Intense competition and government encouragement push weak commercial lenders to consolidate China's second and third-tier banks are entering a period of consolidation as weaker players succumb to intense competition and the government encourages more mergers and acquisitions, ratings agency Standard & Poor's said yesterday. 'The consolidation is happening, especially at the city commercial bank level,' S&P analyst Ryan Tsang said. 'Banks are talking to each other and local and central governments are encouraging these banks to consolidate so they can survive the coming competition.' In accordance with its World Trade Organisation accession agreement, China will allow foreign banks to conduct yuan business with individual domestic customers at the end of this year. Consolidation is likely to come mostly from among the 117 third-tier city commercial banks, which operate in regional centres. Some of these new entities could then apply to become joint stock commercial banks with nationwide operating licences and some of the existing second-tier national banks could acquire smaller players in cities they do not yet have a presence. The 'Big Four' state-owned commercial banks and Hong Kong-listed Bank of Communications are unlikely to be involved in the consolidation trend, according to S&P's director of public finance ratings, Chew Ping, because they are already very conscious of costs and are actually shutting down branches rather than expanding their networks. The total number of city commercial banks is likely to decline but it is hard to predict numbers, considering that many cities and provinces are hoping to establish new banks. One example is the national-level Bohai Bank which is 19.99 per cent owned by Standard Chartered and went into operation last week in Tianjin. S&P believes the overall situation in the banking sector is improving in terms of asset quality, profitability and capitalisation and will further improve when the government provides expected capital injections to Agricultural Bank of China, the only one of the big four not to have received a state bailout, and the two national joint stock commercial banks with the highest non-performing loan ratios - Guangdong Development Bank and China Everbright. But Mr Tsang said he expected polarisation to continue in the banking system because of the natural advantages enjoyed by the state-owned megabanks. He also said the banks that had received capital injections from the government would have an early-mover advantage. Since 1998, the government has spent an estimated 3.57 trillion yuan recapitalising or closing ailing financial institutions, a sum equivalent to 22.3 per cent of the country's gross domestic product in 2004. Mr Tsang said struggling city commercial banks could still avoid takeover by attracting foreign investors interested in gaining access to their customer base. 'Many foreign investors are eager to get their foot in the door and they have the capital to do it,' he said. According to S&P, some poorly-performing potential candidates for acquisition include: Chengdu City Commercial Bank, Kunming City Commercial Bank and Qingdao City Commercial Bank which is majority owned by white-goods giant Haier Group.