Performance, Risk and Competition in the Chinese Banking Industry

Performance, Risk and Competition in the Chinese Banking Industry

First Edition

Yong Tan

Table of Contents

Cover image

Title page

Copyright page

List of figures and tables

Figures

Tables

List of abbreviations

Acknowledgements

Preface

About the author

1: Introduction

Abstract

Introduction

2: The evolution, reform and development of the Chinese banking sector

Abstract

China’s banking reforms

Structure of the Chinese banking sector

Overview of the Chinese banking sector from 2003 to 2011

Summary and conclusion

3: Corporate governance in the banking sector

Abstract

Definition of corporate governance

Theories relevant to corporate governance

Corporate governance problems of banks

Bank corporate governance in practice

Conclusion

4: Risk management and performance in the Chinese banking sector

Abstract

Introduction

Theory of bank performance

Determinants of bank performance

Literature investigating bank performance in China

Methodology and data investigating the impact risk has on bank performance in China

Empirical results on the impact risk has on performance in the Chinese banking sector

Summary and conclusion

5: Competition in the Chinese banking sector

Abstract

Theory of bank competition

Methodology behind estimating bank competition

Literature review

Empirical results

Summary and conclusion

6: Further development in the Chinese banking sector

Abstract

Setting up a fair and equitable salary system

Internationalization

Growth of urbanization

Capital replenishment

Upgrading innovation capacity

Implementation of Basel III Capital Accord

Conclusion

7: Conclusion

Abstract

Introduction and summary of findings

Policy implications and further development of Chinese banking

References

Index

Copyright

Chandos Publishing

Elsevier Limited

The Boulevard

Langford Lane

Kidlington

Oxford OX5 1GB

UK

store.elsevier.com/Chandos-Publishing-/IMP_207/

Chandos Publishing is an imprint of Elsevier Limited

Tel: +44 (0) 1865 843000

Fax: +44 (0) 1865 843010

store.elsevier.com

First published in 2014

ISBN: 978-1-84334-765-1 (print)

ISBN: 978-1-78063-446-3 (online)

Library of Congress Control Number: 2014949851

© Y. Tan, 2014

British Library Cataloguing-in-Publication Data.

A catalogue record for this book is available from the British Library.

All rights reserved. No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording or otherwise) without the prior written permission of the publisher. This publication may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published without the prior consent of the publisher. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

The publisher makes no representation, express or implied, with regard to the accuracy of the information contained in this publication and cannot accept any legal responsibility or liability for any errors or omissions.

The material contained in this publication constitutes general guidelines only and does not represent to be advice on any particular matter. No reader or purchaser should act on the basis of material contained in this publication without first taking professional advice appropriate to their particular circumstances. All screenshots in this publication are the copyright of the website owner(s), unless indicated otherwise.

Project management by Neil Shuttlewood Associates, Gt Yarmouth, Norfolk, UK

Printed in the UK and USA

List of figures and tables

Figures

2.1 Total assets of Chinese banking sector over 2003–11 27

2.2 Market share of state-owned, joint stock, city, and foreign banks in total banking sector assets over 2003–11 28

2.3 Volume of non-performing loans in Chinese banking sector over 2003–11 29

2.4 Non-performing loan ratios in Chinese banking sector over 2003–09 31

4.1 The measurement of technical efficiency 70

4.2 The measurement of pure technical efficiency and scale efficiency 71

4.3 Profitability of Chinese banks over the period 2003–11 104

4.4 Conditions for risk in Chinese banking industry 2003–11 107

4.5 Technical efficiency scores of state-owned, joint stock, and city banks in China (2003–11) 121

4.6 Productivity growth of the three ownerships of Chinese banks over the period 2003–11 124

5.1 The structure–conduct–performance model 144

5.2 Competitive condition of Chinese banking sector over the period 2003–11 160

Tables

2.1 Progress in meeting capital adequacy 32

2.2 Pre-tax profit of commercial banks 33

4.1 Variables used to estimate the determinants of bank profitability and their expected effects 96

4.2 Variables used to examine the determinants of bank efficiency/productivity and their expected effects 98

4.3 Descriptive statistics for profitability measures (ROA, ROE, NIM, and PBT) by ownership type 100

4.4 Summary statistics: explanatory variables 102

4.5 Empirical results: the impact of risk on bank profitability in China: 2003–11 (LLPTL as the risk indicator) 110

4.6 Empirical results: the impact of risk on bank profitability in China: 2003–11 (Z-score as the risk indicator) 112

4.7 Empirical results: the impact of risk on bank profitability in China: 2003–11 (stability inefficiency as the risk indicator) 114

4.8 Summary statistics of inputs and outputs used to estimate efficiency scores 120

4.9 Mean values of technical efficiency, pure technical efficiency, and scale efficiency of all Chinese commercial banks: 2003–11 121

4.10 The Malmquist productivity index of Chinese state-owned, joint stock, and city commercial banks: 2003–11 124

4.11 The impact of risk on efficiency (loan loss provisions over total loans as the risk indicator) 126

4.12 The impact of risk on efficiency (Z-score as the risk indicator) 128

4.13 The impact of risk on efficiency (stability inefficiency as the risk indicator) 130

4.14 The impact of risk on productivity in Chinese banking sector 134

5.1 Discriminatory power of the H-statistic 147

5.2 Panzar–Rosse H-statistic over the period 2003–11 162

5.3 Empirical results (Lerner index as competition indicator) 166

5.4 Empirical results (Panzar–Rosse H-statistic as competition indicator) 170

5.5 Empirical results (three-bank concentration ratio as competition indicator) 172

List of abbreviations

ABC   Agricultural Bank of China

ADBC   Agriculture Development Bank of China

AMC   Asset Management Company

BIS   Bank for International Settlements

BCC   Banker–Charnes–Cooper

BOC   Bank Of China

BOCOM   Bank Of COMmunication

CAR   Capital Adequacy Ratio

CBRC   China Banking Regulatory Commission

CCB   China Construction Bank

CCBs   City Commercial Banks

CCR   Charnes, Cooper, and Rhodes

CDB   China Development Bank

CEIB   China Export–Import Bank

CRS   Constant Return to Scale

DEA   Data Envelopment Analysis

DMU   Decision Making Unit

EXIM   EXport–IMport Bank of China

GLS   Generalized Least Squares

GMM   General Method of Moments

ICBC   Industrial and Commercial Bank of China

IPO   Initial Public Offering

JSCB   Joint Stock Commercial Bank

LLPTL   Loan Loss Provision over Total Loans

NIM   Net Interest Margin

OLS   Ordinary Least Squares

PBC   People’s Bank of China

PBT   Profit Before Tax

PTE   Pure Technical Efficiency

ROA   Return On Assets

ROE   Return On Equity

SCP   Structure–Conduct–Performance

SE   Scale Efficiency

SFA   Stochastic Frontier Approach

SME   Small and Medium size Enterprise

SOCB   State-Owned Commercial Bank

SOE   State-Owned Enterprise

TFP   Total Factor Productivity

TSM   Trusted Services Manager

UCC   Urban Credit Cooperative

VRS   Variable Return to Scale

WTO   World Trade Organization

Acknowledgements

I would like first to express my gratitude to my PhD supervisor, Dr Christos Floros, who was responsible for turning my interest into enthusiasm not only for research in the Chinese banking industry but also for further work in academia.

I would also like to thank Professor Tim Coelli, who gave me permission to reproduce some of his work in my book.

Special thanks also go to Professor Chris Cowton, Dean of the Business School at the University of Huddersfield, and to Dr John Anchor, Head of the Department of Strategy, Marketing and Economics at the Business School. The friendly academic environment at the Business School significantly improved my work efficiency and further contributed to completion of the whole work.

I would also like to express my gratitude to Dr Glyn Jones, George Knott, and Harrier Clayton at Chandos, as well as the book’s project manager, Neil Shuttlewood, who provided strong support during my writing process.

Last but not least, I would like to express my deepest gratitude to my parents: Lianmin Tan and Jie Liu. Thank you ever so much for your consistent patience, guidance, help and encouragement during my eight years of study in the UK. Any achievement I have made would not have been possible without you. This book is not mine – it belongs to the two of you.

Preface

As the largest developing country in the world, economic development in China is attracting great attention across the globe. The banking sector, an important component of the financial system, plays a vital role in promoting the economic development of the whole country. In other words, a sustainable banking sector provides the basics for a well-developed economy. Several rounds of banking reforms in China have aimed to improve bank performance, increase competition and enhance the stability of the banking sector. The government and banking regulatory authorities are concerned about such issues as: How well are Chinese commercial banks performing? Have the conditions for competition in the Chinese banking sector improved? Has the Chinese banking sector become more stable?

The book comprehensively examines how the Chinese banking sector performed between 2003 and 2011. As a result of there being different ownerships of Chinese commercial banks, this book also evaluates the conditions for competition in the Chinese banking sector over the period in question. Not only are the conditions for competition examined on a year-by-year basis, but interbank competition in different bank ownerships is also investigated. Because of the 2007 financial crisis, the risk-taking behaviour of Chinese commercial banks (stability of the Chinese banking sector) has been closely scrutinised by government officials and banking regulatory authorities. The book focuses on this issue. Investigation of the impact risk has had on the performance of Chinese commercial banks coupled with the influence competition has had on the risk-taking behaviour of Chinese commercial banks (stability of Chinese banking sector) are special features of this book.

Chapter 1 mainly deals with the content covered by each chapter of the book.

Chapter 2 reviews the banking reforms brought about by the Chinese government. The structure of the Chinese banking sector is then presented. Finally, there is an overview of the Chinese banking sector over the period in question, in which the total assets, market shares, non-performing loans and non-performing loan ratios among state-owned commercial banks, joint stock commercial banks, city commercial banks and foreign banks are presented, compared, and discussed.

Chapter 3 discusses corporate governance in the banking sector. It starts by reviewing the different definitions of corporate governance. Theories relevant to corporate governance are then discussed, and the corporate governance problems facing banks are presented. Finally, bank corporate governance in practice is discussed.

Chapter 4 investigates the impact risk has on performance in the Chinese banking sector. The chapter begins by looking at the theory of bank performance. There then follows a review of the relevant literature on Chinese bank performance. The methodology used to measure bank risk and performance, as well as the method used to investigate the impact risk has on bank performance are then explained. The chapter finally presents and explains the results.

Chapter 5 examines the conditions for competition in the Chinese banking sector. Much like Chapter 4, the chapter begins by looking at the theory of bank competition. The methodology used to estimate bank competition is then discussed. This is followed by a review of the literature on competition in the Chinese banking sector. Findings on the conditions for competition in the Chinese banking sector and the impact competition has had on the risk-taking behaviour of Chinese commercial banks are finally presented and discussed.

Chapter 6 discusses further development in the Chinese banking sector and focusses on such issues as setting up an equitable and fair salary system, internationalization, the growth of urbanization, capital replenishment, maintaining and improving innovative capacity as well as implementing the Basel III Capital Accord.

Chapter 7 summarizes the book and proffers a number of useful conclusions.

Overall, Performance, Risk and Competition in the Chinese Banking Industry is the first book to examine the state of the Chinese banking sector so comprehensively. The book could be used as a banking course in universities. The Chinese government and China’s banking regulatory authorities could also find the book useful when assessing policy implications.

About the author

Yong Tan, PhD, is Lecturer in Economics at the Business School of the University of Huddersfield, UK, which won the Times Higher Education Award for the University of the Year 2013. Before joining the Business School, he was a part-time Lecturer in Economics at the University of Portsmouth Business School, UK. The author has experience of teaching various modules in various areas of economics and finance for both undergraduate and postgraduate students such as Economics for Business; Macroeconomics; Microeconomics; Econometric Methods; International Trade and Payments; Money, Banking and Finance; and International Economics.

The author is originally from China and has spent eight years studying and living in the UK. He finished his BA(Hons) in International Business English, MSc in Business Economics, Finance and Banking, and PhD in Economics at the University of Portsmouth. While studying for his PhD, he published a number of academic papers about the Chinese banking sector in a number of well-known international journals including Journal of International Financial Markets, Institutions and Money; Journal of Economic Studies; Journal of Emerging Market Finance; Journal of Developing Areas; Economic Issues; Studies in Economics and Finance; and Journal of Chinese Economics and Business Studies. Furthermore, he acts as a reviewer for various economics and finance journals on a regular basis and has presented research papers at international conferences.

1

Introduction

Abstract

The Chinese economy underwent significant growth between 2003 and 2011. As an important part of the economy, the banking sector plays an important role and its performance is being paid a great deal of attention by government officials, banking regulatory authorities, bank managers and academic researchers. The Chinese banking sector has undergone several rounds of banking reforms since 1978, the purpose of which was to increase competition and improve stability. This book investigates not only the performance, risk and competitive conditions in the Chinese banking sector, but also the relationship among them, and in so doing provide policy implications to the government. This chapter will provide background information on the Chinese banking sector and the structure of the whole book will be outlined as well.

Key words

introduction

structure of the book

Introduction

The financial system around the world has undergone significant changes over the last three decades. Banking output in terms of providing various financial services can be done using fewer inputs as a result of deregulation, globalization, financial innovation and technological progress. In other words, technical efficiency has significantly improved in the banking sector. However, the banking sector in developing countries, China especially, suffers from a higher level of government control which in turn leads to lower bank competition and inefficient allocation of resources. Furthermore, as argued by Garcia-Herrero et al. (2009), the Chinese banking sector remains undercapitalized, saddled with non-performing loans and profitability is below international standards. The Chinese government has implemented several rounds of banking reforms in order to create a more competitive environment and improve efficiency and stability in the banking sector.

The economic reform that has been ongoing in China since 1979 has the purpose of transforming the planned economy into a socialist market economy. As the most important component of the country’s economy, the banking sector in China has undergone a number of reforms including creating a two-tier banking system, establishing three policy banks to separate state-owned commercial banks (SOCBs) from policy lending, encouraging banks to be listed on stock exchanges to obtain external monitoring, and relaxing the requirements for foreign banks to enter Chinese markets. The objectives of these measures taken by the Chinese government are to improve the performance of Chinese banks in terms of profitability, efficiency and productivity, and at the same time create a more competitive environment and strengthen stability in the banking sector. Assessing profitability, efficiency, competition and their determinants has policy implications for the government and banking regulatory authority regarding further reforms that need to be initiated.

Corporate governance is an important area that is widely discussed in both non-financial firms and banking sectors. Chapter 3 provides a discussion of bank corporate governance by first defining corporate governance and then overviewing the theories relevant to corporate governance. Three important theories are discussed: agency theory, stakeholder theory and stewardship theory. The chapter also discusses the corporate governance problems that banks have to face by explaining corporate governance structure, government safety nets, opaqueness and market competition. The chapter then turns to the topic of bank corporate governance in practice by discussing ownership structure and governance, and the topic of internal governance.

Chapter 4 examines the relationship between bank risk and bank performance in the Chinese banking sector over the period 2003–11. The risk facing Chinese commercial banks is measured by the ratio between loan loss provisions and total loans. To check the robustness of the results, two alternative risk indicators are used: the Z-score¹ and stability inefficiency. This is believed to be the first study to use these two risk indicators of bank performance in China. The ratio of loan loss provisions to total loans and the Z-score provide the risk conditions of Chinese state-owned, joint-stock and city commercial banks, while the estimation of stability inefficiency provides the risk conditions of the whole Chinese banking sector over the examined period. In terms of bank performance, three different performance indicators are used: bank profitability, bank efficiency and bank productivity. The four profitability indicators used are return on assets (ROA), return on equity (ROE), net interest margin (NIM) and profit margin (PBT or profit before tax). As far as the estimation of bank efficiency is concerned, the non-parametric data envelopment analysis (DEA) CCR and BCC models are used to derive technical efficiency, pure technical efficiency and scale efficiency, while output-oriented DEA is used to measure bank productivity. Besides the impact risk has on bank performance, this chapter also controls