The takeover of Baoshang Bank Co. Ltd. by the Chinese government highlights the credit risks faced by regional banks in the country and could be followed by further small bank failures as authorities become more tolerant of such incidents, according to S&P Global Ratings.

Ryan Tsang, managing director and analytical manager of financial institutions ratings at S&P Global Ratings, said during a May 30 webcast that Chinese regional banks have been under greater pressure over the past few years as a result of stricter regulations, such as the tightening of nonperforming loan recognition rules and increased on-site examinations.

In addition, the rapid expansion of nontraditional lending by small banks deteriorated their asset quality, stemming from poor risk management and inadequate capital buffers, Tsang said.

"In a more challenging macroeconomic environment, we expect stronger banks to be more resilient…regional banks are more vulnerable to regional volatility [due to a concentration on specific areas or industries]," Tsang said.

The Baoshang Bank case marks the first government takeover of a lender in more than two decades since the shutdown of Hainan Development Bank in 1998. The Chinese government will take over management of Baoshang Bank, while China Construction Bank Corp. was ordered to handle the regional lender's financial operations.

Harry Hu, senior director of financial institutions ratings at S&P Global Ratings, expects the banking cleanup by Chinese authorities to continue but with less direct intervention from the government.

News about the Baoshang Bank takeover has led to investor concern over the increasing risk posed by small banks in China's banking system and further bank failures, as the economy slows and authorities tighten regulations.

Yi Gang, governor of the Chinese central bank, said May 30 at a conference in Beijing that the regulator is fully capable of managing small banks' risks and that it will continue to boost lending to small businesses.

Hu believes that Chinese regulators' tolerance for bank failures is now higher than they were before. "There could be more [of such cases] to come but we don't think it will be widespread," he said.