China's small banks face uncertainties under new debt rules

Disadvantage 

“The smaller (banks) will have a difficult time,” said Gary Ng, an economist at Natixis in Hong Kong. “Even if they can manage to increase their loan book, the proportion is still much smaller than large ones.”

One aim of the measures seems to be to push banks to shift their focus back to attracting deposits and lending to the real economy - rather than making speculative bets on securities - as the foundation of growth, analysts said.

But small lenders are at a disadvantage without the national networks of larger competitors, they said.

Industrial and Commercial Bank of China, China’s biggest lender by assets, said in its 2016 annual report that it had 16,788 locations in China. As of March 2017, Baoshang Bank had 18 branches and 291 sub-branches.

Faced with dwindling options for funding, some banks are turning to new forms of debt issuance. A jump in convertible and subordinated debt issued by banks in 2017 is an early sign of what Ng expects to be a steady increase, particularly for banks that lack capital.

This could pour new supply into an already-struggling bond market.

“If banks increase their issuance, that may crowd out some of the space from other companies who need liquidity (in) the bond market,” said Ng.

Some small banks may succumb to the pressure. While it is difficult to forecast whether regulators will allow banks to fail, market observers say consolidation cannot be ruled out.

“There will be a growing tolerance of the PBOC to allow these smaller (banks) to face financial challenges,” said Arthur Lau, co-head of emerging markets fixed income and head of Asia ex-Japan fixed income at PineBridge Investments.

“Whether they will allow them to default, that (is) another issue that we can debate. I think they are likely to ask the strong banks to take over, especially to avoid any systematic crisis,” he said.