TMTPOST--"Our bank is in a very awkward position in the city, facing pressure from both sides," a senior executive at a city commercial bank told TMTPost. His words indicate the mounting challenges faced by many small banks in China today.

As the number of government projects diminish and the burden of real estate assets weighs heavily, smaller banks find it increasingly difficult to compete with large state-owned banks and joint-stock ones. In response, many are pivoting to rural markets, aligning themselves with the government's rural revitalization strategy. However, the rural market is already overcrowded with rural commercial banks and village banks.

China's banking sector, characterized by intense competition among small and medium-sized banks, reflects a broader trend of consolidation and restructuring. This phenomenon is accompanied by a substantial decline in the number of these banks.

Data from Enterprise Warning shows that 77 small and medium-sized banks have undergone mergers or restructurings since this year, equaling the combined number recorded throughout last year.

In just one week in June, 40 rural small and medium-sized banks disappeared due to mergers or closures. The National Administration of Financial Regulation (NAFR)'s Rural Small and Medium-sized Banks Supervision Division has underscored the urgency of accelerating mergers and restructuring efforts, aiming to reduce the number of such banks, enhance centralized management, and mitigate risks.

So, what exactly constitutes a small or medium-sized bank? Excluding the three policy banks, six major state-owned banks, and 12 joint-stock banks, there are over 4,000 banks in China, including city commercial banks, rural commercial banks, village banks, and private banks. Most of them fall into the small and medium-sized category.

According to the People's Bank of China and the former China Banking Regulatory Commission, banks with total assets under 500 billion yuan (US$ 69 billion) are classified as small and medium-sized ones.

At the start of the year, Xiao Yuanqi, the deputy director of NAFR, reported that there were 3,912 small and medium-sized banks in China, primarily city commercial banks, rural credit cooperatives, and township and village banks, with 110 trillion yuan in combined assets or 28% of the banking sector's total assets.

In breakdown, there are approximately 1,600 township and village banks, over 100 city commercial banks, more than 3,000 rural commercial banks and credit cooperatives, and 19 private banks. Township and village banks, rural commercial banks, and rural credit cooperatives make up the majority.

Unlike the dramatic failures of banks like Baoshang Bank, the small and medium-sized banks have actually undergone mergers rather than closures. Many small banks have not gone bankrupt but have instead been absorbed through consolidation.

The small banks being integrated generally fall into two categories. The first category is rural credit cooperatives, which were originally independent but have gradually merged into county-level cooperatives and then into corporate entities under centralized control.

For instance, numerous credit cooperatives in Shanghai were merged into county cooperatives in the 1990s, eventually forming the Shanghai Rural Commercial Bank. Similarly, in Hainan province, rural commercial banks and credit cooperatives were consolidated into the Hainan Rural Commercial Bank.

The second category consists of township and village banks, established to address financial gaps in rural areas. Many of these banks have struggled with operational difficulties due to their small scale and poor operations. Regulators previously required each village bank to have a sponsor bank, which could either increase capital or merge the struggling bank into its branches. This year, many banks have opted to merge into their sponsor banks, leading to the "disappearance" of their names.

For example, Zhenglanqi Huize Village Bank's dissolution application over being acquired by Ordos Bank was approved on June 21. Similarly, Zhongshan Guzhen Nanyue Village Bank, Meihekou Minsheng Village Bank, and Pingshan Xibaipo Jiyin Village Bank are set to dissolve after their shareholders increase their stake to 100%, transforming them into branches.

In other cases, sponsor banks have increased their shareholdings to improve management and governance of village banks while maintaining their independent legal status with minimal impact on customer services.

Township and village banks, the dominant force among small and medium-sized banks, were initially intended to address financial gaps in rural regions. However, they often face challenges due to their small scale and operational difficulties. The policy to loosen village bank establishment began in 2006, with the former China Banking Regulatory Commission encouraging private capital involvement by reducing the minimum shareholding ratio of the main sponsor bank from 20% to 15%.

From 2012 to 2017, between 100 and 200 new village banks were set up each year. However, the emergence of village banks has been driven more by administrative measures than market forces. Experts like Liu Xiaochun argue that the notion of "small banks can better serve small and micro enterprises and disadvantaged groups" was more a product of theoretical assumptions rather than practical viability.

Village banks have faced new challenges compared to earlier rural credit cooperatives. The rise of internet finance and financial technology has undermined the "small banks can better serve small and micro enterprises and disadvantaged groups" notion. Moreover, as city commercial banks aggressively pursue the rural market as part of the rural revitalization strategy, competition has intensified.

The operational pressures on small and medium-sized banks are evident. Many rural small and medium-sized banks have faced significant operational risks. For instance, Liaoyang Liaodong Rural Commercial Bank's non-performing loan rate soared from 2.82% in 2020 to 18.51% in mid-2022. Similarly, Anshan Rural Commercial Bank and Yingkou Rongsheng Rural Commercial Bank reported non-performing rates exceeding 20%.

Additionally, the exposure of city and rural commercial banks to long-term bonds highlights their struggles on the asset side. Small and medium-sized banks' heavy investment in long-term bonds has led to risks interweaving with interest rate and credit risks, potentially impacting their capital base.

Industry experts believe that the trend of mergers among small and medium-sized banks will persist. Ji Shaofeng, an expert in small and micro credit, asserts that the primary aim of these mergers is to manage and mitigate risks through consolidation. As small and medium-sized banks face rising credit risks, the trend of mergers is expected to continue.

Liu foresees that a significant reduction in the number of small and medium-sized banks could occur within the next one to two years. Some banks may go bankrupt, while others will be merged or absorbed by larger institutions.

Internationally, the consolidation trend among small and medium-sized banks is also evident. In the United States, the number of community banks has decreased from about 7,000 in 2013 to around 4,000 in 2023. Similar trends have been observed in Germany and Japan, where the financial crisis accelerated the consolidation of banking sectors.

Despite these challenges, some experts believe there is still potential for small banks to thrive. Finding a unique customer base and leveraging local advantages may offer survival opportunities. Small banks should focus on achieving good returns and improving their return on equity rather than expanding their scale.

While the era of major mergers is transforming the banking landscape, small and medium-sized banks must adapt to survive. The ability to leverage local advantages, manage risks effectively, and find niche markets will be crucial for their future in an increasingly competitive environment.