Skip to main content

Credit risk and macroeconomic stress tests in China

Journal of Banking Regulation volume 20, pages 211–225 (2019)Cite this article

Abstract

This paper examines the vulnerability of commercial banks in China to the changes in macroeconomic conditions by employing a macroeconomic stress test. We particularly focus on how the changes in housing market-related variables and the scale of shadow banking influence the credit risks of China’s entire banking system. Based on the result of a vector autoregression model, we proceed with a five-scenario analysis. Our main finding is the ability of shadow banking to absorb the credit risks of commercial banks rather than there being a spill-over effect, according to the data from Q1 2005 to Q2 2016. Moreover, the mortgage loan is risky to commercial banks during this period. In addition, our scenario analysis suggests that China’s banking system is relatively stable and that the Central Bank of China is capable of monitoring the credit risks of commercial banks using appropriate credit policies.

This is a preview of subscription content, access via your institution.

Access options

Buy single article

Instant access to the full article PDF.

USD 39.95

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Fig. 1

Source China Banking Regulatory Commission (Q1 2005–Q2 2016) and Author’s Model Forecast (Q3 2016–Q4 2018)

Fig. 2

Source China Banking Regulatory Commission (Q1 2005–Q2 2016) and Author’s Model Forecast (Q3 2016–Q4 2018)

Notes

  1. See “Property loans, the glass chin of China banks”. Available at http://www.reuters.com/article/us-china-banks-realestate-idUSKCN0YG05Z.

  2. The non-performing loan ratio is published by China Banking Regulatory Commission.

  3. We convert the monthly data into quarterly data.

  4. We assume the scale of shadow banking increases (decreases) under the scenario of expansionary (tightening) credit policy because of our above argument that the relationship between shadow banking and regular banking are complementary.

References

  1. Cao, L. 2015. Research on credit risk management issue of commercial banks in China. In Proceedings of 2014 1st international conference on industrial economics and industrial security, 545–550. Berlin: Springer.

  2. Li, Z., Liu, S., and Tian, M. 2011. Macro-stress testing of credit risk for Chinese Banking sector: Two comparative approaches. In 2011 8th international conference on service systems and service management (ICSSSM), 1–6. IEEE.

  3. Wei, S. 2016. Shadow banking in China: Risk, regulation and policy. Cheltenham: Edward Elgar Publishing.

    Google Scholar 

  4. Wen, S., J. Ma, Y. Pan, Y. Qi, and R. Xiong. 2017. The impact of business scale of “shadow banking” on credit risk of commercial banks-take ten domestic listed commercial banks as examples. International Journal of Economics and Finance 9(5): 94.

    Article  Google Scholar 

  5. Borio, C., M. Drehmann, and K. Tsatsaronis. 2014. Stress-testing macro stress testing: Does it live up to expectations? Journal of Financial Stability 1(12): 3–15.

    Article  Google Scholar 

  6. Marcelo, A., A. Rodríguez, and C. Trucharte. 2008. Stress tests and their contribution to financial stability. Journal of Banking Regulation 9(2): 65–81.

    Article  Google Scholar 

  7. Drehmann, M. 2005. A market-based macro stress test for the corporate credit exposures of UK banks. In BCBS seminar–banking and financial stability: Workshop on applied banking research.

  8. Wilson, T. 1997. Portfolio credit risk II. Risk 10(9): 111–117.

    Google Scholar 

  9. Wilson, T. 1997. Portfolio credit risk II. Risk 10(10): 56–61.

    Google Scholar 

  10. Virolainen, K. 2003. Macro stress testing with a macroeconomic credit risk model for Finland, Bank of Finland.

  11. Sorge, M., and K. Virolainen. 2006. A comparative analysis of macro stress-testing methodologies with application to Finland. Journal of Financial Stability 2(2): 113–151.

    Article  Google Scholar 

  12. Misina, M., Tessier, D., and Dey, S. 2006. Stress testing the corporate loans portfolio of the Canadian banking sector, Bank of Canada.

  13. Jiménez, G., and J. Mencia. 2009. Modelling the distribution of credit losses with observable and latent factors. Journal of Empirical Finance 16(2): 235–253.

    Article  Google Scholar 

  14. Xu, M., and X. Liu. 2008. Financial system stability assessment: Based on the comparison of macro stress testing method. Study of International Finance 2: 39–42.

    Google Scholar 

  15. Ren, Y., and X. Sun. 2007. The application of stress testing of credit risk. Statistic and Decision 7: 101–106.

    Google Scholar 

  16. Yuan, F. 2011. The credit risk macro stress testing of the Chinese banking system. In Control and Decision Conference (CCDC), 2011 Chinese, 1198–1203. IEEE.

  17. Li, J., and L.P. Liu. 2008. An assessment on the credit risk for China commercial bank system based on macro-stress testing. Modern Economic Science 6: 009.

    Google Scholar 

  18. Tang, T.T., and Z.B. Fang. 2011. Credit risk of commercial banks and macro economy—Research based on stress test. Modern Economic Science 4: 010.

    Google Scholar 

  19. Feng, J., and H.B. Zhu. 2009. An analysis of the results of stress test of commercial banks on mortgage loans. Journal of Wuyi University (Natural Science Edition) 4: 007.

    Google Scholar 

  20. Wang, H., and K. Wang. 2012. What is unique about Chinese real estate markets? Journal of Real Estate Research 34(3): 275–289.

    Google Scholar 

  21. Froyland, E., and K. Larsen. 2002. How vulnerable are financial institutions to macroeconomic changes? An analysis based on stress testing, Norges Bank. Economic Bulletin 73(3): 92.

    Google Scholar 

  22. Hoggarth, G., and J. Whitley. 2003. Assessing the strength of UK banks through macroeconomic stress tests. Financial Stability Review 14: 91–103.

    Google Scholar 

  23. Mawdsley, A., M. McGuire, and N. O’Donnell. 2004. The stress testing of Irish credit institutions. Financial Stability Report 2004: 103–109.

    Google Scholar 

  24. Bunn, P., A. Cunningham, and M. Drehmann. 2005. Stress testing as a tool for assessing systemic risks, Bank of England. Financial Stability Review 18: 116–126.

    Google Scholar 

  25. Boss, M. 2002. A macroeconomic credit risk model for stress testing the Austrian credit portfolio. Financial Stability Report 4: 64–82.

    Google Scholar 

  26. Lan, T. 2014. House price bubbles in China. Research in Applied Economics 6(1): 86–106.

    Article  Google Scholar 

  27. Lu, Y., H. Guo, E.H. Kao, and H.G. Fung. 2015. Shadow banking and firm financing in China. International Review of Economics & Finance 1(36): 40–53.

    Article  Google Scholar 

  28. Li, T. 2014. Shadow banking in China: Expanding scale, evolving structure. Journal of Financial Economic Policy 6(3): 198–211.

    Article  Google Scholar 

  29. Huang, X. 2015. A study on potential risks of shadow banking in China. In Proceedings of 2014 1st international conference on industrial economics and industrial security, 571–576. Berlin: Springer.

  30. Liang, Y. 2016. Shadow banking in China: Implications for financial stability and macroeconomic rebalancing. The Chinese Economy 49(3): 148–160.

    Article  Google Scholar 

  31. Luo, J. 2017. Shadow banking, interest rate marketization and bank risk-taking: An empirical study of the 40 commercial banks in China. Journal of Financial Risk Management 6(01): 27.

    Article  Google Scholar 

  32. Box, G.E., G.M. Jenkins, G.C. Reinsel, and G.M. Ljung. 2015. Time series analysis: Forecasting and control. New York: Wiley.

    Google Scholar 

  33. Xu, J.W., and S. Moon. 2011. Stochastic forecast of construction cost index using a co-integrated vector autoregression model. Journal of Management in Engineering 29(1): 10–18.

    Article  Google Scholar 

  34. Dickey, D.A., and W.A. Fuller. 1979. Distribution of the estimators for autoregressive time series with a unit root. Journal of the American Statistical Association 74(366a): 427–431.

    Article  Google Scholar 

  35. Dickey, D.A., and W.A. Fuller. 1981. Likelihood ratio statistics for autoregressive time series with a unit root. Econometrica: Journal of the Econometric Society 49: 1057–1072.

    Article  Google Scholar 

  36. Phillips, P.C., and P. Perron. 1988. Testing for a unit root in time series regression. Biometrika 75(2): 335–346.

    Article  Google Scholar 

  37. Nelson, C.R., and C.R. Plosser. 1982. Trends and random walks in macroeconmic time series: Some evidence and implications. Journal of Monetary Economics 10(2): 139–162.

    Article  Google Scholar 

  38. Kwiatkowski, D., P.C. Phillips, P. Schmidt, and Y. Shin. 1992. Testing the null hypothesis of stationarity against the alternative of a unit root: How sure are we that economic time series have a unit root? Journal of Econometrics 54(1–3): 159–178.

    Article  Google Scholar 

  39. Stock, J.H., and M.W. Watson. 2012. Introduction to econometrics, Global ed. Boston, MA: Pearson Education.

    Google Scholar 

  40. Lütkepohl, H. 2013. Introduction to multiple time series analysis. New York: Springer.

    Google Scholar 

  41. Kau, J.B., D.C. Keenan, and T. Kim. 1994. Default probabilities for mortgages. Journal of Urban Economics 35(3): 278–296.

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Department of Land Economy, University of Cambridge, 19 Silver Street, Cambridge, CB3 9EP, UK

    Philip Arestis & Maggie Mo Jia

Authors
  1. Philip Arestis
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Maggie Mo Jia
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Maggie Mo Jia.

Appendices

Appendix 1

See Table 4.

Table 4 Explanation of the variables used for the estimation.
Full size table

Appendix 2

See Tables 5, 6 and 7.

Table 5 Phillips-Perron test.
Full size table
Table 6 GLS-based Dickey–Fuller test.
Full size table
Table 7 Kwiatkowski–Phillips–Schmidt–Shin test.
Full size table

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Arestis, P., Jia, M.M. Credit risk and macroeconomic stress tests in China. J Bank Regul 20, 211–225 (2019). https://doi.org/10.1057/s41261-018-0084-1

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1057/s41261-018-0084-1

Keywords

  • Macroeconomic stress test
  • Vector autoregression
  • Banking system
  • Central bank
  • Shadow banking

JEL Classification

  • E58
  • G21