New disclosures from the National Audit Office (NAO) suggest that an increasing number of China’s small banks are struggling with toxic debts on their balance sheet.

The report focused on Henan province, where it found that 42 banks had crossed the red line of 5 percent non-performing loans in their lending portfolio; 12 banks had rates over 20 percent; and “a few” had non-performing loans in excess of 40 percent.

These banks are small, regional players, and taken in isolation their toxic debts do not represent a systemic risk. However, there’s still some important takeaways here:

First off, the NAO report highlights a dissonance between the official numbers and ground-level realities. According to China’s official statistics, the national rate of non-performing loans is a mere 1.89 percent. That’s a far cry from what we’re seeing in Henan.

The report also highlights how the frontline of toxic debt accumulation is the local level. In many ways this is by policy design, as the post-2009 stimulus credit binge was funneled through local financers rather than the central government. And when regulations were too restrictive or financing was unavailable, lending would be routed through atypical financing vehicles – the ‘shadow banking’ sector.

Now, years later, these debts are coming due amidst an economic downturn. Moreover, the money in question often went toward projects with dubious long-term economic merit – real estate investment, urban redevelopment, etc. – which has resulted in unpayable loans. Thus, the situation has come full circle and now it’s the central government that needs to step in and ensure the continued solvency of heavily indebted local entities, whether it be governments or small-scale private banks.