Chinese Banking Reform

China, one of the fastest-growing countries in transition, is leaping from its socialist past to its current market-oriented environment, making an economic miracle in history with an average annual growth rate of about 9% over nearly four decades (1978–2016). In 2010, China overtook Japan and became the second largest economy in the world. However, much of this near double-digit-type growth experience in China was achieved without a modern financial sector in place. Banking reform was regarded as a failure when mounting non-performing loans (NPLs) came to surface in 1999, and starting only in 2005, the largest Chinese banks entered the capital markets shattering the previous market capitalization records for financial intermediaries in the initial offering markets. While China’s economy surpassed the European Union’s economic bloc in 2011, its banking system overtook the Eurozone and became the world’s largest banking sector in terms of total assets five years later in 2016. As of the end of 2016, China’s banking assets reached $33 trillion, which is higher than that of $31 trillion for the Eurozone, more than double that of $16 trillion for the United States, and more than four times that of $7 trillion for Japan (www.​ft.​com).

This chapter provides a systematic review of the evolution of the Chinese banking sector in Sect. 2.1, beginning from its establishment in 1949 through to early institutional reforms in the 1980s, commercialization reforms in the mid-1990s, modernization reforms in the early twenty-first century, and modern banking development in the post-crisis era from 2011 onwards. Section 2.2 discusses the theoretical underpinnings that motivate and guide the banking reform in China. Finally, Sect. 2.3 analyzes the banking sector’s overall performance in terms of capital adequacy, asset quality, profitability, and liquidity for the period 1995–2015 based on a conventional financial ratio analysis using key macro-prudential indicators proposed by the International Monetary Fund (IMF).

One main objective of banking reform in China is to improve bank performance so that the banking sector could allocate capital more efficiently. While three decades of reform give rise to a number of important research questions, this chapter addresses the following three issues: Has the banking reform been motivated by the agency theory and the budget constraint theory? Has the banking sector become more efficient? What impact has the privatization strategy had on bank efficiency? This chapter starts with an introduction of the efficiency concept and a brief literature review on bank efficiency in Sect. 3.1. After outlining research methodology in Sect. 3.2, this chapter empirically tests for whether banking reform strategies have been motivated by the agency theory and/or the budgetary constraint theory in Sect. 3.3. The privatization of state banks has been the focus of banking reform to alleviate the agency problem and to harden budget constraints aiming at improving bank efficiency. Partial privatization has led to significant changes in banking, and this chapter examines how concrete privatization strategies affect bank cost and profit efficiency in the short run and in the long run in Sect. 3.4. Section 3.5 concludes.

Banks are the cornerstone of the financial system, especially in developing countries where capital markets are underdeveloped. The global financial crisis in 2007–2008 caused great turmoil in the banking sectors of the developed world with the clustered collapses of international financial giants in the advanced economies. However, there have been fewer bank failures in transitional and emerging economies and it is important to understand the role of the banking sector in developing countries and transitional and emerging economies. This chapter takes a comparative approach and puts Chinese banking into the context of the emerging economies. The importance of the banking systems in Brazil, Russia, India, China, and South Africa (hereinafter the BRIC refers to Brazil Russia, India, and China and the BRICS includes South Africa) has been rising in the global banking marketplace, noticeably witnessed by the launch of the New Development Bank in 2015. Moreover, BRICS’ banking sectors have withstood the storm wave of the 2008–2009 global financial crisis without major bank failures. This chapter, in particular, examines the impact of bank risk-taking and market concentration on bank performance from the perspective of emerging economies. The rest of this chapter unfolds as follows. Section 4.1 reviews related literature on developing countries and transitional and emerging economies. Section 4.2 introduces the economies and the evolutionary background of the banking systems in BRICS. Section 4.3 outlines the research methodology—the output distance function approach—and describes data. Section 4.4 discusses empirical results, and Sect. 4.5 concludes.

Competition is important in any industry, with impacts on a wide range of issues such as productivity, innovation, and consumer welfare. In banking, competition is even more important because of its externalities beyond the banking industry. Anti-competitive behaviour of banks may have far-reaching influences on social welfare and well-being of the economy with implications for not only banking and financial services sector regulation and supervision but also financial stability and macroeconomic policy. The market-oriented banking reform in China started from deregulation in order to increase competition in the sector. After more than two decades of reform, the banking sector has undergone significant changes and it is of great interest to understand whether the sector has become more competitive. This chapter addresses this issue by assessing the degree of banking competition and its evolution over the period 1995–2015 using multiple competition measures.

Over the last few decades, the financial system has gone through enormous transformation due to a number of driving forces, such as globalization, financial liberalization, financial innovation, and technological advancement. Development in information and communication technologies has blurred the boundaries of different segments of the financial system. Both banks and non-bank institutions/intermediaries take advantage of arbitrage opportunities in information, regulation, price and taxation systems and engage in off-balance sheet activities for profit. Financial institutions have become more closely interconnected in a global network through financial derivatives and highly leveraged products. The disastrous global financial crisis in 2008–2009 showed the contagion effect among the financial systems in major developed economies, for which shadow banking activities have been considered by many scholars and authorities as one of the important causes for the crisis. Subsequently, the shadow banking system has become the centre of the governments’ emergency policy in response to the crisis.

In the past decade, the financial services industry has changed significantly, especially after the 2008 global financial crisis. The emergence of FinTech has been enabled by a “perfect storm” of rising customer expectations for services, increased access to VC funding, reduced barriers to entry, and accelerated technological advancements (World FinTech Report, Capgemini Consulting Technology Outsourcing, 2017). The dramatic rise of FinTech opens up a revolutionary means of financing and global FinTech investment continues to grow; it reached $15 billion by mid-August 2016 (The Fintech Ecosystem Report, Business Insider’s premium research service, 2016). More than 80% of global financial services companies consider their business at risk and plan to increase FinTech partnerships with tech companies to avoid losing revenue to innovators (Redrawing the lines: FinTech’s growing influence on Financial Services, Global FinTech Report, 2017). As mainstream financial institutions adopt new business models and emerging technologies, FinTech and the financial industry become more integrated. The influence of FinTech on the markets is growing with significant long-term potential.

In most countries, pawnbroking is an intermediate financial instrument to help private households or individuals meet their short-term and urgent consumption needs. In China, due to market imperfection and institutional discrimination against the small and medium-sized enterprises (SMEs) by commercial banks and other formal financial institutions, pawnbroking has been used as a supplementary financing source for SMEs and private entrepreneurs when they cannot get access to bank credits or other financial sources such as usury (underground money shops). This chapter uses first-hand survey data in 2009 in Zhejiang Province, China’s pioneering region for pawn business, and secondary data for the whole country during 2004–2012, to analyze the special characteristics of the pawnbroking industry and explain why it has become a viable and useful financing instrument in China. It also explains the puzzle of a serious setback and widespread losses in the industry during the global financial crisis in 2008. A corporate financing model of SMEs is developed to explain the substitution relationship between formal bank credits and pawnbroking. It suggests that the stimulus plan implemented by the central government of China during the global financial crisis reduced the borrowing cost and lowered the access barrier of bank credits to SMEs, leading to a temporary setback of an otherwise rapidly growing pawnbroking business in 2008 and 2009. However, as quantitative easing is gradually phased out after the global financial crisis, pawnbroking activities recover rapidly, implying that the industry will continue to play an important role in China’s economic development given its current financial system which is still unfriendly to the SME sector.

This book presents a series of our studies on various aspects of the Chinese banking industry over the last 15 years. It starts from the economic and banking sector reform, which matches China’s long-term ambition to build a modern financial services industry. When we initially started our research on the Chinese banking industry, we encountered two important international events. The first was China’s accession to the World Trade Organization (WTO) in 2001, forcing the authorities to gradually open up for international competition and inward foreign direct investment into the otherwise tightly controlled domestic financial market; and the second was the world financial crisis triggered by the US subprime crisis in 2007.