Failure to get to grips with small problem banks is hindering growth in both China and Europe, writes Brian Caplen.

China and the eurozone don’t have much in common but they do share a problem of local banks with unsound business models that carry high risks. Consolidation would be healthy in both regions and would give economic growth a big boost. But local banks are usually protected by local political interests and so often carry on operating long after they should have been merged or closed. 

In China, there was a flurry of excitement in mid-November when Bloomberg ran a report that financial regulators were ‘‘considering urging problematic lenders with less than Rmb100bn [$14bn] of assets to merge or restructure’’. Fitch noted that there were 4000 banks of that size in China accounting for 20% to 25% of banking system assets. "These banks have poor franchises and typically have some combination of weak capitalisation, low profitability, strong local government influence and high related-party lending, and large exposure to opaque non-loan investments that in many cases are larger than their loan book,’’ commented Fitch. 

But since then things have gone quiet and the concern must be that political interests have trumped economic ones. Local banks the world over are often controlled by regional governments with a strong interest in retaining them as policy instruments. 

The eurozone has a similar problem. There, the ultra-loose monetary policy of the European Central Bank as well as targeted longer term refinancing operations (TLTROs), designed to help smaller banks with their funding, has kept uncompetitive players alive artificially. TLTRO funding has been estimated as accounting for about 6% of banking assets in Spain and Italy. 

Regulators are naturally cautious about bank mergers as they have a very poor track record. But unless something is done about zombie banks, economic recovery in Europe will be constrained. 

Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen

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