The Magic of Disappearing Deposits: Decoding China's 2025 Banking "Great Reshuffle" and the Transfer of Bad Debt

TL;DR: In 2025, China's banking sector unleashed an unprecedented wave of consolidation. Under the "Village to Branch" policy, hundreds of small local banks are being swallowed by state-owned giants or provincial entities. This isn't just financial reform; it is a massive "balance sheet magic trick" designed to transfer private losses created by local elites onto the backs of all taxpayers. This article cuts through the fog to explain the political economy behind the Henan bank scandals and what this massive centralization means for the future of China's economy.

James here, CEO of Mercury Technology Solutions.

I once spoke at an online seminar about the importance of "Inclusive Finance." A Chinese economist in the audience got very agitated, angrily refuting me. He insisted that even if China's financial system is extractive, the national economy still takes off. He asked, "What right do you have to say growth requires inclusivity?"

However, looking at the events of the past few years—depositors having their health codes suddenly turn red to prevent them from traveling to withdraw money, deposits vanishing into thin air—I have to re-evaluate the underlying logic of this system.

There is a saying circulating on the internet that captures it best: "Under Chairman Mao, we had no deposits. Under Chairman Xi, our deposits are gone."

Behind this dark humor lies a massive financial upheaval that is reshaping China's next decade.

Act 1: The "Financial Alchemy" of Local Tycoons

Imagine you are a wealthy local power player. In the old days, you relied on land ownership and clan influence to dominate. How do you play the game in the modern era? You get into finance.

The Henan village bank scandal is the perfect case study. "Shadow bosses" like Lu Yi, who wasn't even a bank official on paper, controlled over a dozen village banks through complex shareholding structures. They used these banks, coupled with internet platforms like Baidu and Xiaomi Finance, to suck in deposits from ordinary people all over the country.

It was like opening a private vault using public licenses. They used the money to fund their own businesses or lend to their inner circle. If they made a profit, it was theirs. If they lost money, it was the bank's loss (and by extension, the depositors').

These local banks, originally mandated to serve small rural businesses (inclusive finance), morphed into the personal ATM machines of local elites—the modern version of the "local tyrant."

Act 2: The State Enters – "Big Fish Eats Small Fish"

When these private vaults exploded, deposits froze, and social unrest threatened to boil over, Beijing stepped in. This brings us to the headline event of 2025: The "Village to Branch" Policy.

Simply put, the policy mandates that Big Banks (Big Fish) must swallow the Small Banks (Small Fish).

In 2025 alone, over 366 banks in China have vanished. These were mostly fragile village and township banks. They didn't go bankrupt; they were "consolidated."

• Model 1: The State Takeover. For example, the Industrial and Commercial Bank of China (ICBC)—a massive state-owned giant—acquired Jinzhou Bank. The Jinzhou signage comes down, ICBC signage goes up. Your card still works, but your bank's boss is now the State.
• Model 2: Provincial Packaging. In provinces like Henan and Liaoning, dozens of rotten small banks were bundled together to form a single, provincial-level "Rural Commercial Bank." Think of it like taking a pile of rotten apples and a few good ones, mashing them together, and labeling it a jar of "Premium Jam."

Act 3: Where Did the Bad Debt Go? (The Balance Sheet Magic)

This is the most fascinating part. Why would a healthy big bank want to eat a toxic small bank? They wouldn't—unless the "poison" was removed first.

If you were buying a house with a leaking roof, you'd insist the seller fix the leak or deduct the repair cost before you signed.

The Chinese government uses two "magic tricks" to handle these bad debts (toxic assets):

1. Offloading to AMCs (Asset Management Companies): Imagine a specialized "Garbage Collection Company" (AMCs like Great Wall Asset Management). The bank bundles its uncollectible loans (the garbage) and sells them to the AMC. The bank's books are now clean, and ICBC is willing to take over.
   • The Catch: Where does the AMC get the money? It’s still state money, or borrowed money.
2. Issuing "Special Purpose Bonds": Local governments issue special bonds to borrow money from the market. They lend this money to the banks to "replenish capital." In reality, the bank takes this cash and uses it to fill the holes left by the bad debts.
   • The Catch: Who owes this debt? The local government owes it. Which means future taxpayers owe it.

Conclusion: The bad debt didn't disappear; it just moved. Private losses incurred by corrupt bankers have been transformed into public debt. This is called the "Socialization of Debt."

What Does This Mean for the Future?

1. Re-Centralization of Power: Beijing used the big state banks to seize the "money bags" back from local tycoons. Local power is weakened; central control over finance is absolute.
2. Bureaucratization of Credit: Big banks like ICBC are used to serving massive state enterprises. They do not understand rural farmers or small shop owners. In the future, it will be much harder for the "little guys" to get loans. It’s like the capillaries of the economy are being clogged.
3. The Invisible Tax: By using government bonds to plug private holes, the entire population is effectively paying a "Financial Stability Tax."

China has avoided a short-term collapse (depositors got their money back), but at the cost of a long-term burden. Local governments are now saddled with more debt, reducing their ability to provide public services. The banking system has become more rigid, potentially strangling the vitality of the grassroots economy.

Returning to that economist's question: Does this extractive financial manipulation actually favor long-term growth? Or are we simply overdrafting the future vitality of the economy to buy stability today?

For investors and observers, understanding the cost behind this magic trick is the only way to see the true picture.

Mercury Technology Solutions. Accelerate Digitality.