A series of protests have since broken out Henan’s capital, Zhengzhou, with savers demanding back their money – estimated to be billions of yuan, according to depositors.

Cash crisis amid China’s stalling economy as rural banks freeze accounts

“Some small and mid-sized banks were put together quickly, and some have ulterior motives such as making loans to themselves. Governance is a problem. Risk control is another problem,” said Joe Zhang, the author of 2013’s Inside China’s Shadow Banking: The Next Subprime Crisis, who also worked at China’s central bank in the 1980s.

There are more than 4,000 small banks in China that broadly include city commercial banks and rural banks, many of which have been built to serve local economies. However, as competition grows, they have struggled with shrinking deposits while non-performing loans have been on the rise.

“Right now, the small to medium-sized rural banks are still facing challenges when it comes to sustainable development,” said a note by Everbright Securities late last month. “In some parts of the country, the aggregate risks are still large; it will require a bigger effort to tackle.”

It added that coronavirus outbreaks and various economic factors will bring some problems to the surface.

At the heart of the issue is the opacity of small banks’ shareholding structure, which has allowed some shareholders to amass substantial stakes in the banks without regulatory approval, while also using lenders to secure loans.

Why are China’s small rural banks important?

Zhang said it would be hard to consolidate small lenders, largely due to problems with placing an accurate value of their assets, and some of the controlling shareholders such as state-owned firms are unlikely to relinquish their privilege.

Over the past few years, the CBIRC has tightened supervision in the nation’s small banks, but poor governance has continued to plague the sector.

Since 2020, a total of 124 corporate investors have been called out for “gravely” violating rules and laws by the CBIRC. Flouting regulatory ownership rules; using unqualified sources of funding; fabricating materials; profiting from illegal transactions; concealment of affiliated relationships; appointing people who aren’t qualified to perform their duties as senior managers; and being associated with gang-related crimes are among the examples of malfeasance that have been found among the shareholders of small banks, the CBIRC said.

The CBIRC has also been encouraging local governments to take stakes in the weaker small lenders through companies they control, as well as allowing them to use local government debt to inject liquidity into cash-strapped small lenders.

The state-owned Economic Daily said in an editorial on Tuesday that, despite tighter scrutiny by regulators, shareholders of small banks continue to abuse their positions.

“In recent years, the violation of laws and regulations by shareholders of rural banks has been exposed, but despite the repeated bans [of such behaviour], it hasn’t stopped. Perhaps it’s because the whip didn’t really hit the right places,” the editorial said.

“Regulatory authorities also need to conduct due diligence, check shareholder identity information, strictly enforce access qualifications, and strengthen risk education,” it said, adding that small rural banks themselves need to improve disclosure and risk management as well.

The task of finding suitable and qualified shareholders to invest in China’s small banks is getting harder as profits at these lenders could further decline while the sector looks to be saddled with more bad debt.

“China, overall, is overbanked,” Zhang said. “A vast majority of the banks will survive because of government support and the support of the central bank.”