Local small and medium-sized banks accelerate reform and risk mitigation; market-oriented "capital infusion" demand heats up

Ask AI · What are the hidden factors behind the non-redemption of Tier 2 capital bonds by mid-sized and small banks?

21st Century Business Herald reporter Yu Jixin

During the earnings season, market attention has focused on the fundamentals of mid-sized and small banks.

On the one hand, since March, some mid-sized and small banks have chosen not to redeem their Tier 2 capital bonds, and in some cases have even delayed interest payments, prompting the market to pay attention to the credit risk of certain institutions.

On the other hand, efforts to resolve insurance-related issues, “refinancing” within the industry, and structural optimization are also accelerating in parallel. In many places, capital for mid-sized and small banks has been strengthened through multiple channels—such as injecting funds via special bonds, absorption through mergers, converting convertible bonds into shares, and issuing perpetual bonds—driving reforms to deepen further in addressing those issues.

Song Ge, deputy general manager of the rating department of China Securities Pengyuan’s financial institutions, told the reporter that in recent years there have been a certain number of cases where Tier 2 capital bond redemption rights of some mid-sized rural commercial banks have not been exercised. However, “cases where interest on Tier 2 capital bonds was not paid on time are still relatively rare.” In fact, at the end of March this year, some mid-sized rural commercial banks located in Qinghai and Jilin experienced situations where the outstanding Tier 2 capital bonds were not redeemed during the exercise period and where the interest on the bonds was not paid on time. In recent years, operating pressure on the banking industry—especially on mid-sized and small banks—has increased somewhat. Mid-sized and small banks with relatively weaker credit profiles have also shown more clearly exposed risks.

“However, it is not entirely due to operational difficulties that some mid-sized and small banks have chosen not to redeem their Tier 2 capital bonds or failed to pay interest. For example, Qinghai Huzhu Rural Commercial Bank and Changchun Development Rural Commercial Bank. At this stage, both banks are currently in the process of merger and restructuring.” Song Ge said.

In March, some rural commercial banks temporarily did not redeem their Tier 2 perpetual bonds​

Looking back to late March, announcements from two rural commercial banks once led the industry to re-examine credit risk at certain mid-sized and small banks.

On March 25, Qinghai Huzhu Rural Commercial Bank announced that it decided not to exercise the redemption option for its “21 Qinghai Huzhu Rural Commercial Bank Tier 2 01” bond. The bond was issued in March 2021, with a total issuance amount of 0.6 billion yuan. For the portion not redeemed, the bond coupon rate will be adjusted to 5%. The contents of its credit rating report state that the bank has a certain level of competitiveness within the region, but due to the local industrial structure, the concentration of loans in the industry is high. Since 2024, some customers’ business operations have run into difficulties, putting pressure on the quality of its credit assets. It is understood that the city of Haidong in Qinghai Province, where the bank is located, is actively promoting the establishment of a municipal-level unified-legal-entity rural commercial bank, with plans to integrate five county-level legal-entity rural commercial banks within its jurisdiction, including Qinghai Huzhu Rural Commercial Bank.

Also on March 25, Changchun Development Rural Commercial Bank announced that it would defer payment of the current-period interest on its “21 Changchun Development Rural Commercial Bank Tier 2” bond, and at the same time announced that it would not exercise the redemption option for the bond. The bond size is 6 billion yuan, with a current-period coupon rate of 5.80%. The announcement stated that deferring coupon payments is “part of progressing the reform and risk resolution work in accordance with relevant arrangements.” Public information shows that Changchun Development Rural Commercial Bank has already been formally placed under the management of China Agricultural Bank, and the regulatory approval for the renaming of 57 of its affiliated institutions was also obtained in September 2025.

It is reported that in recent years, against the backdrop of intensified credit-tiering, the objective difficulty for tail-end mid-sized banks to “refinance capital” through market-based bond issuance exists.

For Tier 2 capital instruments, in the last five years before maturity, the amount that can be included in capital decreases by 20% each year. Therefore, banks generally prefer to redeem at the end of the fifth year and issue new instruments to maintain capital adequacy levels. As a result, market participants believe that if banks choose not to redeem Tier 2 capital bonds, it is mainly due to capital replenishment pressure, limited external financing channels, or operating pressure. Choosing not to redeem, deferring interest payments, or signals that risks at some tail-end banks may evolve from a “technical non-redemption” into a deeper stage.

However, “temporarily not redeeming” is not the end of the story. Previously, some banks after temporarily not redeeming later chose to exercise their redemption rights. Since the first case appeared in 2017, non-redemption cases were more concentrated in 2021 to 2022. Then, as regulators strengthened efforts to resolve risks, such cases decreased.

Mid-sized and small banks: reform and risk resolution in progress

Since 2026, reforms and risk resolution at mid-sized and small banks nationwide have continued to deepen. In addressing existing stock risks and strengthening capital strength, a “two-line parallel” approach has emerged. Through multiple measures—including market-based “capital replenishment,” injection of funds via special bonds, and mergers and absorption among institutions—the initiatives not only enhance banks’ own risk-absorption capacity, but also lay a stronger foundation for better serving the real economy and promoting high-quality development of the financial industry.

In terms of institution consolidation, cases of dissolution and absorption through mergers have been frequent. On April 7, the Shaanxi Bureau of the National Financial Regulatory Administration approved the dissolution of Shaanxi Taibai Changyin Rural and Township Bank, with all its business, assets, creditor and debtor rights and obligations to be assumed by Bank of Changan. On the same day, the Sichuan regulatory bureau approved the dissolution of Leshan Kunlun Rural and Township Bank, with its claims and debts to be taken over by Leshan Rural Commercial Bank. Analysts noted that this kind of “reclassification from village to branch” and institution mergers help consolidate regional financial resources and reduce potential risks arising from having too many institutions.

On the aspect of capital replenishment, local government special bonds continue to play an important role. On April 7, Gansu Financial Holding Group announced that, according to the implementation plan for special bond issuances, it had injected 24 billion yuan into Gansu Rural Commercial Bank. The bank was listed and began operation on March 20. Also in March, approvals for capital increases at mid-sized and small banks were granted in several places, such as on March 11 when the Jining regulatory sub-bureau approved Shandong Jiaxiang Rural Commercial Bank’s capital increase of approximately 18 million yuan; and on March 6 when it approved Shandong Yutai Rural Commercial Bank’s capital increase of more than 9 million yuan. Earlier, on February 10, Hubei Bank completed a private placement to raise 8B yuan, all of which was used to replenish core Tier 1 capital. Debt financing instruments remain an important channel. On March 9, Dongguan Rural Commercial Bank was approved to issue capital instruments of no more than 6 billion yuan; on February 13, Qingdao Bank was also approved to issue capital instruments of no more than 60M yuan.

At the same time, more diverse, market-based capital replenishment tools are being widely used. On March 7, Chengdu Bank announced that, because its convertible bonds triggered large-scale conversion, the bank’s registered capital increased from 7.61B yuan to 3.74B yuan, making it the first bank in 2026 to expand capital through convertible bond conversion.

The reporter noticed that convertible bond conversions can directly replenish core Tier 1 capital, which helps optimize the capital structure. Through the combined approach of the above “capital replenishment” and “integration,” while resolving existing stock risks, mid-sized banks are continuously strengthening their capital strength.

Introducing market-based mechanisms will be an important part

Overall, in recent years, the disposition of high-risk mid-sized financial institutions has been further deepening. The 2026 government work report states that in 2025, local mid-sized financial institutions’ risk disposition and transformation development were advanced as one integrated effort. The number of high-risk institutions declined significantly, and results in risk resolution were evident.

Dong Ximing, deputy director of the Shanghai Finance and Development Laboratory and chief economist at China Merchants United Finance, told the reporter from 21st Century Business Herald that reform and risk resolution for mid-sized financial institutions needs to further improve top-level design, while also adhering to local conditions and “one province, one policy.” Rural credit cooperative reform is one of the current key priorities. It is recommended that guidance be issued at the national level to strengthen overall coordination. Structural reorganization of township banks should also be planned systematically. In implementation, the dual goals of promoting development and preventing risks should both be considered, and the focus and sequence of reforms may differ across regions.

For example, in central and western regions and the northeast, risk resolution could be given higher priority, with the establishment of municipal- and provincial-level rural commercial banks advanced to a moderate extent. In eastern regions, the focus could be more on leveraging the “big platform, small legal entities” characteristics to enhance the competitiveness of legal-entity institutions. In addition, during mergers and restructurings, market-based mechanisms should be introduced, with appropriate arrangements made for equity structures, institution integration, and executive appointments, to avoid a simple “forcing mismatches of partners.”

Looking ahead within this year, some market voices believe that in China’s domestic bond market in 2026, about 1.4 trillion yuan of outstanding bank capital replenishment instruments will face exercise of rights or maturity, and risks related to tail-end, weak-credit local mid-sized financial institutions will still require attention. But overall, it is always the regulatory bottom line to ensure that no systemic risk occurs.

Song Ge told the reporter that in the short term, recent risk events such as non-redemption and deferred interest payments will cause investors to “pay more attention to the risk profile of certain banks,” and may also “demand a higher risk premium from some mid-sized banks.” In credit analysis, it is necessary to focus on financial indicators that reflect how banks have performed in past operations and risk control effects. At the same time, it is also necessary to emphasize regulatory indicators, such as asset quality measures—like the non-performing loan ratio, the proportion of watchlist loans, and the provision coverage ratio—and indicators for assessing capital strength, such as the capital adequacy ratio.

The above sources specifically pointed out that “the risk incident cases of some mid-sized banks in Qinghai and Jilin also remind us that in investment analysis, we should also pay attention to the impact of non-operational, event-driven factors such as mergers and restructurings.”

In his view, in the future, mid-sized banks should “more clearly define their business positioning of serving the local area, serving mid-sized and small enterprises, and serving the rural sector,” and “long-term adhere to advantage business areas,” gradually “moving away from traditional scale-driven and short-sighted behavior.” Mid-sized local banks will also need to systematically enhance their capabilities in multiple areas going forward, including business operations, product development, model innovation, and risk management, so as to achieve high-quality development and make a greater contribution to serving the local real economy.