Finance

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

There is some good news for Chinese bank investors if first-quarter earnings are anything to go by: Soured debt is falling.

Score Card
Nonperforming loans at China's biggest banks have been falling since the end of last year
Source: Jefferies
Note: Postal Savings Bank of China's nonperforming loan ratio for 2016 is for the full year. The big four banks are ICBC, China Construction Bank, Agricultural Bank of China and Bank of China.

But bad news is never far from the surface for lenders in Asia's largest economy, and this time it's taking the form of potential share sales.

The nation's largest banks, flush with deposits, are doing well, thanks to a stronger economy and cost cutting. But their fortunes are diverging from smaller rivals like China Minsheng Banking Corp. and Bank of Communications Co.

Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Bank of China Ltd. and Agricultural Bank of China Ltd., along with mid-sized China Merchants Bank Co., all posted bigger increases in earnings in the three months ended March 31, and healthier net interest margins.

Deposits were also up. The big four, plus China Merchants, reported growth that averaged 5.3 percent in the period. That wasn't the case for smaller financial institutions, whose deposit base expanded just 0.7 percent.

For that, blame Beijing and its crackdown on liquidity and wealth management products. Lacking the large branch networks of competitors, China Minsheng, Bank of Communications, China Citic Bank Corp. and China Everbright Bank Co. are battling declining net interest margins.

Those margins slumped an average 20 basis points from the December quarter, compared with a 4-basis-point gain at larger lenders. China Minsheng and China Merchants were especially hit, recording a 28 basis point and 23 basis point quarter-on-quarter drop, respectively.

Money in the Door
Bank of China had one of the highest deposit growth rates in the first quarter versus the last three months of 2016
Source: Bernstein

That should concern investors. In the absence of hundreds of branches to attract savings, smaller lenders are going to find authorities' efforts to tighten liquidity particularly painful. And with prospects of deposit growth limited, that could mean they're going to have to sell shares to raise funds.

When it comes to China's banks, thinking big may be an investors' best bet.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net