Abstract
Is there evidence that market forces effectively discipline risk management behaviour within Chinese financial institutions? This study analyses information from a comprehensive sample of Chinese banks over the 1998–2008 period. Market discipline is captured through the impact of four sets of factors namely, market concentration, interbank deposits, information disclosure, and ownership structure. We find some evidence of a market disciplining effect in that: (i) higher (lower) levels of market concentration lead banks to operate with a lower (higher) capital buffer; (ii) joint-equity banks that disclose more information to the public maintain larger capital ratios; (iii) full state ownership reduces the sensitivity of changes in a bank’s capital buffer to its level of risk;(iv) banks that release more transparent financial information hold more capital against their non-performing loans.
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Notes
The big four customarily refers to the Agriculture Bank of China (ABC), the China Construction Bank (CCB), the Bank of China (BOC), and the Industrial and Commercial Bank of China (ICBC).
Shrieves and Dahl (1992) use data from 1983–1987 on 1800 FDIC-insured independent and holding company affiliated commercial banks with assets in excess of $100 million. Arguing that changes in capital and changes in risk are simultaneously related, they employ three simultaneous equations for changes in capital, non-performing loans and asset risk, respectively, to estimate the relationship between changes in risk and changes in capital. Calomiris and Wilson (2004) focus on New York City banks in the 1920s and 1930s to estimate the effect of changes in capital on changes in asset risk. However, they find that results are similar between the 2SLS approach and an OLS fixed-effect approach, which both indicate a significant positive relationship between capital and asset risk. There is another branch of literature analyzing the relationship between capital and asset risk in the context of regulatory enforcement. Aggarwal and Jacques (1998) repeat the analysis of Shrieves and Dahl, using cross-sectional, US bank data for 1991, 1992, and 1993. They are particularly interested in the impact on bank behavior of the 1991 FDIC Act (FDICA) legislation and the prompt corrective action provisions it laid down. These provisions oblige supervisors to take specific actions when a bank’s capital ratios falls below certain trigger levels. They find that banks in the undercapitalized categories increase their capital target ratio more quickly than banks with higher initial capital. Using a three stage least squares (3SLS) framework, Jacques and Nigro (1997) analyze the relationship between bank capital, portfolio risk and the risk-based standards. Their results suggest that the median bank reduced its portfolio risk by 3.49 percentage points over the period 1990 to 1991 as a result of the enhanced regulatory pressure of risk-based standards.
The Chinese regulators are in the process of replacing implicit deposit insurance with an explicit scheme following the establishment of the “deposit insurance office” by the Financial Stability Bureau of PBOC (the People’s Bank of China, the central bank). Recent reported proposals indicate the China Banking Regulatory Commission may introduce a formal system like the US Federal Deposit Insurance Corporation (China Daily 2008).
The Chinese government played a central role in writing off bad loans or in paying off outstanding debts in the case of bank failures before 1999. One example is that of the Hainan Development Bank which went bankrupt in 1998, whereupon the central government assumed responsibility for repaying its outstanding debts.
Joint equity banks in China refer to domestically-owned commercial banks with a mixed ownership structure consisting of the state, state-owned enterprises, and private enterprises or public individuals. In the Chinese banking literature, joint equity and joint stock are equivalent concepts. Listed banks refer to banks which list their shares on either the Shanghai Stock Exchange or the Shenzhen Stock Exchange, and they are more like private banks. However, among the listed banks, only the Minshen Bank has no state ownership and has raised its equity capital exclusively from the equity markets.
In line with the regulations of the Chinese financial authorities (e.g. the Chinese Banking Act 1995), all commercial banks are required to maintain a capital ratio in accordance with the Basel criteria (Basel I and II). The sample period in this study employs capital ratios calculated according to both Basel I and II definitions.
The BOC, CCB, ABC, and ICBC were only allow to undertake business in foreign trade and exchange, construction, agriculture, and industrial and commercial lending, respectively.
However, competition among the big four was still very limited until the mid-1990s, because they served mainly as policy-lending “conduits” for the government and lacked tangible incentives to compete (Allen et al. 2005).
In 1999, 1.4 trillion RMB of non-performing loans of the big four were purchased at face value by four state-owned asset management companies.
See Berger et al. (2009) for further details.
Ferri (2009) conducts comparative performance analysis across state banks and a number of joint-equity and big city commercial banks in China. Denoting the latter “new tigers” he finds that they outperform state-owned banks, a fact attributed to better corporate governance.
We thank Phil Molyneux for motivating further discussion of this issue which is pervasive in analyses of the type undertaken in this paper.
The quantity of non-performing loans is taken from the global standard reports provided by Bankscope.
Note that whenever a bank provides information on three of these items, one can infer the fourth.
Detailed information on how we construct this index is provided in Appendix 2.
See Imam (2004) for a detailed discussion of the Chinese interbank market.
The literature customarily focuses on subordinated bank debt as the appropriate instrument to examine market discipline. However, as Chinese banks have not historically issued such debt it cannot be incorporated in this study.
Moreover, state ownership has also been criticized for creating inefficient banking systems reducing social welfare (Allen et al. 2005; Clarke et al. 2005). Bonin et al. (2005) investigate the impact of bank privatization in the east European countries and find that government (foreign) owned banks are the least (most) efficient. Fries and Taci (2005) examine 15 post-communist economies and conclude that privatized banks with a majority foreign (domestic) ownership are the most (least) efficient. Existing research on the impact of transition from a planned economy to a market economy indicates that foreign and private ownership both induce a more efficient banking system than state ownership.
The time-series information for these banks ranges from one to six years. Therefore, data in this study mainly reflects information from the state-owned, joint-equity, and listed group. Overall, our sample size compares favourably to that in other banking sector studies for emerging economies. For instance, Martinez and Schmukler (2001) include 83, 38 and 12 banks in their analysis of Argentina, Chile and Mexico, respectively. The Jia (2009) study of Chinese bank risk management practices includes only 14 banks.
Nier and Baumann (2006) among others encounter the same potential endogeneity issues. We wish to thank a referee for motivating the approach in this paragraph.
We note that China is not included in either the Nier and Baumann (2006) or Fonseca and Gonzalez (2009) studies.
Calculated as ((1.19 + 0.71)*1.69%) times one standard deviation in the capital ratio (0.061).
We thanks the comments of an anonymous referee in motivating this section of the paper.
Equal to (2.17*0.0006).
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Appendices
Appendix 1: Ownership structures, credit ratings and support ratings of main Chinese banks
Table A.1 Detailed information of main Chinese banks
No. of Bank | Bank Name | Ownership Structure | Credit Rating by major agencies | Supporting Rate |
1 | Agriculture Bank of China | State-owned | Yes | 2 |
2 | Bank of Beijing Co. | Joint-equity | Yes | 4 |
3 | Bank of China | State-owned | Yes | 2 |
4 | Bank of Communications | Joint-equity | Yes | 2 |
5 | Bank of Shanghai | Joint-equity | Yes | 4 |
6 | China Construction | State-owned | Yes | 2 |
7 | China Development Bank | State-owned | Yes | 1 |
8 | China Everbright Bank | Joint-equity | Yes | 3 |
9 | China Merchants Bank | Listed Bank | Yes | 3 |
10 | China Minshen Banking Corp. | Listed Bank | Yes | 4 |
11 | CITIC | Joint-equity | Yes | 3 |
12 | Guang Dong Development Bank | Joint-equity | Yes | 4 |
13 | Hua Xia Bank | Listed Bank | Yes | 4 |
14 | Industrial and Commercial Bank of China | State-owned | Yes | 2 |
15 | Industrial Bank | Joint-equity | Yes | 4 |
16 | Shanghai Pudong Development Bank | Listed Bank | Yes | 4 |
17 | Shenzhen Development Bank | Listed Bank | Yes | 4 |
Data source: the Bankscope database and the Almanac of Chinese Finance and Banking (1998–2009).
Appendix 2: The synthetic disclosure index based on FITCH IBCA BANKSCOPE information
To construct the market discipline variables, we develop a disclosure index using the BankScope database as our root source of information. This index evaluates bank-specific information on disclosure taken from their published accounts. To arrive at the disclosure index we focus upon a number of dimensions of accounting information which we maintain can be utilised as indicators of bank risk. 15 sub-indices are created which reflect whether the bank’s accounts as presented in BankScope provide any detail on each dimension. The sub-indices are then aggregated to form a composite disclosure index.
The composite index is defined as \( INFOR = \sum\limits_{i = 1}^{15} {{S_i}} \)
Where each sub-index, S i , can be related to one or more sources of risk (interest risk, credit risk, and liquidity risk). Rather than ordering the sub-indices with respect to the source of risk on which they inform, the definition and ordering of the sub-indices follows the presentation in the BankScope database.
The following table lists the sub-indices used to construct the composite disclosure score. For all sub-indices, we assign a 0 if there is no entry in any of the corresponding categories and a 1 otherwise, except for the capital sub-index. For the latter, we assign a 0 if there is no entry in any of these categories, a 1 if there is one entry only, a 2 if there are two entries and a 3 if there are three or four entries. Note that whenever a bank provides information on three of these items, one can infer the fourth. Providing three items if therefore viewed as informationally equivalent to providing four items. The maximum attainable score on the sum of the sub-indices is 17.
Table A.2 Sub-indices to construct the synthetic disclosure index
Sub-index | Categories | |
Assets | ||
Loans | S1: Loans by maturity | Short-term loan(<1 year), Medium-term loan(<3 years, Long-term loan (>3 year) |
S2: Loans by type | Trade bill and bill discounted, other loan | |
S3: Problem loans | Total impaired loans | |
Other Earning assets | S4:Investment | Investment, Trading securities, Entrusted loans and investment, and securities held under Repurchase agreement |
S5: Investment by maturity | Long-term investment, and short-term investment | |
S6: Deposits with other parties | Deposits with central bank, deposits with other banks | |
Liabilities | ||
Deposits | S7: Deposits by maturity | Demand deposit, short-term deposit (<1 year), time deposit |
S8: Deposits by type of customer | Bank deposits, municipal/government deposits | |
Other Funding | S9: Long-term funding | Long-term deposit, bond issued, other funding |
Memo Lines | ||
S10: Reserves | Loan loss reserve | |
S11: Capital | Total capital Ratio, Tier 1 ratio, Total capital, Tier 1 capital | |
S12: Contingent liabilities | Total contingent liabilities | |
S13: Letter of credit and guarantee | Collection for customers, letter of credit issued, and bank guarantee letter | |
Income Statement | ||
S14: Non-interest Income | Net Commission Income, Net fee income, Gain on exchange | |
S15: Loan Loss Provisions | Loan loss provisions | |
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Wu, Y., Bowe, M. Information Disclosure, Market Discipline and the Management of Bank Capital: Evidence from the Chinese Financial Sector. J Financ Serv Res 38, 159–186 (2010). https://doi.org/10.1007/s10693-010-0091-6
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DOI: https://doi.org/10.1007/s10693-010-0091-6