MasterMasterMasterMaster thesis thesis thesis thesis

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Master

Master thesis

thesis

T

The

he

he research

research

research on

on

on the

the

the influence

influence factors

influence

factors

factors of

of

of commercial

commercial

commercial bank

bank

performance

performance in

in

in China

China

China 2000-2007

2000-2007

September

September 2008

2008

A A A

Author:uthor:uthor:uthor: Supervisor:Supervisor:Supervisor:Supervisor: Res. MethodologyRes.Res.Res.MethodologyMethodologyMethodology Supervisor:Supervisor:Supervisor:Supervisor:

Jiaying Li (S1731076) Dr. Gabor Peli Prof. H.W.A. (Erik) Dietzenbacher Faculty of Economics Faculty of Economics Faculty of Economics

and Business and Business and Business

University of Groningen University of Groningen University of Groningen The Netherlands The Netherlands The Netherlands

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A

Abstract

bstract

With the development of international economic and financial incorporation science the beginning of the 21st _{Century, Chinese Government adopted a series of} financial reforms. Within all of these reforms, the reform in the banking industry, especially the commercial bank reform has been always the key of success for the whole series reforms. There have been a lot of turns and twists during the process of the commercial bank reform before they reached the basic system requirement. Recently, the deepening of this reform is still a tough mission for the government of China. This paper used statistic analysis to explore the influence factors of commercial bank performance in China. The basic findings are: The ownership concentration, minority foreign ownership, being listed on the stock market, the size of the bank and the new policies after entrance WTO are the main factors which can promote commercial bank performance; correspondingly, the state ownership is negatively related with commercial bank performance. The results show compelling proofs to support the efforts and policies made by Chinese government and indicate the feasible way in the future.

Key Key

KeyKey Words:Words:Words:Words:

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C

ontents

Abstract……… ..2

List of Abbreviations……… ..5

1. Introduction……… ..6

1.1 Competitors Situation and General information……… ...6

1.2 Recent Development……… ....8

1.3 Study Target……… 11

2. Literature Review……… ...11

2.1 General Findings in Related Literature……… ..11

2.2 Related Literatures Methodologies……… ....13

3. Research Questions and Hypothesis……… ...…...14

3.1 Research Question……… ..14

3.2 Hypothesis……… ..14

3.3 Added Value of My Paper ……… ..19

4. Methodology……… ..21

4.1 Data Source……… ....21

4.2 Dependent Variables……… .…..21

4.2.1 The evaluation system: Three basic elements/characters of commercial banks performances……… 21

4.2.2 Dependent Variables Description……… 22

4.3 Independent Variables……… ....24

5. Data Analysis……… .26

5.1 Summary description of observation and statistics……… 26

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7.2 State ownership……… ..35

7.3 Foreign ownership……… ..37

7.4 Listed dummy……… .39

7.5 Size……… .40

7.6 Running Area Dummy and GDP per capita……… .………...40

7.7 Year dummy 2004……… .……..41

8. Conclusion and Future Exploration……… ...………42

Reference……… ..44

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List

List of

of

of Abbreviations

Abbreviations

ABC Agriculture Bank of China

BOC Bank of China

CBRC China Banking Regulatory Commission

CCB China Construction Bank

EQTA Equity to Total Assets Ratio

FDI Foreign Direct Investment

ICBC Industrial and Commercial Bank of China

IPO Initial Public Offering

LIQ Liquid Assets to Short term funding ratio

OCF Operation Cash Flow Ratio

POC People’s bank of China

ROA Return on Assets

ROTA Return on Total Assets

ROAA Return on Average Assets

RONA Return on Net Assets

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1.

1. 1. IIIIntroduction

ntroduction

Within the last decade, China’s economy has been growing rapidly remaining a high level at around 10%, and some scholars even expected it to become the world’s largest economy in the coming decades (e.g., Allen, Qian, and Qian, 2005). Until right now, the rapid growth of developing economy should be mainly own to the fast growth of trade globalization and great deal of infrastructures investments. Chinese government adopted an open policy in 1978 to introduce foreign competitors and FDI into its domestic market which considered as a very successful policy to maintain a sustainable economic development. However, compared with other industries, the liberalization and globalization of its banking industry especially the commercial banking system is just starting. There have been a lot of turns and twists during the process of the commercial banks reform before it reached the basic system requirement. Recently, the deepening of this reform is still a tough mission for the government of China.

This paper is designed to explore what kind of factors can influence the commercial bank performance in China? To what extent do they affect it? What can Chinese government do to encourage the performance exaltation of commercial banks?

1.1

1.1 1.1 C

C

Competitor

ompetitor

ompetitorssss Situation

Situation and

Situation

and

and General

General

General information

information

The contemporary commercial banking system of China has a short history, with the People's Bank of China (PBOC) ending its monopoly of the banking sector and being recast as the national central bank in the late 1970s and early 1980s.

There are mainly four different kinds of players for this sector:

A. State-Owned Commercial Banks – The ‘Big Four’

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Bank of China (BOC), the Industrial and Commercial Bank of China (ICBC), the China Construction Bank (CCB) and the Agriculture Bank of China (ABC).

B. Joint-stock commercial banks

Joint-stock commercial banks are partially owned by local governments, partially owned by the state, and sometimes there is an exception for private investors. There are currently eleven banks. Five of the eleven banks are listed on local stock markets. These five banks account only for 10% of total bank assets. The biggest joint-stock commercial banks are: Bank of Communications, China Minsheng Bank, China Everbright Bank, China Merchants Bank, Shanghai Pudong Development Bank and Shenzen Development Bank.

C. Licensed foreign commercial banks

Foreign banks play currently a very limited role in the Chinese banking system. The foreign banks hold 0.3% of the local currency lending market and around 13% in the foreign currency lending market; all together it only accounts for 1.2% of total bank assets. In addition, some joint-stock commercial banks are partially owned by foreign investors.

D. Smaller city commercial banks

Since 2002, the reorganization and acquisition of commercial banks are in full swing in China. A lot of small urban/rural credit cooperatives were reorganized to city commercial banks running in given areas.

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RMB3.0 trillion, an increase of RMB791.3 billion or 35.3 percent (Appendix 1). The five large banks' total assets reached RMB28.0 trillion, an increase of 16 percent. (China Banking Regulatory Commission, 2007) What is quite interesting in China, other financial departments do not function well that the bank sector accounts for a lion’s share of the total financial assets in China, at around 73% (as Appendix 2 showed). On the other hand, the NPLs (non-performing loans)of the major commercial banks measured by the five-category loan classification standards totaled RMB1.2 trillion, marking a ratio of 6.72 percent, a decline of 0.79 percentage point from that of 2006 (Appendix 3)

1.2

1.2 1.2 Recent

Recent

Recent Development

Development

The whole commercial banking industry is still dominated by “Big-four” (four biggest state-owned commercial banks in China, including ABC, CCB, BOC and ICBC), the legal and financial systems are not well developed-even by the standards of most developing countries. (Berger, Hasan and Zhou, 2006) However, the situation is changing toward a better direction:

According to the agreement Chinese government signed in 2001 with World Trade Organization (WTO), from 2007, the China’s domestic commercial banks have to compete with foreign banks fairly in China’s financial market. Accordingly, Chinese government accelerated the pace of opening its financial market and deepened the commercial banking industry reform since it joined WTO. The main reform under this time period is on ownership shift of state-owned banks in the hope of enhancing corporate governance to improve efficiency. These reform measures are grounded on the mounting empirical findings in which state-ownership is generally found less efficient.

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(http://www.lawinfochina.com/) indicated that the aim of the reform is “Deepening the reform of financial enterprises. All commercial banks and securities, insurance and trust investment companies should become modern financial enterprises with ample capital, tight internal management, safe operation, excellent services and good economic returns. We shall promote the shareholding reforms in some qualified state-owned commercial banks, which shall step up efforts in handling bad assets and increasing capital funds to create conditions for being listed on the stock market.” As a sequence, with a sequence of capital injections and stripping-off of non-performing loans (NPLs) from 1998 amounting to 2.57 trillion RMB, the Bank of China (BOC), the China Construction Bank (CCB) and the Industrial and Commercial Bank of China (ICBC) have successfully made their initial public offering (IPO) in the Shanghai and Hong Kong Stock Exchanges. The market reaction to these IPOs was highly positive from the second half of 2006, with their share prices rocketing by up to 100%, making them among the few largest firms in the Shanghai Stock Exchange. Based on market values, ICBC is now the second largest bank in the world, second only to Citigroup. (Yao and Jiang, 2007).

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their way:

On June 17, 2005, Bank of America agreed to buy 9% shares of China Construction Bank (CCB), and promised to invest a further US $500 million to maintain its ownership level when the IPO occurred. Bank of America also promised to purchase more shares in CCB until the share percentage arrive 19.9% (the highest level allowed by Law of the People’s Republic of China on Commercial Banks) at the price of shares in the IPO. In addition, it has a seven-year strategic alliance with CCB that involves committing the equivalent of 50 Bank of America employees' time to work at the Chinese bank. Also, Bank of America has one seat on a 15-person board, and the two sides have agreed to discuss a potential credit-card joint venture in China. As part of this, Bank of America agreed to withdraw from retail banking in China, though it retains its corporate and commercial-banking presence (Wall Street Journal, Eastern Edition, Feb 23, 2006, p. C1). As the second foreign comate, Temasek paid 1.46 billion dollars for 5.1% shares in CCB and more one billion dollars when IPO at the same time.

In the case of the second largest banks in China—Bank of China(BOC), Temasek and Royal bank of Scotland Group (combination leaded by Royal bank o f Scotland, Merrill Lynch and personal foundation of K.S. Li participated) bought 10.0% shares respectively with the price around 3.10 billion dollars.

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1.3

1.3 1.3 Study

Study

Study Target

Target

All the efforts mentioned above showed the attitude of Chinese government while the effects of these measures still need to be tested. Whether IPO or foreign acquisition can significantly improve the efficiency and performance? Will they cause other problems? Are there any other factors can affect the performance which still has not been mentioned in this reform?

Under this precondition, in order to do some help for the reforms and provide some new theoretic and practical angles of thinking, this paper will use panel data from 2000-2007 focusing on what kind of factors will influence the performances of commercial banks in China to explore how to build up a more effective system in practice according to my results.

2.

2. Literature

Literature

Literature Review

Review

2.1

2.1 2.1 General

General

General Findings

Findings

Findings in

in Related

in

Related Literature

Literature

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scale exists.

On the other hand, there are also a lot of scholars concerned about the influence of ownership structure on the bank efficiency. Most of the researches focus on the shareholder type (state-owned, private or foreign owned), and a large proportion of them have the similar finding: the state ownership usually is linked with lower efficiency (Berger, Hasan, and Zhou, 2006; La Porta, Lopez and Shleifer, 2002; Tian and Estrin, 2007; An, Bae and Ratti,2007) interpreted that state ownership might be linked with political influence with the banking sector (politically concerned firms receive favored treatment from state-owned banks in Korea, in other words, these firms will be more possible to get loans without considering their financial performance from state-owned commercial banks. As a sequence, the larger non-performing loans risk will damage the profitability and liquidity thus the performance of state-owned commercial banks.) I think the similar situation exist in China because we have similar Confucian cultures.

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and 2004 were part of the agreement and promises Chinese government made when China entered WTO. It just took some time to put the agreement into practice since China’s entry into WTO in 2001 so they are considered as a part of the results of China’s entry into WTO. )

2.2

2.2 2.2 R

R

elated

elated Literatures

Literatures

Literatures Methodologies

Methodologies

One similar paper with my topic I found is a Wharton Financial Institutions Centre Working Paper 2007, named “Bank ownership and efficiency in China: what will happen in the world’s largest nation?” by Berger, Hasan, and Zhou. In their paper,

they build up two functions (cost and profit functions) to compute the efficiency levels and ranks with 266 observations from 38 Chinese commercial banks during 1994 to 2003. They divided their samples into four groups of majority bank ownership types: Big Four, non-Big Four majority state-owned, majority private domestic, and majority foreign, then tested the differences in average profit and cost performance among them. Furthermore, they explored whether the Big Four banks have a problem of low efficiency and whether minority foreign ownership of these institutions might help correct such a problem.Their finding was quite interesting: “minority foreign ownership of the Big Four and other reforms that allow foreign banks to play larger roles will likely improve the performance of the Chinese banking sector, with positive effects on economic growth.” This result is consisted with the expected result in my study while I’ll try to get it in another way.

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because my paper is not a cross-country research. However, their model is a good sample for me to study what I am interested in. They introduced a CAMEL model (capital, asset quality, management, earning and liquidity) to evaluate banks’ performance and analyzed so called “market structure” which they explained as government ownership, foreign ownership and ownership concentration which is exactly what my research will focus on. I will also borrow some of their variables to measure the three dependent variables in my research.

3.

3. R

R

Research

esearch

esearch Questions

Questions and

Questions

and

and Hypothesis

Hypothesis

3.1

3.1 3.1 Research

Research

Research Question

Question

What kind of factors can influence the commercial bank performance in China? To what extent do they affect it? What can Chinese government do to encourage the performance exaltation of commercial banks?

3.2

3.2 3.2 Hypothesis

Hypothesis

Hypothesis Hypothesis

HypothesisHypothesis 1111: The ownership concentration negatively affects commercial bank performance in China.

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They face higher risks, more complex market situations and bigger possibilities of failures which need different management characters and specialties. Thus the results they found in their researches based on general firms might be not suitable for commercial banks. I expect it’s a negative effect in China’s commercial banks industry as in China, because of the company cooperation, general meeting of stockholders, legal and supervision system are still far away from perfect, a high ownership concentration (the bank has one or several main shareholder which can control the company easily with the shares it/they have) means a complex network of “Guanxi” and a large possibility of insiders control problem (the big shareholders control the banks and make all the managerial decisions which might damage the interests of other smaller shareholders). These “Guanxi” network and insiders control problem usually trend to cause a large number of loan between relative parties and this kind of loan may potentially damage the profitability and asset quality of that bank by a larger non-performing loan ratio.

HypothesisHypothesis 2222: The state ownership will negatively affect the bank performance in China.

Concerning about this question, most literatures I found have similar results: “The key findings are that the Big Four state-owned banks are by far the least efficient.” (Berger, Hasan, and Zhou, 2006); “Despite charging lower rates, banks controlled by government experience higher bad loans” (An, Bae and Ratti, 2007); “We argue that the failure of corporate governance may derive from the shared government ownership of lenders and borrowers, which nurtures soft budget constraints.” (Tian and Estrin, 2007). Generally speaking, all the problems which might be harmful to the commercial bank performance leaded by state or government ownership can be categorized into three: owner absence problem, political influence (soft budget constraints) problem and the inefficiency of monetary policy.

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leaded to a new dilemma. At one hand, the Huijin Company has been defined as a company which is established to act as an attorney, to hold the share of other companies without taking part in their management affairs. This directly caused an owner absence problem: since the nominal biggest owner does not take part in the management affairs, who will take its place in the corporate governance? Nobody can take its responsibility as a main shareholder and that obviously will have a negative effect on the performance of the company. On the other hand, if the Huijin Company decided to take its responsibility by accrediting the directors of the company, it will also conflict with the contemporary law. The contemporary law states that: “The officers of the government are not allowed to be the top management of a public company”. Obviously, the Huijin Company is not a qualified trustee for the state-owned asset because it has a lot of shortcomings since its establishment and the state is not an efficient shareholder for the commercial bank in this way.

B. Political influence (soft budget constraints) problem: banks controlled by government usually experience higher non-performing loan ratio, and this kind of non-performing loans is in line with expectation of forbearance and government protection for recipients of political loans. In the history, Chinese government required state-owned banks to offer a large number of political loans to SOEs (state-owned enterprises) which directly caused the depression of their asset qualities.

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HypothesisHypothesis 3333: The existence of minority foreign ownership (less than 25%) has

positiveeffect on commercial bank performance in China.

Very limited literatures can be found on this topic. Most relative researches are concerned about the efficiency difference between foreign-owned banks and domestically banks. Berger in 2007 found that “The efficiency disadvantages of foreign-owned banks relative to domestically owned banks tend to outweigh the efficiency advantages in developed nations on average, and this situation is generally reversed in developing nations”. Most of other scholars’ results about this in developing countries supported his point. Some studies of banks in individual developing nations also find that foreign banks are the most efficient in Croatia (Kraft, Hofler and Payne, 2006), Pakistan (Bonaccorsi and Hardy, 2005), Hungary (Hasan and Marton, 2003), and Malaysia (Matthews and Ismail, 2006).

However, the situation in China is a little bit different. According the regulation rules, if foreign investors control more than 25% of a bank, it’ll be treated as a foreign owned bank. The supervision regulars and treatments were totally different between foreign-owned banks and domestic banks with minority foreign ownership until 2007 and there were a tight limitation before that on foreign-owned banks such as not allowed to service domestic customers with local currency and so on. So generally, most foreign investors chose the minority foreign ownership in domestic banks. There are, of course, also several foreign-owned banks in China. Actually, these kinds of banks usually are the filiales of foreign banks, thus cause a problem: their histories are very short (founded in 2006 or 2007) and their financial performance data are not available for most cases. Furthermore, as filiales, their managements and strategies will be decided by their mother companies which might cause better or worse performances. So in this study, we only consider the influence of minority foreign ownership in domestic banks.

HypothesisHypothesis 4444: Going to public will has positive influence on the bank performance in China.

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stock markets (Shanghai, Shenzhen and Hong Kong stock markets). Most of them are joint-stock commercial banks (second tier group) and state-owned commercial banks which occupied more than 70% of total assets of whole commercial bank industry. Generally, there is a common idea that it’s an effective way to promote the process of capital expansion, the increase of competitive edge and the efficiency of commercial banks in China. (Cheng, 2006). However, because of the complexity of China’s stock market (the shares can be divided into two parts: circulating shares and non-circulating shares, the state government and institutions control relative large number of non-circulating shares), to what extent going to the stock market can promote the efficiency is still a controversial problem. In my opinion, there are two positive factors for bank efficiency: Firstly, going to public means tighter regulation requirement (information disclosure and accounting principle), also the public supervision can work to some extent. Generally speaking, better supervision and regulation will spur the company to improve its efficiency. Secondly, easier and cheaper capital access is the other point. Financially, the cost of capital from the stock market is lower which might enhance the profit. A newly case is ICBC, its profitability surged significantly since its IPO in 2006 and for the first half financial year 2008, ICBC’s net profit reported as No.1 of all China’s commercial banks at 64.53 billion Yuan.

HypothesisHypothesis 5555: The size of banks willpositivelyaffect the performance.

As mentioned above, Berger and Humphrey, 1991; Mester 1992, Humphrey, 1990; Mehdian and Rezvanian, 1998 indicate that the economy of scale only exists when the banks are very small because they find the average cost curve shows like U-shaped and the cost will increase with the surging of scale. In my case, most of my samples are relative smaller companies (total assets less than 1 billion Yuan) so I expect the more possible that the economy of scale will exist.

H H

HHypothesisypothesisypothesisypothesis 6666: Being national banks affects commercial bank performance positively

relative to being local banks.

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banks and local running banks. For the national banks, they can disperse their risk in the big market and usually they are more attractive to good professionals than local banks. However, each cloud has a silver lining, the market and competition situation they face is much more complex than local banks do. The combination of these two factors is hard to expect and the better performance of national banks is just my general felling, we will find the result after my study.

H H

HHypothesisypothesisypothesisypothesis 7777: The level of economic development in different areas positivelyaffects local bank performance.

For the local banks, the areas they based are not developed equally and the unbalanced economic development level might affect the local bank performance. I will firstly test the performance difference between two groups and then for the local banks case only, a new variable will be introduced into regressions and a new group of regressions will be run to measure the economic development level’s influence on local banks performance.

H H

HHypothesisypothesisypothesisypothesis 8888: China’s entry to the WTO has apositiveinfluence on commercial bank performance.

After the Chinese government signed the agreements with WTO, a lot of new policies have been implemented to upgrade the competitive edges of China’s commercial banks. Considering the introduction of new legal system, new regulation institution and the time lag of economic policies, I would like to set up the year 2004 as a dividing line to test the efficiency difference before and after China’s entry into WTO.

3.3

3.3 3.3 Added

Added

Added Value

Value

Value of

of

of My

My

My Paper

Paper

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research mentioned above especially in the China banks case they only used the data until 2003. Banking industry in China are changing rapidly since 2001 and the internationalization and liberation of financial department are on the way right now. So the recent data can explain more clearly about the research question. Besides that, I will also imitate their way to define the different ownership types but I will do some improvement:

A. Their paper used 50% as a boundary of minority/majority of foreign ownership but according to “The law of Commercial Banks”, the minority foreign ownership should be restricted no more than 25% and any excess of this restriction, the bank will be supervised and regulated as a foreign owned bank rather than domestic banks. So 25% is a more reasonable level.

B. I will introduce more variables which they ignored or not mentioned but do affect bank efficiency such as whether the banks have been listed on the stock market or not, running area and economic development and China’s entry of WTO. All of them will be taken into account hoping that can make my research more comprehensive.

C. I will not follow their way to build a rank system to compare the efficiency difference because my regressions contain more variables than they did. I expect that I can reach a similar result as they did by using a totally different methodology to prove the result is exactly right.

D. The last but not the least, my target will be restricted only on the commercial banks so I exclude the policy banks1_{, central bank and other financial} institutions.

1 _{Policy bank is a special type of bank which is unique in China. They are built up to assume the function of politic}

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4.

4. Methodology

Methodology

4.1

4.1 4.1 Data

Data

Data Source

Source

The basic data source is Bankscope. Whenever Bankscope doesn’t provide enough information or has questionable values (Bankscope doesn’t contain the data for the year 2007), I will double check other official source, such as annual reports provided by individual banks via their websites, and newspaper releases on the performance and financial information of the banks in tracing missing or unavailable data points, in some cases. Now I use unbalanced panel data for 51 commercial banks from 2000-2007 (in some cases the data before 2002 or the year 2007 are missing) and there are 317 observations. For the areas’ economic development data, I collected them from the website of National Bureau of Statistics of China (http://www.stats.gov.cn/) which provides complete data I need.

4.2

4.2 4.2 Dependent

Dependent

Dependent V

V

Variables

ariables

4.2.1

4.2.1 4.2.1 The

The

The evaluation

evaluation

evaluation system:

system:

system: Three

Three

Three basic

basic

basic elements/characters

elements/characters

elements/characters of

of

commercial

commercial banks

banks

banks performances

performances

Profitability, liquidity and security are the three basic elements of commercial bank’s operating principles. Since they are interdependent, interactive and contradictory to one another, it is a challenging issue for commercial banks to balance these three elements harmoniously. (Xu, Zhu and Chi, 1999). Some popular financial ratio measures can be used to represent the level of these basic elements:

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any companies. The most representative measure is ROA (return on assets). It has three different types: ROAA, RONA and ROTA, the differences are the return on average assets, net assets or total assets.

B. Liquidity: Liquidity acts like a lever between profitability and security. Commercial banks often change their portfolio structures to find a balance between profitability and security, so it is more possible and more often for commercial banks to meet with over or lack liquidity situation compared with other types of companies. LIQ (liquid assets to short term funding ratio) indicates the percentage of customer and short term funding that could be met if they were withdrawn suddenly. OCF (operation cash flow ratio=operation cash flow/ short-term liability)

gauges a company's liquidity in the short term.

C. Security: According to the Basel Capital Agreement, the security has been introduced as a basic requirement of commercial banks. EQTA (equity to total assets) is the extensively used ratio to capture one aspect of security (capital strength) while non-performing loan ratio (risk management loans / total loans) shows the level of asset strength as another aspect of security.

Furthermore, as another commercial bank performance evaluation system, CAMEL model also mentions these characters. It is an internationally accepted tool for evaluating performance and predicting bank failures. CAMEL stands for Capital Adequacy, Asset Quality, Management Quality, Earnings Quality and Liquidity. I would borrow the measures mentioned above to evaluate the commercial bank performance in my study and the details of corresponding variables selections will be discussed latter.

4.2.2

4.2.2 4.2.2 Dependent

Dependent

Dependent V

V

Variables

ariables

ariables Description

Description

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researches such as Fotios, Chrysovalantis and Constantin, 2006; Poon and Firth, 2005 and so on. There are three different types: ROAA, RONA and ROTA, the differences are just the different way to calculate the asset. I will adopt ROAA because it’s directly available according to the Chinese Accounting Principle. ROAA= net income/average asset

B. Liquid assets to deposits & short term funding ratio (LIQ). Liquid assets means short-term assets that can be easily converted into cash, such as cash itself, deposits with the central bank, treasury bills, other government securities and interbank deposits among others. Bankscope uses this ratio to show the liquidity of commercial banks and I will follow this way in my paper. LIQ= liquid assets/ deposits & short term funding

C. Equity to total assets ratio (EQTA): With the introduction of Basel Agreement II, capital requirements have received increased attention in recent years (Fotios, Chrysovalantis and Constantin, 2006). EQTA is the most intuitionist ratio to measure the capital strength which is also used by Fotios, Chrysovalantis and Constantin. EQTA= equity/total assets

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4.3

4.3 4.3 Independent

Independent

Independent V

V

Variables

ariables

Table 1 shows the brief information of all my independent variables:

T T T

Tableableableable 1:1:1:1: IndependentIndependentIndependentIndependent variablesvariablesvariablesvariables information:information:information:information:

Variable Abbreviation of Variables Description Source

Ownership concentration OC The shares percentages of 3 biggest shareholders

Annual reports and public disclosure

State ownership SO Shares percentages owned by state or local government/ government department/ state-owned

enterprise

Minority foreign ownership dummy

FO _{Whether the individual} commercial bank has minority foreign ownership.

“1” means “yes” and “0” means “no”.

Listed dummy LD Whether the individual

commercial bank has been listed on the stock market or not. “1” means “yes”

and “0” means “no”.

Size SIZE Total assets Bankscope and annual reports

Running area dummy AD “1” represents national banks and “0” represents

local banks

GDP per capita GDP GDP per capita of running areas

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A. Ownership concentration percentages (OC): the shares percentages of 3 biggest shareholders. This variable can indicate the ownership concentration, whether there are some powerful shareholders in one commercial bank to affect the decision of corporate governance and then the performance. (Hypothesis 1)

B. State ownership percentages (SC): shares percentages owned by state or local government/ government department/ state-owned enterprise. This percentage indicates to what extent the state has influence on each commercial bank which might affect bank efficiency through corporate governance and political influence. (Hypothesis 2)

C. Minority foreign ownership dummy variable (FO): whether the individual commercial bank has minority foreign ownership. “1” means “yes” and “0” means “no”. This dummy is designed to test the Hypothesis 3.

D. Listed dummy variables (LD): whether the individual commercial bank has been listed on the stock market or not. “1” means “yes” and “0” means “no”. This dummy is designed to test the Hypothesis 4.

E. Size: logarithm of total assets. Usually, total assets and employee numbers are two basic indexes to measure the firm size. Because of the difficulty of getting employee numbers from my time period, I will use total assets in my regression model (Hypothesis 5).

F. Running area dummy variable (AD): “1” represents national banks and “0” represents local banks to test the efficiency difference between two types of commercial banks. (Hypothesis 6)

G. GDP per capita of running areas(only for local banks): I choose GDP per capita to measure the economic development level of individual area in which local bank is running to explore the relationship between bank performance and economic development level of running area. (Hypothesis 7)

Year dummy 2004 D2004A The data for “year”>=2004 are marked as “1” and for the rest of them are marked

as “0”

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H. Year dummy 2004 (D2004A): the data for “year”>=2004 are marked as “1” and for the rest of them are marked as “0” to test the performance difference before and after 2004. (Hypothesis 8)

5.

5. Data

Data

Data Analysis

Analysis

5.1

5.1 5.1 Summary

Summary

Summary description

description

description of

of

of observation

of

observation

observation and

and

and statistics

statistics

The basic statistical characters of my observations are showed as the following table 2 and 3:

T T T

Tableableableable 2:2:2:2: InformationInformation forInformationInformationforforfor continuescontinuescontinuescontinues variables:variables:variables:variables:

Source: Source: Source:

Source: authorauthorauthorauthor’’’’ssss calculationcalculationcalculationcalculation T

T T

Tableableableable 3:3:3:3: InformationInformation forInformationInformationforforfor dummydummydummydummy variables:variables:variables:variables:

Source: Source: Source:

Source: authorauthorauthorauthor’’’’ssss calculationcalculationcalculationcalculation

As it shows in table 2, the non-dummy variables fluctuated overtime. Here I calculate the mean value, median value, maximum, minimum and standard deviation

Variables Mean Median Max Min Std.Dev

Number of Observations ROAA (%) 0.600568 0.49 8.58 -1.25 0.652349 317 LIQ (%) 24.23587 17.89 246.61 6.46 26.26479 317 EQTA (%) 8.80735 4.61 87.23 -11.74 13.34672 317 Ownership Concentration (%) 57.18164 42.71 100 15.93 29.87542 317 Size 557758.5 39793.4 8532370 375.6 1368599 317 State Ownership (%) 48.14438 43.7 100 0 28.88435 317 GDP per capita 22089.21 18462.42 65473 4446.908 13562.15 192 Dummy Variables Number of Observations for "1" Number of Observations for "0" Area dummy 125 192

Foreign Ownership Dummy 130 187

D2004A 178 139

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of them to indicate the basic statistical measures of them. What I would like to point out is that the “number of observations” for “GDP per capita” is 192. In this case, I only studied the influence of “GDP per capita” on local banks’ performances so the corresponding data for national banks were filtrated.

Table 3, on the other side, shows the observation information about my dummy variables. For “Area Dummy”, “1” means national bank and “0” means local one; for “Foreign Ownership Dummy” and “Listed Dummy”, “1” means “yes” and “0” means no while the year dummy “D2004A” have a special meaning which “1” means after 2004(included) and “0” means before 2004. Approximately, the distributions of my dummy variables are balanced but the “Listed Dummy” is an exception: for most listed companies in my samples, they only went to the stock markets recent years (typically after 2003).

5.2

5.2 5.2 Data

Data

Data diagnoses

diagnoses

Because of the veracity of the data, data diagnoses is absolutely necessary to check whether the variables have been adopted appropriately for my regression model and are there any data biases might affect the accuracy of my result.

A. Normal Distribution:

First of all, all my testing is based on t- and F-distributions. This is only true if the errors are normally distributed. The Jarqure-Bera value of the residuals of my regression is 80014.82, much bigger than the Jarqure-Bera χ2 _{critical value 14.067.} This result means clearly that the residuals are normally distributed.

B. Nonstationarity:

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only on the length of time separating the two values, and not on the actual times at which the variables are observed.” (Hill, Griffiths and Judge, 2001). In order to avoid the spurious regression, a Unit Root Test—a Dickey-Fuller test on all my continuous variables was run. The results are showed in Appendix 4: all the null hypothesis is rejected at significance level 5% and there is no unit root test in my variables.

C. Heteroscedasticity:

If all the observations’ variances are not the same, the heteroscedasticity exists. (Hill, Griffiths and Judge, 2001). and “Heteroscedasticity is most commonly expected in cross-section data.” (Johnston and Dinardo, 1996). Usually the White Test is the most popular method to test the heteroscedasticity and we can use White’s estimator to overcome it. According to the results of White test reported in Appendix 5: the H₀ “there is no heteroscedasticity” was rejected and White’s estimators are adopted to overcome this problem.

D. Autocorrelation:

“The disturbances are autocorrelated (correlated with themselves)” (Johnston and Dinardo, 1996). Here we obtain the definition of autocorrelation. It is easy to test the autocorrelation with Durbin-Watson test while the DW value is given by the output of Eviews. H_0:the error terms are uncorrelated and there is no autocorrelation. The DW values were significantly different with 2 and -2 in my original regressions but with the introduction of AR(1), the problem of autocorrelation was solved.

E. Multicollinearity

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correlation coefficient is -0.60) and we can conclude that there is no multicollinearity problem in my regression.

6.

6. Model

Model

Model Estimation

Estimation

6.1

6.1 6.1 Model

Model

Model Construction

Construction

Generally, there are 3 ways for model estimation with panel data: the polled regression model, the random effects model and the fixed effects model. When there is no significant difference between each unit overtime, the simple polled estimation is the easiest way. Unfortunately, under most circumstance including my study, this assumption is not satisfied and we will have to choose random effects model or the fixed effects model. Some researchers believed fixed effects estimation to be more persuasive than random effects estimation. (Johnston and Dinardo, 1996) and the conclusion of that chapter seems give no simple rule to help us about the selection. In this case, the Hausman test can be used to select the model. The result of Hausman test of my regression shows the random effects are correlated with the independent variables (the p-value=0) which means the assumption of Random Effects Model is not satisfied and we will choose Fixed Effect Model. Furthermore, I still have 3 alternatives: fix the units, fix the time or fix both of them. According to my knowledge, the performance difference between my samples is big from year to year because of the short-term national economic fluctuation. When I tried to introduce unit dummies into my model, the “near singular matrix” problem occurred which might because the unit dummies have similar trends with year dummies. So I have to use time fixed effects estimation in my study.

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can be categorized into 3 groups while group 1 is the basic group (time fixed model including area dummy) and the expressions and statistical results are as follow:

Model group 1:

ROAA=β0+β1OC+β2SO+β3FO+β4LD+β5SIZE+β6AD+β7AR(1)+α1+α2D2000+… +α2006D2006+εit(Equation 1)

LIQ=β0+β1OC+β2SO+β3FO+β4LD+β5SIZE+β6AD+β7AR(1)+α1+α2D2000+…+α2006 D2006+εit(Equation 2)

EQTA=β₀+β₁OC+β₂SO+β₃FO+β₄LD+β₅SIZE+β₆AD+β₇AR(1)+α₁+α₂D₂₀₀₀+…+α₂₀₀₆ D₂₀₀₆+ε_it(Equation 3)

Model group 2:

ROAA=β0+β1OC+β2SO+β3FO+β4LD+β5SIZE+β6GDP+β7AR(1)+α1+α2D2000+… +α2006D2006+εit(Equation 1)

LIQ=β0+β1OC+β2SO+β3FO+β4LD+β5SIZE+β6GDP+β7AR(1)+α1+α2D2000+…+α2006 D2006+εit(Equation 2)

EQTA=β0+β1OC+β2SO+β3FO+β4LD+β5SIZE+β6GDP+β7AR(1)+α1+α2D2000+…+α200 6D2006+εit(Equation 3)

Model group 3:

ROAA=β₀+β₁OC+β₂SO+β₃FO+β₄LD+β₅SIZE+β₆AD+β₇D2004A+β₈AR(1)+ε_it(Equati on 1)

LIQ=β0+β1OC+β2SO+β3FO+β4LD+β5SIZE+β6AD+β7D2004A +β8AR(1)εit(Equation 2)

EQTA=β0+β1OC+β2SO+β3FO+β4LD+β5SIZE+β6AD+β7D2004A+β8AR(1)εit(Equatio n 3)

6.2

6.2 Estimation

Estimation

Estimation Results

Results

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T T T

Tableableableable 4:4:4:4: OverviewOverview ofOverviewOverviewofofof estimationestimationestimationestimation resultsresultsresultsresults

N N N

Notes:otes:otes: “otes:“““++++””””meansmeans positivemeansmeanspositivepositivepositive influenceinfluenceinfluenceinfluence,,,, ““““----”””means”meansmeansmeans negativenegativenegativenegative influence,influence,influence,influence, ““““NN”NN””” meansmeansmeansmeans notnotnotnot significant.significant.significant.significant.

T T T

Tableableableable 5:5:5:5: ResultsResultsResultsResults ofofofof modelmodelmodelmodel groupgroupgroupgroup 1111

Notes Notes Notes

Notes:::: ““““****””””,,,, ““**““******””””,,,, ““““************”” indicate””indicateindicateindicate significancesignificancesignificancesignificance atatatat thethethethe 10%,10%,10%,10%, 5%,5%,5%,5%, 1%1%1%1% levelslevelslevelslevels respectively.respectively.respectively.respectively.

Table 5 shows the results of my model group 1. The R-square values of these three regressions are 0.321100, 0.814596 and 0.649558 respectively. Now, we are going to analyze the estimated coefficients. First of all, the ownership concentration percentage shows positive effects on all my three dependent variables at 1% significance level which is on the opposite of my hypothesis 1. Similar result which

Independent Variables＼Dependent

Variables ROAA (%) LIQ (%) EQTA (%)

Bank Performa nce Expected Signs Ownership Concentration (%) + + + + -State Ownership (%) - - - -

-Foreign Ownership Dummy + N + + +

Listed Dummy + + + + +

Size + + - + +

Area Dummy - N - - +

GDP per capita - - - - +

D2004A + + - + +

Independent Variables＼Dependent Variables ROAA (%) LIQ (%) EQTA (%)

C 1.18429*** (70.49111) 30.96856*** (52.94003) 6.270988*** (23.72178) Ownership Concentration (%) 0.003875*** (13.25585) 0.204697*** (19.95895) 0.187668*** (35.57528) Size 2.37E-08*** (8.272356) 2.72E-07* (1.757264) -4.14E-07*** (-5.518846) State Ownership (%) -0.007730*** (-25.50360) -0.301071*** (-28.38271) -0.183366*** (-27.64439) Area dummy -0.056856*** (-5.305781) 0.060647 (0.118118) -4.508263*** (-15.31107)

Foreign Ownership Dummy

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surprised me most is the case of area dummy. The area dummy has negative influences on both ROAA and EQTA at 1% level of significance while it’s coefficient in equation 2 is not significant. These results mean that generally, the national commercial banks performed worse than local banks. This is again the opposite of my hypothesis. Fortunately, other independent variables’ coefficients were proved consisted with my expectation. Size of commercial banks provides positive signs on ROAA and LIQ at 1% and 10% level respectively and shows negative sign on EQTA at 1% level. According to the rank of these three dependent variables, ROAA and LIQ (profitability and liquidity) are more important than EQTA (security) in my commercial bank performance system so I can give the conclusion that the size of commercial banks has positive effects on performance. State ownership, as I expected, has negative signs at 1% level in all three regressions. There is the similar story for listed dummy: the positive coefficients are significant at 5% and 1% level respectively.

The listed dummy also shows positive signs on three dependent variables at 5% and 1% respectively. Lastly, the foreign ownership dummy has significant effects (1% level) on ROAA and EQTA while the coefficient in equation 2 is not significant.

In model group 2, the samples were reduced to only local banks (area dummy=”0”) and I replaced area dummy with GDP per capita to test my hypothesis 6.

The results are indicated by table 6.

T T T

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The results show that the most coefficients are similar with those in model group 1 (same positive or negative direction, some different significance levels in some case.) The core task of this model group is to test the GDP per capita. The results are disappointing that it provides negative signs in all three regressions at 1% significance level.

Table 7 reports the results of model group 3 which is designed to test my hypothesis 8. Because of the singular matrix problem (D2004A has similar trend with other year dummies), I have to remove them thus my model group 3 is no longer to be time fixed effect. D2004A shows positive signs on ROAA and LIQ at 1% and 5% level of significance respectively while it is reported negatively affect EQTA at 1% significance level. According to my ranking system mentioned before, EQTA accounts for smaller proportion of commercial bank performance and thus I get the conclusion that generally, D2004A is positive significant. The other coefficients are similar with group 1 and 2.

T T T

0.055007** (2.397683) 5.187370*** (7.627351) 5.533254*** (14.11149) Listed Dummy 0.052230* (1.673589) 4.323200*** (7.458742) 3.534703*** (6.845663)

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7.

7. 7. Results

Results

Results Discussion

Discussion

7.1

7.1 7.1 O

O

Ownership

wnership

wnership concentration

concentration

How and to what extent the ownership concentration of commercial banks in China will affect the commercial bank performance? In my hypothesis 1, I expected a negative influence considering mainly one reason: because of the imperfect company cooperation, general meeting of stockholders and legal and supervision system in China, high ownership concentration will cause a complex network of “Guanxi” and a large possibility of insiders control problem which potentially damaging commercial bank performance. However, the results of my regression I stated above don’t support my hypothesis 1 and indicate positive signs on all my performance variables which are consisted with other researcher’s findings. (Claessens and Djankov, 1999 and Pivovarsky, 2001.) It is probably because several reasons: first of all, the lower ownership concentration usually causes higher governance cost (time wasting managerial decision procedure) as Pivovarsky mentioned in his paper. On the other hand, the “Guanxi” and insiders control problems (both of them are linked with corporate governance) which I expected potentially damaging commercial bank performance can be conquered under current situation in China by stricter supervision and regulation. 14 of my samples have been listed on the stock market which means these banks’ governance will be not only supervised by their shareholders but also by public such as consensus. Further more, as a special industry concerning the financial safety of the whole country, commercial banks are regulated by China Banking

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Regulatory Commission (CBRC). The stricter supervision and regulation overcome the “Guanxi” and insiders control problems to some extent.

Generally speaking, the results show that under current circumstance in China, a larger ownership concentration structure for commercial banks promote the commercial bank performance.

7.2

7.2 7.2 S

S

State

tate

tate ownership

ownership

The results are unanimous with my hypothesis 2 and all the other studies I mentioned (Berger, Hasan, and Zhou, 2006; La Porta, Lopez and Shleifer, 2002; Tian and Estrin, 2007; An, Bae and Ratti, 2007): the state ownership shows significant influence on commercial bank performance. As I stated above in section 3, these results mainly owning to three problems which are caused by state ownership: owner absence problem, political influence (soft budget constraints) problem and the inefficiency of monetary policy. Now there is no doubt that over-concentrated state ownership is harmful to commercial banks performance and the results of my study strongly support this point.

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act as a savior just as it did in the plane economy so giving up part of its power is necessary. In the transition economy, it is the government’s duty to learn how to use the efficient monetary policy to replace the administrative policy and improve it into a more efficient way. For the third point, under the integration of world economy, the culture collisions are unavoidable and what the government should do is to adjust itself to the globalization. As for the finial worrying, I don’t think the financial safety of China will be threatened because even though the government declines its share, it will still remain comparative dominance of the Big Four and that’s enough to guarantee the financial safety. A percentage of approximately 30% is enough I think which can keep the state as a main shareholder in this industry.

Here comes the second question we need to answer: to whom should the government sell its share and at what price? The potential investors include private investors, domestic institutional investors and foreign investors. Firstly, considering the huge amount assets, the share will be mainly sold to domestic and foreign institutional investors. Especially the introduction of foreign institutional investors can bring advanced management and supervision systems to improve the efficiency and promote the reform of a traditional system. On the other hand, the pricing problem can be summarized into one question: Whether the commercial banks of China are being sold at an underestimate price? There are two arguments about this question: Some scholars (Chen, 2005) claimed that when the state-owned commercial banks introduced strategic investors into their shareholding and management structures,

the price were at such a low level which is far away under the real value of those banks. They argued that considering the networks, brands and reputations of business of the 3 big state-owned commercial banks, the price were too low. They use the ICBC as an example case: it sold 10% of their stocks to the strategic investors from Hong Kong and America with approximately 3.78 billion dollars, that’s means the investors have these stocks without paying any premium while after the IPO of ICBC, the annual return rate was more than 30%.

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heavy historical burden, the unreasonable management structure, the excessive intervention from the government, the over-strict limitation of the shareholding ratio for foreign capital and the different revenue and accounting system from international tradition which all of them will lead to some potential risks, the foreign investors always have stronger bargaining power and ask for “special discount” to make up that kind of potential risks. Especially the lack of preparations for bad debts for Chinese commercial bank will overestimate the profitability. For example, in the case of the IFC (International Financial Corporation) purchasing the share of Shanghai bank, the evaluation of net assets per share according the Chinese accountant rule and the Pricewaterhousecoopers rule were CHY 2.1 and CHY 1.07 respectively. What causes the huge gap was the difference of preparations for bad debts. On the other hand, the competition capacities of Chinese commercial banks are so weak and their credits are mainly guaranteed by the government. If we use an international standard to compare them with foreign ones, the Chinese commercial banks’ indexes of profitability, liquidity and security are comparatively lower. So in generally, I claim that the prices for shares are reasonable.

7.3

7.3 7.3 F

F

Foreign

oreign

oreign ownership

ownership

My hypothesis 3 is to explore whether the existence of foreign ownership will improve commercial bank performance in China and the answer is yes which is consist with not only my expectation, but also findings of other scholars (Berger , 2007;

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agree with Cheng’ argument and I want to point out that comparing with other transition economies such as East-European countries, the percentage level of foreign ownership is much more lower in China. There is still a large room for China to improve the commercial bank performance by introducing more foreign investors.

7.4

7.4 7.4 Listed

Listed

Listed dummy

dummy

My results show clearly positive relationship between commercial bank performance and going to public which supports my hypothesis 4. As I have mentioned above, “create conditions for being listed on the stock market” is one of the bank reform targets captured by Central Committee of the Communist Party of China. The Chinese government encouraged commercial banks to go to public mainly because two reasons: It is a feasible method for state government to transfer part of shares it has to private, foreign and domestic investors, in another word, decline its shares in the commercial bank industry. My research results and other studies about hypothesis 2 have proved the negative relationship between state ownership and commercial bank performance. It seems like the government itself has also realized this problem. Furthermore, tighter regulation requirement, public supervision and easier capital access are the main positive factors of performance improvement for listed commercial banks as I argued in section 3.

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7.5

7.5 7.5 S

S

Size

ize

The results again support my hypothesis 5 indicate that the size s positively related with commercial bank performance in China. The economy of scale is the most reasonable explanation as I have discussed. Most of the commercial banks in China are comparative small that the economy of scale exists in their cases.

These results are also related the facts: in recent years (since 2002), the reorganization and acquisition of commercial banks are in full swing in China. In fact, most of my samples which named “** city commercial bank” are reorganized from several smaller banks in given area and these kind of reorganization and acquisition are theoretically encouraged by my results.

7.6

7.6 7.6 Running

Running

Running Area

Area

Area Dummy

Dummy

Dummy and

and

and GDP

GDP

GDP per

per

per capita

capita

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financial institutions and private finance, my research doesn’t take these factors into account which might be the main reason which caused the biases of hypothesis 6 and 7. Unfortunately, there seems to be no official data source in the foreseeable future, either. Future exploration can base on nonofficial ways to collect all indispensable information and data.

7.7

7.7 7.7 Y

Y

Year

ear

ear dummy

dummy

dummy 2004

2004

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with Chinese banks. The existence of foreign competitors will obviously encourage the increasing of competition level in China’s commercial bank market thus inspirit the performance improvement of the whole industry.

8.

8. Conclusion

Conclusion

Conclusion and

and

and Future

Future

Future Exploration

Exploration

Generally speaking, the findings of this research can be categorized into 2 groups: One is concerned with commercial bank performance’s influence factors. The ownership concentration, minority foreign ownership, being listed on the stock market, the size of the bank and the new policies after entrance WTO are the main factors which can promote commercial bank performance; correspondingly, the state ownership is negatively related with commercial bank performance.

The second is concerned with facts about commercial bank performance in China: local banks performed better than national banks and the local economic development level is negatively linked with local bank performance.

The first group of findings compellingly support all the efforts Chinese government made to promote the bank reform: decline state-owned shares in commercial bank industry and introduce foreign investors into domestic commercial banks; encourage the qualified commercial banks to issue their shares on the stock market; encourage the reorganization and acquisition of local city commercial banks; last but not least, carry out the WTO agreement actively and built up better legal, supervision and competition system for the commercial bank industry. Furthermore, all these findings also encourage the government to go further (release more limitation and keep on the improvement of banking supervision and regulation as such) in the future with the deepening of the financial reform especially the commercial bank reform.

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Compared with foregoing researches, my paper has some new contribution: first of all, the adoption of recent data is one highlight. The recent data can explore my topic better especially in the rapid changing economy in China. Secondly, the introduction of more comprehensive variables can explain the research questions better. Thirdly, the using of different methodology with foregone search validates the accuracy of the

results about commercial bank performance. Most papers discussing bank

performance or efficiency adopt ranking system to compare the different efficiencies between groups. My paper follow their variables setting but using a time fixed effects regression model to test whether I can get similar results with different ways.

However, like a concave and convex nutshell, there are also some limits:

A. Because of the limit of data availability and the veracity, the result might be biased to some extent: The data are unbalanced and there are some missing values; The accounting principle is a little bit different in China compared with international principle; Some potential factors maybe not included (such as competitors situation)

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