A gap is opening among Shandong banks. The lenders with reasonable capital buffers and asset quality are better positioned to support SOEs. However, the province greatly relies on banks in Shandong's rural and economically weaker regions, and these institutions have less capacity to support faltering entities.

Shandong is going through an economic transformation. Local governments in the province encourage banks to lend to state-linked firms in emerging sectors, particularly high-end manufacturing. We believe this will widen the gap between the better capitalized banks in the upper-tier markets, and the banks with moderate capital buffer in Shandong's hinterland.

Shandong's Transition Both Uplifts And Leaves Entities Behind

Banks in the province will likely need to absorb rising bad debt from enterprises, including state-owned enterprises (SOEs) and local government financing vehicles (LGFVs), that have trailed in Shandong's transition. Problematically, they are concentrated in lower-tier markets, where the resources of local governments are thin. Banks are likely to take the hit in the event of a default.

Bank capacity to support Shandong's government-linked entities differs significantly between those in economically developed cities, such as Qingdao and Jinan, and those in less-developed parts of the province.

Rural banks and some city banks in less developed regions may speed up their lending to stimulate the local economy, which could lead to asset quality issues down the road. During economic downturns, their capital and asset quality could deteriorate significantly. They may need the support of local governments.

We look at the sector through a survey of select Shandong-based banks that represent the spectrum of lenders in the province. Specifically, we look at:

• Bank of Qingdao
• Qilu Bank
• Qingdao Rural Commercial Bank
• Weihai Bank
• Weifeng Bank

Shandong's Banking Sector At A Glance

Shandong's banking sector features a higher proportion of city and rural banks compared with the national average. These lenders are not as well capitalized as the national banks and are thus less able to absorb credit shocks.

Chart 1

The government has tried over the past five years to stabilize asset quality and to enhance the capitalization of Shandong lenders. These efforts include facilitating the disposal of nonperforming assets and establishing debt-resolution committees.

The government has also created a provincial financial commission and has issued special bonds to strengthen the capital positions of some banks.

Table 1

Shandong banks' asset-quality metrics improved after writing down some nonperforming loans (NPLs) and beefing up provisioning. The province's headline NPL ratio has improved while provision coverage fell to a rate in line with the national average. Additionally, the level of special-mention loans is falling and should align closely with the overall system.

Banks in Shandong that we covered have generally improved their risk recognition and increased transparency in disclosure. Furthermore, they are implementing stricter criteria in asset classification to ensure compliance with regulatory requirements.

Chart 2

Asset-Quality Disparities Are Linked To Banks' Business Profiles

Qingdao

Banks operating in Qingdao have maintained relatively stable asset quality after local authorities encouraged lenders to write off hefty volumes of bad loans. The city's strategic coastal location and diverse industrial base have also helped the lenders.

Chart 3

Rural banks typically have weaker asset quality due to limited market diversification and less-stringent risk management, making them more susceptible to economic downturns.

Qingdao Rural Commercial Bank's ratio of special-mention loans to total lending is substantially higher than the provincial average and the national average for rural banks. That said, Qingdao Rural Commercial Bank maintains a moderate capital profile with adequate provision coverage. It is unlikely to put a significant burden on the Qingdao government.

Chart 4

Outside Qingdao

Banks outside Qingdao, especially in less-developed cities, may impose an additional burden on local governments. These institutions often face a limited customer base, weaker capital and profitability, and heightened asset-quality challenges. This stems from concentration risk and a lack of business diversity.

Qiliu Bank has a stronger credit profile due to its operations in the larger city of Jinan, while Weihai Bank and Weifang Bank contend with weak capital and profitability, higher nonperforming assets and lower provision coverage.

Chart 5

Banks Are Using Perpetual Bonds To Restore Regulatory Capital

Shandong banks have been actively tapping the perpetual-bond market since 2020 to strengthen their capitalization. About two-thirds of the perpetual bonds will become callable in 2025 and 2026. We anticipate the banks will likely call the bonds and replace them with perpetual bonds or other additional Tier 1 instruments, to take advantage of low interest rates.

Chart 6

Our estimates indicate that our sample banks could boost risk-weighted assets growth by 20%-25% (or RMB65 billion–RMB100 billion) while maintaining a buffer of 50-100 basis points above minimum capital requirements.

Chart 7

Pressures remain for Shandong's lower-tier banks. The decline in China's property market, along with economic shifts in Shandong, have affected many enterprises. Shandong's banks will directly feel the effects, supporting corporate transformation while managing exposure to special mention and non-performing loans.

Related Research

• China LGFVs In Transition: Shandong's Race To Reform, May 7, 2025
• China's Upper-Tier Local Governments Are Not Immune From Debt Buildup At Lower-Tiers, Jan. 15, 2025)
• China's Local Governments: Capacity To Support SOEs Will Be Tighter For Longer, July 8, 2024