In Depth: China’s Inclusive Finance Success Leaves Banks Burdened

China’s inclusive finance initiative has seen remarkable growth, aiming to extend affordable financial services to individuals and small businesses typically underserved by traditional banks. Inclusive finance, as regulated by China’s central bank, targets loans under 10 million yuan ($1.4 million) for small companies, individual enterprises, or self-employed persons. These loans are generally offered at below-market rates — for instance, in May, the weighted average interest rate for such loans was 3.69%, compared to over 4% for comparable home loans at major banks[para. 1][para. 2][para. 3][para. 4].

The government’s commitment to inclusive finance began intensifying in 2017. Subsequently, outstanding inclusive loan balances surged more than fivefold by June 2024, reaching about 36 trillion yuan. This expansion was propelled by policy mandates requiring commercial banks to prioritize inclusive lending, particularly to micro and small enterprises (MSEs). Inclusion of these loans in official performance metrics—where they can account for over 10% of local branch assessments among major state-owned banks—has incentivized widespread participation. The dominant state lenders—the “Big Four” (ICBC, Agricultural Bank of China, CCB, and Bank of China)—use performance metrics heavily weighted towards inclusive lending, further fueling this sector’s rapid growth[para. 5][para. 6][para. 7][para. 8][para. 9][para. 10][para. 11][para. 12][para. 13].

From 2019 to 2023, the average annual growth rate of inclusive lending to MSEs was 25%, although this cooled to 14.6% in 2023. This reflects a persistent focus by banks, driven by official mandates and the government’s push for “common prosperity” and a real economy orientation, as outlined in national strategies since 2015 and highlighted by President Xi Jinping’s 2017 call for an inclusive financial system. However, for the major state banks, this effort is seen as a matter of political commitment and social responsibility rather than commercial profitability[para. 14][para. 15][para. 16][para. 17][para. 18].

Despite its achievements, the rapid rise of inclusive finance has also exposed banks to significant risk, particularly as China’s overall economic recovery falters. The sector has seen a substantial increase in non-performing loans (NPLs): at the end of June 2020, NPLs from inclusive MSE loans reached 400 billion yuan (2.99% of the total, nearly 1 percentage point above the average NPL rate). While the ratio dropped to 2.2% by April 2022, the outstanding NPL volume grew to around 450 billion yuan. The main drivers are economic slowdown, the volatility of MSEs, and the challenges in assessing their creditworthiness, as their financial data are often incomplete or unreliable. Collateral-backed inclusive loans, sometimes tied to the property market, have proven especially risky amid declining real estate values, prompting strategic defaults[para. 19][para. 20][para. 21][para. 22][para. 23][para. 24][para. 25][para. 26][para. 27][para. 28][para. 29][para. 30].

Operationally, the inclusive finance model’s scale has strained banks’ resources, as banks are compelled to conduct frequent due diligence on a large and dispersed client base, without significant increases in staff or organizational adjustments. Digital financing models leveraging big data are being developed to improve efficiency and accuracy, but these face challenges such as data fraud from illicit intermediaries. Nonetheless, the transition toward digitalization is viewed as the inevitable future of inclusive finance in China[para. 31][para. 32][para. 33][para. 34][para. 35][para. 36][para. 37][para. 38][para. 39].