By Wang Gang Research Report Vol.19 No.6, 2017

Small banks^① are an essential part of China’s financial system, an important force for promoting economic transformation and financial competition, and the mainstay in serving micro-, small and medium-sized enterprises. In recent years, the Research Institute of Finance, Development Research Center of the State Council (DRC) has conducted continued surveys, in such forms as special seminars and field visits, on the transformation of small banks in different regions. Overall, under the impacts of interest rate liberalization and FinTech, small banks are making active explorations in transforming themselves, though there are still many problems. To attain the objectives of developing small and medium-sized banks and building a multi-tier, extensive and differentiated banking institution system as stated at the Fifth National Financial Work Conference, a variety of measures should be taken to guide small banks to clarify their development strategy, prevent mistakes in the course of transformation, and achieve differentiated development.

I. Problems Facing Small Banks in the Process of Transformation

1. Inclination for expansion and prominent homogeneity in transformation

From the viewpoint of growth pace, the assets of small banks accounted for 25.11% of the total as of the end of 2016, up 0.82 percentage point year on year. Specifically, the assets of urban commercial banks grew 24.5%, 8.7 percentage points higher than the average growth rate of the banking industry. However, they failed to grow stronger while growing bigger. In 2016, the return on assets (ROA) and return on equity (ROE) of urban commercial banks were 0.88% and 13.27%, respectively, both lower than the average levels of commercial banks^②. Small banks accelerated cross-regional operations within the provinces in the case that the restrictions on cross-provincial institutions were not relaxed. In 2016, urban commercial banks established 65 intra-provincial branches, compared to only 29 in 2015. The Bank of Nanjing and Zhongyuan Bank now have branches in all cities of the provinces they are based in. But overall, cross-regional development plays a limited role in building up brands; the performance of local branches generally falls short of expectations, and some even become “chicken ribs” consuming valuable resources but bringing few benefits.

Small banks mostly see themselves as followers of larger banks and revolve their development strategy around “serving local economic development, serving urban and rural residents, and serving micro-, small and medium-sized enterprises”, resulting in homogeneity in market positioning and in turn their transformation. The first is homogeneity in development strategy. Small banks set development directions similar to those of large and medium-sized banks, taking FinTech, transaction banking, retail banking, asset-light bank, and asset management as key areas^③. The second is homogeneity in market positioning. Under the pressure of market competition and the strict assessments on relevant indicators by regulators, banks of all types are now going after micro-, small and medium-sized enterprise customers, squeezing the market share of small banks. The third is homogeneity in business structure. The non-interest income of small banks is generally below 30%, and the development space is restricted against the backdrop of the tightened regulation on fees in recent years.

2. Significant changes in the structure of balance sheets

In terms of structure, the proportion of deposit and loan business drops markedly, and off-balance sheet assets are close to balance-sheet assets. As to assets, for example, the percentage of loans granted by urban commercial banks has declined year by year, while investments have grown rapidly, exceeding the size of loans in 2016. As of the end of 2016, outstanding loans of urban commercial banks amounted to RMB10.2 trillion, accounting for 36% of total assets; investment balance totaled RMB11.5 trillion, accounting for 40.6% of total assets, 4.6 percentage points higher than the proportion of loans. Twelve out of the 134 urban commercial banks see the percentage of investments in total assets exceed 50%, up to 70% at most. The survey by the People’s Bank of China on 193 banks with legal person status across the country also finds similar results (see the following table).

With regard to liabilities, the proportion of deposits at commercial banks declined from 82.7% at the end of 2010 to 63.9% at the end of 2016, while inter-bank debts rose from 14.5% to 29.5%. Since they were allowed to issue interbank negotiable certificates of deposit (IBNCD) at the end of 2013, the proportion of these instruments in total liabilities of the 193 banks sampled had reached 8.6%. With the increase in wholesale financing sources, attention should be given to potential liquidity risks. At the end of 2016, the core debt dependency ratio of urban commercial banks was 50.6%, down 5.4 percentage points compared to the end of 2010 and 6.1 percentage points lower than the average level of commercial banks. Meanwhile, the proportion of interbank financing in the total debts of urban commercial banks was 18.8%, much higher than the average level of commercial banks, reflecting the higher dependence of urban commercial banks on wholesale lending. In 2016, off-balance sheet assets of urban commercial banks were RMB25.6 trillion, with a growth rate 12 percentage points higher than balance-sheet assets. The average growth rate of off-balance sheet assets of the 193 banks sampled reached 60.2% from 2012 to 2016, 40.6 percentage points higher than that of balance-sheet assets. The diversified operations of small banks can be explained by not only external factors such as the diverse needs of customers and the increasingly fierce market competition, but also the motivation of regulatory arbitrage. In this process, interbank business and asset management business are intertwined across institutions and across markets and the trading structure is rather complicated, while credit risks, especially liquidity risks, are poorly managed. As a result, risks are concentrated in small banks, and part of the capital is flowing from the real economy to financial sector or being operated beyond the scope of government regulation, thus undermining the quality and efficiency of serving the real economy.

3. Insufficient corporate governance

Phenomena like inappropriate performance of responsibility by shareholders are common in urban commercial banks. Some local enterprises fail to have full understanding of the particularity and social responsibility of bank operations, and lower requirements on return in the period of economic downturn; some local government see urban commercial banks under their jurisdiction as administrative departments and intervene in their operations by appointing executives and setting remuneration limits. As to rural financial institutions, though more than 1,100 rural commercial banks have become joint-stock banks with legal person status, provincial rural credit unions still play a dominant role in the nomination, appointment, dismissal and performance appraisal of bank directors, supervisors and senior executives, deterring banks from playing a leading role in the market as legal persons and consequently making corporate governance a mere formality. With the growing pressure of reform and transformation, the contradictions between the financial innovation needs, market-based operation appeals, and self-governance requirements of rural commercial banks and the current administrative system of provincial rural credit unions have become increasingly prominent.

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