In recent years, China’s banks have navigated a series of challenges, from a global pandemic and property market distress to rising geopolitical tensions. Nonetheless, headline indicators—such as strong capital buffers, ample liquidity, and low reported non-performing loan (NPL) ratios—continue to paint a relatively reassuring picture.

However, recent incidents suggest some underlying vulnerabilities. Signs of stress are emerging for loans in segments such as small and medium-sized enterprises (SMEs), smaller banks, and in areas related to bank compliance and governance.

Solid foundations

China’s banking system remains relatively solid due to stricter regulations. One of the key risks—property-related exposure on banks’ balance sheets—has declined from over 13.3 percent in 2021 to 10.4 percent in 2024, helping mitigate risks in the sector.

Authorities have taken proactive measures to bolster financial stability, injecting over RMB 1 trillion into both large state-owned commercial banks and smaller institutions. Rural cooperative reform has also gained momentum since 2022, merging banks to form several bigger banks with improved structure at the provincial level. Meanwhile, regulatory forbearance has been deployed to support SMEs and property developers.

As of the first quarter of 2025, the overall banking system’s capital adequacy ratio stood at 15.3 percent, well above the minimum requirement, and the NPL ratio declined to 1.5 percent. Credit and deposit growth remained steady at around 7 percent, underpinned by ample liquidity.

SME lending expansion

To better support the real economy, banks have significantly expanded credit to SMEs in recent years. While this aligns with policy goals, it also introduces new risks.

Between 2019 and 2024, SME loans grew at an average annual rate of 17.2 percent rose to 60.7 percent of GDP from 36.7 percent. Inclusive SME loans expanded even faster under the support of relending policies, averaging 23.4 percent annual growth.

Large commercial banks have now overtaken smaller peers as the primary providers of these inclusive SME loans. Given the inherently higher default risk among SMEs, this lending boom has elevated credit risks. As SME lending continues to grow, strengthening credit assessment standards and enhancing monitoring practices will be essential.

Weakness in rural commercial banks

Although smaller banking institutions account for roughly 10 percent of system-wide banking assets, they are facing greater pressures and carry disproportionate credit risk, especially rural commercial banks.

In early 2025, the NPL ratio for rural commercial banks stood at 2.9 percent, down from earlier peaks but still nearly double the system average. Profitability also slipped, with return on assets dropping from a 1.4 percent in 2014 to just 0.6 percent.

These banks’ high exposure to local economies, narrow client bases, and limited access to diverse funding sources make them more vulnerable to shocks. Their challenges are compounded by structural headwinds, including rural population decline, weakening local industries, and constraints on business model innovation.

Governance challenges

Bank compliance and governance remains an area of concern. Some banks continue to prioritize business expansion over regulatory compliance, exposing themselves to higher operational risks.

In the first quarter of 2025 alone, regulators issued 1,466 penalties to banks and resulted in a total of RMB 485 million in fines—a 20.1 percent increase from the previous quarter. The most frequent violation was imprudent loan management.

In recent years, high-profile incidents have also drawn market attention to governance issues. Cases such as the misuse of RMB 40 billion in deposits by several rural banks in Henan and the misappropriation of RMB 150 billion by the major shareholder of Baoshang Bank reflect deeper problems about internal controls, transparency, and accountability.

Reform for resilience

China’s banking sector will need to adopt a more cautious and forward-looking approach. Strengthening credit risk assessment and improving internal governance frameworks will be crucial. However, stronger compliance alone is insufficient. Long-term financial stability will also hinge on structural reforms, particularly in rural banking, SME credit evaluation, and shareholder oversight.

In the rural banking segment, further consolidation and restructuring will be needed. Efforts to merge smaller, weaker rural commercial banks into more unified provincial entities have already gained traction in several provinces. Expanding such reforms—alongside enhanced regulatory oversight and resolution mechanisms—can help address persistent weaknesses in fragmented local banking systems.

In addition, revitalizing the broader rural economy—through measures such as agricultural modernization, rural infrastructure investment, and digital service expansion—will be essential to sustaining the rural commercial banks. A more vibrant rural economy can help diversify credit demand, improve asset quality, and reduce concentration risks for these smaller institutions.

With continued policy support and enhanced regulatory vigilance, China’s banking sector can stay resilient and be better prepared for the next phase of sustainable growth.