Fitch Ratings says China's banking sector faces growing risks from small banks' aggressive issuance of wealth management products (WMPs) to attract and retain depositors. WMPs are akin to time deposits, but the interest rates can be set freely by banks. As competition for deposits has intensified, Chinese banks, particularly small non-state-owned entities, have been rapidly expanding their WMP offerings.

At end-Q212, WMPs stood at an estimated CNY10.4trn, or 11.5% of total deposits, largely unchanged from Q112. However, unlike the past, recent issuance has been driven by non-state banks, while state banks have been reining in activity.

"There was a dramatic shift in issuance patterns in Q212, with state banks' posting a CNY1trn contraction and small banks posting a nearly equivalent rise," said Charlene Chu, Head of Chinese banks' ratings at Fitch.

Small banks' weaker funding and liquidity relative to state-owned peers could make them more susceptible to WMP repayment issues.

"The fact that smaller, less resilient banks are now driving activity means that overall WMP risks are rising," said Chu.

According to Fitch, liquidity risk is the paramount concern for WMPs, but product credit risk also remains an issue.

"Regulators have cracked down on the amount of loans moving into products, but a myriad of credit-related assets disguised as non-credit still appear," Chu said.