more difficult for them to supplement their capital internally via retained earnings, if their profits have come under pressure due to poor operations.
These same difficulties make it harder for smaller banks to use external market-based financing channels - such as IPOs - as sources of capital, since they invariably fail to satisfy investment requirements.
For this reason, Liu Ya and Mo Kaiwei both believe that the only way to boost the health of China’s vulnerable lenders will be for local governments to come to their aid, by sourcing funds for capital injections via debt issues.
“Small and medium-sized banks urgently need to use issues of [local government] special bonds to expand the support for capital supplementation,” Liu said.
“We need to establish long-term effective mechanisms for the supplementation of capital for smaller banks.”
“The proposal by bank chief Liu Ya is congruent with the current state of China’s capital conditions of China’s smaller banks and the need to prevent risk, and is a critical measure that greatly warrants attention and promotion,” Mo writes.
“It is very clear that small and medium-sized banks urgently need issues of special purpose bonds, and that expanding support for capital supplementation has been an extremely urgent task.”
Bailing out banks conflicts with reforms
While local governments could help to bailout vulnerable regional banks by issuing special bonds, the move would also run against the grain of one of China’s top economic missions at present - dealing with the issue of opaque, risk-fraught regional debt.
China is still grappling with the dilemma of the huge amount of hidden debt amassed by local governments since 2009, when Wen Jiabao launched a four trillion yuan stimulus package to deal with the fallout of the Global Financial Crisis.
To this end, Beijing’s latest budget has approved the issuance of 4.4 trillion yuan in special bonds by local governments this year, much of which will be used to defuse debt risk by rolling over hidden liabilities.
Mo Kaiwei also points out that local governments will acquire far greater control of banks within their jurisdiction as a result of the bailouts.
This too runs against the grain of China’s long-standing financial reforms, which have sought to increase the autonomy of smaller banks vis-a-vis local governments and prevent official collusion seeking to tap into them as cash cows.
In the 1980s and 1990s, the ability of China’s local governments to exercise administrative control of banks in their regions was a key driver of the surge in non-performing loans that brought the financial system to the brink of collapse.
Local governments abused their authority to compel the banks to lend to preferred businesses or investment projects, in order to pump up growth figures and keep ailing state-owned enterprises afloat. This resulted in wasteful credit binges and the endemic accumulation of defective debt.
Is state control of banks intrinsic to the Chinese model?
Several decades later, however, Mo Kaiwei considers the reassertion of local government control over the regional banking sector to be a thoroughly positive development - as well as one which is wholly consistent with “socialism with Chinese characteristics.”
In Mo’s opinion, the move will serve to further cement the signature advantages of the China’s economic model - chief amongst them the tight coordination of fiscal, monetary and financial policy and the control of credit allocation by the state.
“The issuance of special-purpose bonds (for the banks) can deeply cement the relationship between fiscal and financial systems,” he writes.
“State-owned capital can strengthen the management of local financial institutions and better leverage the synergies between fiscal and financial policies.
“It also improves the allocation of credit resources in line with the development of sectors with competitive advantages, continuously enhancing the ability of banks to serve the real economy.”
While collusion between local governments and the financial institutions under their oversight was once considered a source of debilitating risk, Mo contends it could now become a regulatory advantage that stymies emerging perils and enhances the health of the banks.
“Most importantly, this move helps prevent local financial risks, enhances market confidence, spurs credit financing and serves the local real economy,” he writes.
“It helps increase the equity concentration of small and medium-sized banks, streamlines shareholder interests and improves board structures, thus improving the operational quality of small and medium-sized banks.”