The abnormal reaction of banks’ share price by changed in deposit reserve requirement during the global financial crisis : the case of China

The abnormal reaction of

banks’ share price by

changed in deposit reserve

requirement during the

global financial crisis- the

case of China

Liang Kuixu

10604243

University of Amsterdam Business Economics: Finance Supervisor: Enrico Perotti

Table of Contents

5.2 Results Based On All Events Across Each Banks ... 17

5.3 Results of Increasing Deposit Reserve Requirement ... 20

5.4 Results of Abnormal Return with Different Ownership ... 25

6. Conclusion ... 29

Reference ... 30

1. Introduction

As we known, the financial stability has strong connection to the stock market performance. Since the increasing technology lead to the world became more globalization, no matter the US sub prime mortgage crisis or the European sovereign debt crisis; they both seriously affect the global investors’ confidence on their investment decisions. Therefore, in order to help the world economy out of recession, different countries performed vary kind of policies and try to pursue monetary or financial stability aim. Deposit reserve requirement is one of important instruments that will let the central bank to regulate the banks behavior. For most of monetary authorities in emerging economies, especially in Asian and Latin America, they prefer choose the reserve requirements as their primary instrument to keep the stability of financial markets (Montoro and Moreno, 2011).

According to the historical data, as one of the largest emerging market in the world, China still keep at a relatively high GDP growth rate during the financial crisis. Since 2008, the China Central Bank (PRC) modified the deposit reserve requirements more frequency and intensively than any other periods before in order to implement the monetary policy to combat the global financial crisis and stimulate the financial market development (Ma, Yan and Liu, 2011). The study from Yao and Wang (2011) illustrated that even adjusting reserve requirements can help to strengthen bank cash liquidity, but it can also lead to the reducing on the banks’ credit scale in the short term. Besides, changing reserve requirements at high frequent basis will also enlarge the cost of financial institution management. Therefore, theoretically speaking, there are two expected potential outcomes that can be caused by the changing on deposit reserve requirements. The first outcome is we can expected that the banks’ share price will go down due to the higher reserve requirements lead to less money in the market to invest, which will cause downward trend forecast on share price. Alternatively, we can also expect that the banks’ share price will increase since the tighter bank regulation will upgrade banks’ stability which can increase investors’ confidence and finally stimulate the share price increasing. Therefore, to find out the answer for which kind of influence has larger effect, downward pressure or upward pressure? We formulated the research question for this paper as: How did the banks’ share prices react to the announcement of

changing deposit reserve requirements in China during the global financial crisis? We believed China Central Bank’s action of changing deposit reserve requirements at high frequency basis during the financial crisis provide a good sample to test the connection between deposit reserve requirements and banks’ share reaction. Furthermore, since most of the announcements posed an increasing trend of reserve requirements. Therefore, I will also try to get a conclusion of how the increasing deposit reserve requirements affect banks’ share price. In addition, since the ownership of Bank is quite important for Chinese Banking industry, I will further try to test whether the level of effects caused by change reserve requirements is different due to the banks’ ownership difference. Through the results of this paper, I hope can make contribution on provide the investors valuable information for their investment decisions when they face reserve requirements changes intensively. This study also will help the banks realized their potential risk when reserve requirements changing announcement established, and then perform correspond strategy to attract investors. In addition, it also provide the policy implication which can be applied to other emerging countries who also decide choose use the deposit reserve requirements serve as instrument of changing monetary policy.

In this research, I formulated four hypotheses for this research in this paper:

H1: The announcements of changing deposit reserve requirements do not have significant

effect across all Chinese banks’ share price during the financial crisis.

H2: The announcements of changing deposit reserve requirements do not have significant

effect across each Chinese bank’s share price during the financial crisis.

H3: The announcements of increasing deposit reserve requirements generated positive

abnormal return on the banks’ share price in China during the financial crisis.

H4: The Nationalized banks in China will be affected more than other ownership bank by

announcement of changing deposit reserve requirement.

To solve first three hypotheses, I conducted the event study to analyze how the deposit reserve requirements announcements affected the banks’ share price. By doing this, I

conducted the deposit reserve requirements as an instrument to combat the financial crisis at a high frequency basis. Moreover, I have chosen all 14 Chinese Banks’ that have public traded in Shanghai Stock Exchange (SSE) as my research sample. Besides, I also classified the Chinese Banks into two categories by their ownership type in order to test my last hypotheses, which are “Nationalized Bank” group and “Non-Nationalized Bank” group. In order to tell the abnormal return level under different type of ownership bank, I will use the OLS analysis to test whether there is a potential relationship between the cumulative abnormal return and banks’ deposit and asset amount. Furthermore, considered that we need generate the abnormal return of the banks’ share price due to the changing on the reserve requirements, we introduced Index of Shanghai Stock Exchange as the benchmark in our empirical analysis.

The outline for rest of this paper is as follow, section 2 will introduce the literature review which included some related studies in this area. After that, the section 3 provides a data description consist the data we have used in this research. Section 4 will introduce the methodology we have performed in this paper. Furthermore, the section 5 will present the results for our paper. At last, we are going to draw a conclusion in section 6.

2. Literature Review

The effect of reserve requirements has always been one of interesting subject analyzed by the financial economists. Even there are a lot of literatures related to the reserve requirements and financial markets, but there is rarely literature directly link to the two concepts, especially connected to the banking sector in the stock market.

Kolari, Mahajan and Saunders (1987) use the single-factor market model testified that the change on the reserve requirements do have significant effect on bank stock value by using the sample of a developed country-United State. Unlike other papers, this study choose the banks’ share price as measure for banks’ expected profitability instead of using accounting measurement, which is more accurate for estimate the banks’ long-run performance. However, this paper more focuses on how the share price reaction level difference between the temporary changing and permanent changing on reserve requirements. Instead of this, my paper will include all the events of changing reserve

requirements, irrespectively whether is permanent change or temporary change, which will help me to get a more accurate results for how the reserve requirements announcements affect the banks’ share price at a short-term period.

The study from Osborne and Zaher (1992) also get similar results by using event study which contained 7 events, they found that after one day following the announcement of changes in reserve requirements, there is significant abnormal return for the bank stock price. More important, the abnormal return trend is opposite to the direction of changing reserve requirements for the affected banks. Nevertheless, since their study paid more attention proved that the reserve requirements are serving as a tax on deposit, and further leads to this paper focus more on determined which parties will bear more on tax. The recent study from Binica and Koksal (2011) proved this result as well by using the Turkey as an example; they pointed out that the stock return decreased because the shareholders took most of burden on negative effect caused by reserve requirements announcements. Moreover, Carvalho and Azevedo (2008) compared the relationship between changes in reserve requirements and stock price through separate the economy into financial sector and non-financial sector by testing 16 events over 25 years in Brazil. According to their research, they found Brazilian bank stock returns were significantly affected by changes in reserve requirements in both sectors. All these three articles only use small amount of events to test the reaction of banks’ share price to announcements of reserve requirements, which lead the finds are less contribution to the short-term investors who invested during the period of the reserve requirements changing at high frequency basis, especially in the financial crisis period.

Besides, study from KS. Bartunek and J,Madura (1996) solely focus on the effect of lowering reserve requirement on value of depository institutions by use the multivariate regression to test two event of decreasing reserve requirements in US. They concluded that the decreasing reserve requirements can enhance the value of depository institution and help to strength their balance sheet, which will benefit the financial market healthy. In addition, the reduction in reserve requirement also generates benefits for banks because it indicates the signal of lower future interest rates.

On the other hand, since the capital requirements and reserve requirements served similar effect on contribute financial market stability. Research from K. Cooper, J. Kolari and J.Wagster (1991) used two-index regression model to test the relationship between capital requirements changing and banks’ stock market return by use developed countries as investigation target include US, Canadian and UK. They pointed out that these banks’ in those countries exhibiting the large negative reaction on their market return.

In addition, the study of Abdullah Yavas (2013) through an empirical analysis on the modified version of Taylor Rule, found out that limit the credit growth by using policy like reserve requirements instead of targeting asset price is much efficient to reach the financial stability. Also, Tovar Mora (2012) used event analysis and dynamic panel vector auto regression to emphasize that the reserve requirements can indeed have positive effect on the banking sector when the liquidity is scarce. Moreover, it will help the banking system to strengthen their funding structure and decreasing banks’ exposure.

Besides the articles relate to reserve requirements directly, there are also some studies that connected to the reserve requirements with some important bank performance indicators. For example, Ma, Yan and Liu (2011) have paid special attention on the reserve requirements adjusting which happened in China. They found that adjusted for reserve requirements reveals China Central Banks’ monetary policy changing and normally leads the loan growing. It further caused higher and more volatile market interest rates. This phenomenon caused the deterioration of profitability of banking industry. On the contrary, even the study by Glocker and Towbin (2012) also found the lower bank profit through the positive relationship between reserve requirements and financial stability. But by using the small-economy model with investment and financial accelerator mechanism in banking sector, they confirmed the reserve requirements can be served as an efficient instrument for price and financial stability. It proved the banking industry would be benefited from the adjustment of reserve requirements.

To sum up, different economists do have different opinion on define the connection of reserve requirements with stock return and financial stability. Moreover, most of existing literatures tested the direct effect of reserve requirements on banks’ share price by using few reserve requirements announcements. This paper is unique because I attempt to

analysis the impacts of banks’ share price through changing reserve requirements through large quantity of events within relatively short period in the large emerging country. By conducted the event study, this paper provide the results for direct reactions of banking sector caused by intensively changing the reserve requirements policy. It will also provide valuable information for shareholders of banks when they facing the macro economy circumstance with high frequency changing of the monetary policy in emerging country.

3. Methodology

As I mentioned before in the introduction part, I will conduct the event study methodology to test whether the announcements of changing deposit reserve requirements in China will have a significant influence on the Chinese bank share price in Shanghai Stock Exchange during the period of recent financial crisis in 2008-2012.

In our case, due to we put special attention on the short-term abnormal return. Therefore, we have chosen the market-adjusted return model which is suggested by J. Brown and B. Warner (1985) as our main empirical model, which has been formulated as follow:

①  : The return of an individual stock at time t  : The return of market at time t.

 : error term

Unlike market model and factor model which can also be used for event study, the market-adjusted return model can help to eliminate the chance of bias results because we do not need to estimate other variables. In another word, this model does not require parameters estimation and is thus preferable when there is only a short time-series of pre-event data available. Consider the deposit reserve requirements in China during the research period are adjusting at high frequency basis; the market-adjusted return model will be the best choice to estimate the stock return for each bank in our case.

Besides the model we have chosen, as a stock exchange located in the biggest emerging country in the world, in order to make our research consistency, we need a key assumption as follow:

The Chinese Stock market (Shanghai Stock Exchange) is an efficient market. The key assumption indicates that the Chinese stock market will react to the news that relate to itself within a very short period after the announcements have been released to public. Considered that the Chinese market have grown prosperous rapidly in last two decades, the Shanghai have also became one of the most important financial central in the world, the assumption above can be a quite reasonable for our research.

To estimate the banking industry abnormal return performance in the Chinese stock market. We first obtained the historical share price data of all 14 banks listed in Shanghai Stock Exchange during the period of 2008-2012. To understand each bank’s share price movement during the financial crisis, I also have downloaded the historical data of Shanghai Stock Exchange Index in order to have general picture of Chinese stock market reaction during the same period.

Before the determination of time interval for event window and estimation window in our analysis, we have made a time line of event study below to present how we choose these two important factors. From this graph, it clear indicated that the estimation window=T1

-T0 and the event window=T2-T1.

Besides the stock data we have collected, we need the most important factor to fulfill the requirements of event study. According to the announcements information collect from the website of Chinese Central Bank (PRC)1, I have constructed the event list in

1

Appendix 1 which included the date that central bank announced their strategy of changing reserve requirements specifically.

Based on the event list we presented, there is a circumstance that two announcements released within 15 days. It denotes that if we choose the event window with large interval, the results might be biased because the stock price could be influenced by more than one event. Therefore, to ensure get an unbiased results, I will run multiple tests by using different length of event window, but the longest time length will be constrained at 15 days, which are 13 days pre-event and 1 day post-event. Moreover, in order to tell the how the different post-event time length’s reaction on the abnormal return, I will also run another test which include the event window of (-2 days, +2 days) in our data analysis process. Through the test by using different event window, we can detect whether the length of the event window influence the abnormal return of the banks’ share price. On the other hand, besides using share price movement under the influences of different event window length, we also need to estimate the share price movement under the situation of without reserve requirements announced as benchmark. It can be considered as share price estimation under normal circumstance. Therefore, in order to get an unbiased result, I set (-60 days,-30 days) as the estimation window. The time interval difference between the estimation window and event window will help us to predict a stock return without influence of changing deposit reserve requirements.

After we obtained the estimation return under the normal circumstance and influenced return under each event, we can generated each stock’s abnormal return by simply calculated the difference between these two results. So, the following two formulas present how we get cumulative abnormal return across time for each bank and across the entire banking industry in Chinese stock market.

̂ ( ) ∑ ̂ ②

The formula ② represent the cumulative abnormal returns (CARs) under the event window of (T1 days, T2 days) for specific bank. By add up series of correspond

idiosyncratic error term we obtained from conducted formula ①, we can come out the CARs for each bank. On the other hand, the formula ③ represented the CARs under the same event window across the entire banking industry, which is easily to calculate by using the weighted average formula for all banks CARs.

After we generated the cumulative abnormal returns, we can simply find our conclusion on whether the banks’ share price have generated significant abnormal returns on the reserve requirements announcements or not by using the t-statistics at significant level of 1%, 5% and 10%, respectively.

Furthermore, in order to test the last hypothesis, I formulated the simple OLS test as follow:

̂ ( ) ④

I set the CARs as the dependent variable in this OLS test, which will indicate each bank’s share price abnormal return over time. For the independent variables, since the nationalized banks have larger deposit size compared with other ownership banks. We decide to use the deposit amount as one of the most important indicators. However, since the deposit amount is too large compared with the coefficient of cumulative abnormal return, therefore, we also include the banks’ total asset to create the ratio of deposit/asset in order to obtain the suitable results. Moreover, we create the dummy variable D1 to

recognize the bank’s ownership type. D1 equal to 1 means that the bank has Nationalized

ownership, if D1 equal to zero, the bank can be conclude with Non-Nationalized

ownership. Furthermore, we also created the interaction term (

) to identify

whether the ratio of deposit/asset combined with the banks’ ownership type have significant influence on the CARs. More important, in our case, the coefficient will determined the CARs difference between Nationalized banks and Non-Nationalized bank. Therefore, to test whether the nationalized bank will have larger CARs due to the changing on the reserve requirements, we can estimate the level of and , and then test

whether the estimation is significant or not also by using t-statistics at three significant levels mentioned before.

̂ ( ) ( ) ( ) ⑤

After that, we further conducted the test by using formula ⑤, which replace the dummy variable by using the bank size factor (Asset). Because the Nationalized banks normally have larger size, we can try to link the bank size and CARs directly to found whether there is a significant connection between these two factors through this test. Generally speaking, there two tests will help to estimate these coefficients for bank with different type of ownership and try to make a reasonable conclusion based on the how importance for banks ownership to their share price abnormal returns.

4. Data Description

To perform our event study, we extracted the data for 14 Chinese banks’ share price from the DataStream. In order to have brief understanding the share price trend of these banks, we present the Table 1 which indicated all 14 banks’ share price movement during the period of 2008 to 2012. As we can see from the graph, banks’ share prices sharply declined in year 2008 due to the beginning of global financial crisis, after that, even the prices bounced back a little and keep at a relatively stable trend but still remain a slightly decreasing movement thereafter. It is apparently very hard to figure out the abnormal reaction of each bank’s share movement solely based on this graph. Therefore, in order to find out whether the banks’ share price generated significant abnormal return due to the effects of reserve requirements announcements, as mentioned before in the methodology part, we need also combine the Index of Shanghai Stock Exchange and set it as the benchmark, which are also briefly introduced in the Table 2. According to the movement of SSE Index, we found the individual banks stock price have similar trend with SSE Index, which makes our research became more necessary to detect whether there is a significant abnormal return for each individual bank stock. It can also further help us to determine the share price sensitivity to the reserve requirements announcements.

Table 1 All Chinese Banks’ Share Price Movement

(Source: DataStream, 2014)

Table 2 Shanghai Stock Exchange Index Movement

(Source: DataStream, 2014) 0 1000 2000 3000 4000 5000 6000 2-1-2008 2-1-2009 2-1-2010 2-1-2011 2-1-2012

Shanghai Stock Exchange Index

Besides the database of Chinese public listed banks’ share price, in order to perform the event study methodology, we also list all 23 events that recorded the changing of reserve requirements by Chinese Central Bank, which can be found in Appendix 1. The symptom of “↑” and “↓” in the Appendix 1 stands for the increasing and decreasing reserve requirements announcement, respectively. The date for each announcement is based on the exact time which the PRC actually released the news to the public. It potentially means that the stock market will immediately acquire the news when the announcement released based on the key assumption we made in methodology part. Besides, it also makes sure that there is no time lagged effect affect the events time and market reaction, which increased the empirical accuracy for our research. Furthermore, in order to make a clear specification on the abnormal return level caused by each event, we labeled the events from 1 to 23 according to time order.

Consider my last hypothesis will focus on analyze whether the cumulative abnormal return level is different due to the banks ownership, therefore, I classified these all 14 banks’ ownership into two groups, namely Nationalized Banks and Non-Nationalized banks. The specific classification is shown in Table 3 below. The criteria of this group classification are based on the bank identification information that can be found from “corporate information” section in each bank’s annual reports.

Table 3 Chinese Banks Classification Based on Groups

Nationalized Bank Non-Nationalized Bank

AGRICULTURAL BANK OF CHINA (1001) BANK OF CHINA (1002)

INDUSTRIAL & COML.BK.OF CHINA (1005) CHINA CON.BANK (1014)

CHINA MERCHANTS BANK (1003) CHINA CITIC BANK (1004) CHINA EVERBRIGHT BK. (1006) CHINA MINSHENG BANKING (1007)

INDUSTRIAL BANK (1008) BANK OF COMMS. (1009) HUAXIA BANK (1010) BANK OF BEIJING (1011) BANK OF NANJING (1012) SHAI.PUDONG DEV.BK. (1013)

According to the information from Table 3 above, there are 4 nationalized banks which are well-known as “The Big Four” in China. Based on the definition from G. Turner, N. Tan and D. Sadeghian (2012), the Nationalized bank in China stands for the banks which the Chinese Government through obtain the equity stakes of around 60% to 90% in commercial banks. The government has majority ownership of banks that account for more than half of Chinese banking system. We found out that the Nationalized banks have significant larger deposit amount compared with Non-Nationalized banks. Besides, since we need calculate the ratio of deposit to asset, we also download each bank’s total asset from DataStream; we summarized banks’ deposit and asset amount that have listed in Table 4. Combined with these two indicators, we can then easily get the ratio for our OLS test. Besides the information mentioned by the Table 4, the asset and deposit amount have been keep increasing over time. Unfortunately, we cannot get the deposit amount and total asset on daily basis; therefore, we can only use the deposit amount data during period of 2008-2012 based on half-year basis. For example, the Industrial &Commercial Bank of China - the largest bank in China - have average 10816.83 million of deposit during the period of 2008-2012, which is around 8 times compared with Minsheng Bank at same time. On the other hand, the total asset for Chinese banks are have similar trend based on the difference of banks ownership. Therefore, due to this special characteristic difference between the Nationalized banks and Non-Nationalized banks, we used these two important indicators to help us formulated OLS test formulas in order to analyze the cumulative return level’s difference between Nationalized bank and Non-Nationalized bank.

Table 4 Data Summarize on Deposit and Asset for Chinese Banks (Unit: Million)

Note: The * after bank name denote the specific bank belong to group of Nationalized bank.

(Source: DataStream, 2014)

5. Results Description

5.1 General Results

After series of regressions by using STATA on our data collection, I came out the quantitative results for our research topic. In order to easily for us to analysis the results based on different event window, I summarized the general results of banks’ share price reaction across all reserve requirements announcements in Table 5.

Table 5 Results of Events Across all Events

Observation Mean Min Max Mean Min Max AGRICULTURAL BANK OF CHINA* 6 9672.143 8348.82 10862.94 11553.08 9695.967 13244.34

BANK OF CHINA * 10 7346.007 4927.841 9482.564 9937.165 6487.313 12825.59

CHINA MERCHANTS BANK 10 1839.738 1046.626 2532.444 2386.238 1395.791 3408.219

CHINA CITIC BANK 10 1595.593 849.464 2255.141 2039.044 1117.208 3959.939

INDUSTRIAL & COML.BK.OF CHINA* 10 10816.83 7528.748 13642.91 13378.49 9399.96 17542.22

CHINA EVERBRIGHT BK. 5 1231.193 1029.711 1426.941 1850.502 1483.95 2279.295

CHINA MINSHENG BANKING 10 1340.442 760.404 1926.194 1860.362 1054.35 3212.001

INDUSTRIAL BANK 10 1094.57 534.145 1813.266 1857.827 916.964 3250.975 BANK OF COMMS. 10 2774.613 1811.113 3728.412 3875.323 2426.366 5273.379 HUAXIA BANK 10 724.5832 457.321 1036 1022.498 628.146 1488.86 BANK OF BEIJING 10 509.7322 281.255 713.772 716.4555 363.355 1119.969 BANK OF NANJING 10 133.5276 56.43 213.656 210.4272 90.046 343.792 SHAI.PUDONG DEV.BK. 10 1545.338 834.459 2387.968 2084.899 1002.611 3145.71 CHINA CON.BANK * 10 8759.938 5781.573 11343.08 10590.82 7057.706 13972.83 Deposit Asset

Event Window Coefficient t-value Event Window Coefficient t-value

(-1, 1) -0.0506591 (-2.61)* (-8,1) -0.2508641 (-3.55)* (-2,1) -0.0906375 (-2.86)* (-9,1) -0.2488554 (-3.49)* (-3,1) -0.1055267 (-2.83)* (-10,1) -0.2587355 (-3.51)* (-4,1) -0.1471376 (-3.05)* (-11,1) -0.2768585 (-3.63)* (-5,1) -0.176384 (-3.18)* (-12,1) -0.2784454 (-1.67)*** (-6,1) -0.1882762 (-3.21)* (-13,1) -0.2628946 (-3.62)* (-7,1) -0.2269898 (-3.44)* (-2,2) -0.0540754 (-2.40)*

The results from Table 6 reflected that all banks combine have a negative relationship with all 23 reserve requirements changing announcements. Furthermore, consider length of event window, the results also illustrated that as the length of event window increase, the banks’ share price showed a higher level of reaction. More important, the t-value for each coefficient based on varies of event window indicated that all the results are statistically significant at 1% significant level, except the event window (-12 days, +1 day) only significant at 10% level. Therefore, we can reject our first hypothesis, which further concluded that all changing reserve requirements events combine together have significant influenced on share price of all public listed Chinese banks at short term basis. At last, compared results of event window (-2 days, +2 days) with event window (-2 days, +1 day), we also realized that longer length of post-event also lead to higher level of abnormal reaction on banks’ share price. It represented that the adjusting reserve requirements also have late abnormal reaction on the bank’s share price in China.

Since the changing on the reserve requirements is close relate to the banks’ operation strategy. Therefore, our results is quite reasonable consider under the financial reality, the changing on the reserve requirements during this financial crisis lead to the Chinese banks’ share price went down right after the announcements have been released. It potentially indicated that the investor has less confidence for the Chinese bank industry in stock market under the unfavorable economic circumstance.

5.2 Results Based On All Events Across Each Banks

In order to understand how the changing reserve requirements announcements actually influence each Chinese public listed bank, we run series specific test for each bank correspond to each event. With the same methodology mentioned before, we came out more specific results that listed in Table 6. It included all possible event windows we chose and each corresponded to 14 different Chinese public listed banks we have chosen.

Based on the results from Table 6, we can found that even most of Chinese banks’ share price abnormal return are statistically significant at 1% significant level when the changing reserve requirements announcement have been released during the financial crisis period. However, there are still two banks were not statistically significant at all three significant level, which are quoted by company number #1010 (HUAXIA BANK), #1014(CHINA CON.BANK). Moreover, after we have considered the t-value more seriously, we found that Bank #1007 (CHINA MINSHENG BANK) and #1012 (BANK OF NANJING) are only significant at 10% and 5% significant level, respectively.

Furthermore, we also realized that not all these banks showed an increased share price abnormal return reaction when event window length also increased. Therefore, we can concluded that if we emphasized on compared with each specific Chinese public bank, the share price abnormal return reactions have shown a different trend compared to others when the event window length increased, which is different with the conclusion we got if we take all these banks into a group to test across all events during the financial crisis period. For example, even the abnormal reaction of Bank#1007 shows a significant result under the 10% level, however, the level of abnormal reaction is quite unstable, it increased with the length of event window at first but shown a downward trend after event window length over 6 days. Most important, the coefficient of cumulative abnormal return illustrated that even most of banks shown a negative correlation between changing reserve requirements announcements and banks’ share price, but there are also 4 banks have significant positive relationship between the announcements released and banks’ share price under most of event window with different length.

Based on the results above, I believed that the Chinese financial institution’s strategy of using reserve requirements as instrument to combat financial crisis actually generated Chinese banking industry’s share price going downward during the period of 2008-2012 in general. So, the PRC’s contradicted monetary policy leads to these banks have less money to perform their business, such as fewer loans granted. This finally influenced the bank’s general performance and let their share price showed downward trend right after the reserve requirements have been changed.

From the conclusion of Deloitte’s report of 2012, they indicated that due to the influence of macroeconomic environment and financial system’s change in China, even the total asset of Chinese banking industry kept expand during the financial crisis, but the business growth rate was decelerated dramatically (Deloitte, 2012). This can be also considered as another reason of why even the PRC try to stabilize the market by perform the deposit reserve requirement strategy, but the banking industry in China still showed a weak performance during this period. Furthermore, considered the PRC performed increasing deposit reserve requirements reaction most of time during this period. It resulted a higher capital cost for these Chinese banks. So, from the banks perspective, they showed a weaker bargaining power to the lending customer than before. The narrowed net interest spread caused the negative influence on the banks’ profitability and finally leads to the negative trend of banks’ share price.

Besides the results that have negative relationship between event and banks’ share price, we also need pay attention at the results with positive coefficient. Among these 4 banks, all of them are non-nationalized bank with average deposit size from 1000 to 2000 million, which can treated as medium-size bank in China compared with other banks’ deposit size. Therefore, we can conclude that the medium-size banks’ share price is more likely to be increased right after the PRC changing the reserve requirements.

5.3 Results of Increasing Deposit Reserve Requirement

After explained the results for all events combined across each banks from last section, in order to solve my third hypothesis, I abstracted the events that only included the increasing reserve requirements announcements in my event list. By using this modified event list, we came out the results of the relationship between the increasing reserve requirements and abnormal reaction of banks’ share price, which listed in Table 7 as follow.

Table 7 Results for Events of Increasing Reserve Requirements in China

Note: The * ** *** behind each t-value stands for the t-value statistically significant at 1%, 5%, 10% significant level, respectively. The t-value without * means that the results are insignificant at all these three significant level.

According to the results, we realized the new results are quite similar to the results in Table 6. Most of the Chinese public listed banks also have shown a negative relationship between the length of event window and banks’ share price abnormal return. Besides, after we excluded the decreasing reserve requirements announcements, almost all the abnormal return reaction level for each bank became stronger compared with all events combined. Considered this test eliminated the bias from decreasing reserve requirements, the higher level of abnormal reaction is quite reasonable under this circumstance. Furthermore, we also realized that the t-value of the coefficient also have been improved after we modified the event list. To be more specific, different with former results, for Bank #1007 which used to only statistically significant on 10% level, Bank #1007 now have shown a significant result also under the 1% level. But again, the Bank #1010 and Bank #1014 are still statistically insignificant under the three different levels, which is correspond to the results before.

However, we found that even the banks used to have positive relationship between the announcements and share price abnormal return are still shown a positive relationship in the new results. But the new results have shown a weaker positive abnormal reaction compared with old results. I believed this changed in the results also contributed by the modification of the event list. The decreasing reserve requirements announcements’ reduction also decreased the positive influence on the banks’ share price, which finally caused lower level of positive share price abnormal return.

Next, after run the test over different length of event window, the results also illustrated that most of the banks’ share price abnormal reaction increased with the length of event window, no matter the correlation between this two factors are positive or negative. But there are also several banks shown an unstable trend when we run the test under multiple length of event window. If we take ownership of banks into consideration, we found that as long as the event have significant effect on the banks’ share price, the nationalized banks’ share price abnormal return level have been increased with the length of event window. On the other hand, the Non-nationalized banks’ share price reaction trend is hard to predicted due to difference on each banks’ characteristic. For example, Bank

increasing trend after the event window length over 8 days. Besides, the Bank #1007’s results also have illustrated an unstable trend under different length of event window.

Furthermore, if we compared the coefficient results from event window (-2 days, +1 days) and (-2 days, +2 days), the results showed that as we increase 1 day post-event, the share price’s abnormal reaction normally will also be increased a little bit for most of Chinese public listed banks. This might have two explanations for this result, firstly, as we mentioned before, most of banks’ abnormal reaction increased as the event window length grow. Secondly, the second day after event released also have some delay influences on banks’ share price, which caused the changing on the price abnormal reaction.

In order to fully understanding these results; we take into account some financial indicators from the annual report of these banks during the period of 2008-2012 and try to generate a reasonable explanations for these results.

Firstly, we focused on the all these banks credits performance during the period of 2008-2012. The results from Table 8 below illustrated that the credit growth rate sharply increasing, however, the growth rate showed a continuous decreasing trend after 2009. The decreasing on the banks’ credit growth rate reflected that the customers are less willing to borrow from banks during financial crisis. This might due to the changing on the reserve requirements actually lead the Chinese banks’ competitiveness became weaker than before, the effect of bank lending rate increasing have forced customers give up the plan of financing from banks or choosing other financial institution such as shadow banking to finance their projects. Finally, the banks’ business have been heavily reduced and influenced the banks’ performance, which caused the share price are negative related to the reserve requirements increasing.

Table 8 Chinese Banks Credits Performance

(Source: World Bank Database, 2014)

Table 9 Chinese Banks Financial Indicators

(Source: Annual Reports for all 14 Chinese Public Listed Banks, 2014)

2008 2009 2010 2011 2012 Net domestic credit

Increasing 3971,944 11520,16 9274,3753 10064,75 11762,221 Credit growth rate 11,69% 30,37% 18,75% 17,14% 17,10%

0 2000 4000 6000 8000 10000 12000 14000 0,00% 5,00% 10,00% 15,00% 20,00% 25,00% 30,00%

35,00%

Chinese Banks Credits growth

0,00% 10,00% 20,00% 30,00% 40,00% 50,00% 60,00% 2008 2009 2010 2011 2012

Growth Rate of Financial Indicators

Secondly, the results from Table 9 also indicated that even the Chinese banks’ operation profit, ROA and ROE still have increasing trend over these years. However, except the time period of 2009-2010, the growth rates of each indicator have shown a continuous declined trend. To be more specific, the operation profit’s reducing in the annual reports let the investors have negative expectation on the banks’ future. Furthermore, the ROA and ROE also illustrated that these banks’ growing profitability from using asset and equity are not effective as before during the financial crisis. As the reserve requirements have been increased, the investment environment’s changing also caused banks’ future performances have been doubted by the potential investors. Overall, these financial indicators can be another important reason for the negative correlation between the share price’s abnormal return and events.

In conclusion, put all the reasons together, my third hypothesis can be rejected according to the results from Table 7, which means that the increasing reserve requirements announcement normally will generate negative share price abnormal return for Chinese public listed banks due to negative expectation of banks’ future from investors’ perspective of view.

5.4 Results of Abnormal Return with Different Ownership

In this section, instead of using the event study, we performed the OLS test to find out the potential connection between the Chinese banks’ share price and the type of banks’ ownership. In order to do so, I have run tests which help us to determine the importance of bank’s ownership to their share price’s abnormal reactions. Through the formula ④ and ⑤, I came out the results which listed in Table 10 and Table 11 separately.

Table 10 Relationship between CARs and Bank’s Ownership

Cumulative Abnormal Return

Coefficient t-value

β 1.146557 3.17

δ -0.6806089 -2.12*

γ -0.8360044 -2.13*

Note: The * ** *** behind each t-value stands for the t-value is statistically significant at 1%, 5%, 10% significant level, respectively. The t-value without * means that the results are insignificant at all these three significant level.

The results above illustrated that these three coefficients are statistically significant at 1% level. More important, the level of δ indicated that the abnormal reaction of share price in Non-Nationalized banks have lower level compared with Nationalized Banks due to the bank’s ownership difference. To be more specific, compared with Non-Nationalized banks, Nationalized banks’ share price will have 0.836044 lower abnormal reactions. Therefore, we can conclude that the ownership of Chinese bank actually has strong connection to the share price’s abnormal reaction. Furthermore, it also reminded the investors should notice this difference between the Nationalized banks and Non-Nationalized banks when it comes to the time of reserve requirement changing at high frequency basis.

Table 11 Relationship between CARs and Bank Size

Cumulative Abnormal Return

Coefficient t-value

β 10.71333 2.07*

δ -1.342114 -2.48*

γ -1.531295 -2.24*

Note: The * ** *** behind each t-value stands for the t-value is statistically significant at 1%, 5%, 10% significant level, respectively. The t-value without * means that the results are insignificant at all these three significant level.

After run the second OLS test by using the formula ⑤, the results from Table 12 have showed that as the δ and γ have statistically significant negative effect relate to the share

confirmed that the directly linkage between the bank size and CARs in China. Since the Nationalized banks normally have larger size, these results also help to solve the last hypothesis we made.

In order to find out how this phenomenon happened, we will explain the results from different perspective of view. First of all, the studies from Anderson and Joeveer (2012) found out the pure cost efficiency measure from the economies of scale lead to the competitive input pricing fail which finally caused the preponderance of a small number of very large banks within most financial systems. Combined with the Chinese banking industry’s reality, the Nationalized banks have larger size compared with Non-Nationalized banks. It not only represents on their deposit and asset size but also reflect on their business scale. Therefore, the Nationalized banks normally have benefited from the lower operation cost compared with Non-Nationalized banks due to the economies of scale. When the reserve requirements have been changed, especially when it increased, the Nationalized banks can benefit more from this policy. It caused the Nationalized banks can keep a relatively better operation status compared with Non-Nationalized banks. It further lead to the Nationalized banks have taken less affect by the reserve requirements changing. This advantage can also help the Nationalized banks have stronger performance compared with Non-Nationalized banks, which finally lead to the Nationalized banks’ share price have less influenced by the reserve requirements changing.

Secondly, in China, the Non-Nationalized banks normally have tighter liquidity management compared with Nationalized banks (Standard&Poor, 2014). Therefore, even the Non-Nationalized might paid more attention on monitoring the investment projects compared with Nationalized banks, but this action also indicated that the Non-Nationalized banks prefer the project with lower return and risk level. Since this reaction of Non-Nationalized banks, their profit can be decreased due to participation on the low profit projects. It further might lead investors became panic on the banks’ further performance, which finally made the higher level of CARs caused by adjusting reserve requirements compared with Nationalized banks. Moreover, specific on our case, the Chinese banks are more influenced by the intervention of government, especially for the

Nationalized banks because their yearly targets for asset quality and capitalization are more restricted by the government (García-Herrero, Gavilá, & Santabárbara, 2009). Considering the reserve requirements have changed quite frequency during the financial crisis, the Nationalized banks therefore might go through a more strict monitoring process for investment projects than ever. It can lead the non-performance loans sharply decreased in Nationalized banks during this period. This argument also confirmed by the study from Zhou and Wong (2008), they declared that the implicit protection from the Chinese government actually helped the state-owned commercial banks (SOCB) are less prudent underwriting and monitoring loans, which caused the decreasing on the NPLs (Non-Performance Loans) So, the investors are more confidence to invest in these banks instead of Non-Nationalized banks. This can be also an important reason for the Nationalized banks have less significant influences by reserve requirements changing compared with Non-Nationalized banks.

Furthermore, according to the study of Turner, Tan and Sadeghian (2012), the Chinese Nationalized banks lending decisions served purpose of policy priorities rather than purely commercial consideration for sometimes. It caused a large proportion of bank credits are move toward to state-owned enterprises (SOEs) and government infrastructure projects. Consideration the foundation of the SOEs projects have its low risk character due to these project can be bail out by the Chinese government if they fail. On the other hand, the paper from Ma, Yan and Liu (2011) mentioned that the Chinese Non-Nationalized banks have been increased loans to the small and medium enterprises (SMEs) since the Chinese banking reform since 2002. Apparently, SMEs projects have higher market risk compared with SOEs, especially when the economic environment is going through a downward trend. Therefore, as the central bank changing the reserve requirements, the changing on the lending rate have weak influences for Nationalized banks due to their low risk investments. This also lead to the Nationalized banks’ share price have relatively lower abnormal return.

According to Loechel and Li (2011), Chinese banks’ operation often inefficient, but the policy of adjusting reserve requirements helped the Nationalized Chinese banks obtained

low labor cost, this compensate for their low efficiency. According to the study from Shih, Zhang and Liu (2007), the Nationalized banks can directly participate in the process of policy making at the State Council level. This helps them to lobby for preferential policies, unlike the Non-Nationalized banks can only influenced the policy indirectly. Nationalized banks might be benefited from the “too big to fail” subsidies from the government. Therefore, their profitability is not prohibited from the State Council, the Nationalized banks’ share price can actually have less negative influenced by the policy of changing reserve requirements.

So, in conclusion, the Nationalized banks in China will be less affected by the changing on the reserve requirements compared with Non-Nationalized banks due to the ownership characteristics. Besides, the share price of bank with large size also will less influenced by the changing on the reserve requirements. Therefore, our fourth hypothesis should be rejected according to the test results.

6. Conclusion

By using the event study for our analysis, the empirical evidence we have discussed before presented that all Chinese banks’ share price together are significant influenced across all the policy of changing reserve requirements in China during the financial crisis in 2008-2012. More importantly, as we specific the test based on each bank, we recognized most of banks have also significant negative impacted by all the events of changing the reserve requirements. Since the most of reserve requirements announcements during this financial crisis period showed an increasing trend, we also run the test that abstracted all the events with increasing reserve requirements announcements. The results illustrated that the increasing reserve requirements actually have significant negative relationship with most of Chinese banks share price.

The OLS test for analysis the relationship between the cumulative abnormal returns and bank’s ownership helped us to identify that the Nationalized banks are less sensitivity to the cumulative abnormal return compared with the Non-Nationalized banks. It further indicated that the Nationalized banks’ share prices are more likely to be influenced by the changing on the reserve requirements.

As the profitability can be one of important determination for the banks’ share price, when we trying to explain the abnormal reaction for the Chinese banks’ share price during the financial crisis, some important financial indicators for the banks can be very helpful to identify the abnormal reaction of their share price, such as ROA, ROE, Deposit to Asset ratio. Moreover, since the reserve requirements have changed at high frequency basis, the ownership’s differences on the bank determined that Nationalized banks would less influenced by the government’s policy intervention. It caused the Nationalized banks’ share price have shown a less sensitivity to the reserve requirements changing.

Therefore, in conclusion, even the Chinese Central Banks have commonly used the reserve requirements as important tool to combat for the negative influences from the financial crisis. But the results indicated that the Chinese banks’ share price have shown a downward trend over the financial crisis period even this policy might help to stabilized the financial market. So, the investors who decided to invest in banking industry in China, they might be suffer a loss on their shares. The results can also apply to the future investors when they decide to invest in Chinese banking industry when the reserve requirements base is highly unstable. Furthermore, the results of this paper also remind the Chinese Banks should make a suitable operation strategy in order to avoid their market value dropping during the period of reserve requirements changing intensively.

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Appendix 1 Event List

Date Reserve Requirements Change Event Number 1/25/2008 ↑0.5% 1 3/18/2008 ↑0.5% 2 4/25/2008 ↑0.5% 3 5/20/2008 ↑0.5% 4 6/7/2008 ↑1% 5 10/15/2008 ↓0.5% 6 12/5/2008 ↓1% 7 12/25/2008 ↓0.5% 8 1/18/2010 ↑0.5% 9 2/25/2010 ↑0.5% 10 5/10/2010 ↑0.5% 11 11/16/2010 ↑0.5% 12 11/29/2010 ↑0.5% 13 12/20/2010 ↑0.5% 14 1/20/2011 ↑0.5% 15 2/24/2011 ↑0.5% 16 3/25/2011 ↑0.5% 17 4/21/2011 ↑0.5% 18 5/18/2011 ↑0.5% 19 6/20/2011 ↑0.5% 20 12/5/2011 ↓0.5% 21 2/24/2012 ↓0.5% 22 5/18/2012 ↓0.5% 23