China’s smaller lenders are expected to come under funding pressure as the country’s shadow banking sector contracts in the wake of a crackdown on systemic risk by Beijing.

“Shadow banking continued to contract in the first quarter of this year, but the pace eased compared to last year,” said Chen Guanru (陈冠如), director at Fitch Ratings, to 21st Century Business Herald.

“Shadow banking as a share of China’s nominal GDP fell from 68% in 2017 to 55% last year. We expect that it will fall to around 50% by the end of this year.”

The Chinese shadow banking sector saw rampant growth earlier this decade, with data from Basel’s Financial Stability Board (FSB) indicating that China’s shadow banking assets hit USD$8.3 trillion as of the end of 2017, second only to the USA ($14.9 trillion).

Hu Yueming (胡月明), director, Greater China Regional Banking, Fitch Ratings, said to domestic press on 9 July that smaller lenders are more susceptible to the impacts of a contraction in shadow banking activity given their comparatively weak asset and liquidity standing.

China is currently host to nearly 4000 small-scale municipal banks and rural village banks, who amounted for around 13% of banking sector assets as of the end of May this year.

According to Hu financial cost pressure is set to rise for small and medium-sized lenders, while financing channels will also narrow. Central government policy is pushing for Chinese banks to reduce financing costs for enterprises, which will narrow the interest spreads for smaller banks and undermine profits.”

“Taking the 7-day interbank reverse repo rate as an example, certain banks which are smaller in scale or whose credit ratings are lower are seeing fluctuations in financing costs,” said Hu.

Data from Standard & Poor’s further indicates that the recent scandal involving Inner Mongolia’s Baoshang Bank has heightened market trepidations over risk associated with smaller regional lenders.

June saw a sharp decline in net issuance of the interbank negotiable certificates of deposit commonly used by small and medium-sized banks in China to tap funds, with a drop to 226 billion yuan from 278 billion yuan in May.