Thursday, March 29, 2012

29/3/2012: China's Banking Sector Analysis

A very revealing paper on Chinese banking sector - link here. A lengthy summary of some points:

The study describes "aggregate developments of the sector and compare them to the situation in other countries. ...Our results confirm that the Chinese banking sector is truly in a class of its own, especially given the level of China’s economic development. Despite significant reforms, the state and various public organizations still own controlling shares in the largest commercial banks. The state is also present on the borrowers’ side; it is estimated that about half of state-owned commercial bank lending still goes to state-controlled companies." [Note: this induces rather unique risk into China's banking sector - the risk of losses on both sides of the transaction and also quality risk to banks assets, as state-owned enterprises in China tend to be higher risk]. 

Furthermore: "More than 90% of total banking sector assets are state-owned in China (Economist, 2010), while Vernikov (2009) puts the corresponding figure for Russia at 56%. In general, reforms in the Chinese banking sector have lagged relative to other sectors of the economy."

Thus, "Chinese policy has striking parallels to the Russian experience; there has never been a major effort to privatize banking and banks today continue to be directly or indirectly controlled by the state or public institutions." Except, in Russian case, there are far fewer state enterprises and once controlled for extraction sector enterprises [less subject to traditional risks], there are even fewer state-controlled enterprises links to state-controlled banks of the lender/borrower relations side. Furthermore, "the lack of capital controls, of course, means that Russians have greater freedom in choosing providers of their financial services."

"Despite listing and the presence of foreign investors, all the large commercial banks are still majority state-owned. The share of state and state-owned entities at the end of 2010 was 83.1% in ABC, 70.7 % in ICBC, 67.8 % in BOC, and 60.1 % in CCB. The corresponding number for the Bank of Communications was 32.4 %"

"In this way, the banking system can serve as an important policy tool. (see below)

"Another distinctive feature of the Chinese banking sector is the variety of its banking institutions. New types of banking institutions, especially those serving rural areas, are emerging all the time. While equity and debt markets are still tiny relative to the banking sector and their importance as sources of financing of investment remain minor, they have evolved rapidly in recent years."

Some interesting facts: "The government’s stimulus efforts to avoid recession in 2009 resulted in a massive spike in bank lending that increased the consolidated banking sector balance sheet by approximately a third. Rather than pull back, bank lending went on to expand an additional 20 % in 2010. Lending outside the banking sector’s balance sheet has also grown strongly (García-Herrero and Santabarbara, 2011). These lending trends in themselves should be sufficient to raise concerns about the quality of bank loan portfolios and the need to curtail growth of bank lending in coming years..."

"Bank loans are the most important source of external funding for the non-financial sector in China. They accounted for 75% of all external funding sources at the end of 2010, and exceeded 80% during the crisis years of 2008 and 2009 when other external sources were difficult to obtain. As we saw in early 2009, the Chinese authorities can turn to bank lending as a policy tool when the need arises."

The unbalanced nature of Chinese banking translates into significant concentration of State power in lending: "Bank lending grew between 2006 and 2010 at the average rate of 20% a year, thanks in part to the government stimulus program in the face of the global economic re- cession. Loans to non-financial companies accounted for around 70% of new loans. State- owned commercial banks (SOCBs), traditionally the biggest loan providers, accounted for 43% of all new loans issued in 2009 (their share was 51% in 2001). SOCBs accounted for about half of the total banking sector loan stock at the end of 2010. This proportion corresponds to their share in total sector assets."

And more: "Even though the Chinese banking sector is huge for a middle-income nation, bank lending is heavily skewed to state-owned companies. Allen et al. (2008) note that the size of China’s banking system, in terms of total bank credit to non-state sectors, was 31% of GDP in 2005. This figure is not too different from the average of other major emerging economies with a weighted average of 32% of GDP. Looking at total bank credit, including loans to state sectors, the ratio of China’s bank credit to GDP rises to 110% − a level higher than even in countries with German-origin legal systems (weighted average 106%). The difference between total bank credit and private credit suggests that most of the bank credit is issued to companies that are ultimately owned by the state. Also Okazaki et al. (2011) report that bank lending in the recent years has mostly gone to large SOEs. In 2009, about 50% of SOCB loans were extended to large SOEs. Private enterprises received some 14% of total lending provided by the banking sector."


A.K.A. Damo Mackerel said...

This is off topic but may I ask you a question?

What is your opinion on the Austrian School of Economics?

TrueEconomics said...

It is off topic, but very topical.

I think in the history of economic thought, Austrian School is a major contributor to economics and formed the foundation - via its links to markets analysis and empirical grounding - to much of modern economics, especially to microfoundations-based schools of modern economics. In some ways, it is exactly the thinking arising from the classical Austrians that also paved the way to behavioral economics.

It is distinct from Keynesian School and from the structuralist sub-themes precisely because it did not treat aggregate economy as an entity of its own right, but rather as a collection of human actions and social organization.

The roots of this thinking trace back to School of Salamanca, that started translating causal interpretations - cause - effect links - into social organization and into functioning of the macroeconomy (inflation in particular).

This was followed by another pre-cursor to Austrians - the Scholasticists, especially the likes of Cantillon - Irish-born 18th century economist. Cantillon laid foundations to Austrian's focus on entrepreneurship as a systemic process that is still grounded in individuality (behavior and choice). He also formed early Austrian-like understanding of monetary theory (again, inflation).

Turgot, Say, Bastiat - giants of French economic enlightenment followed. Core, as with later Austrians, was empirical focus based on intuitive narrative.

TrueEconomics said...


The first real Austrian economist was probably Menger - challenging proto-Marxists - returning economics back to Scholastic methodology:
1) subjective nature of value in economics (think - that gave future ground to expanding economic thinking to social sciences in general - because it vastly expanded the theory of utility to incorporate effectively any positive or negative value assignment that can be attached to any good or bad - social, political, cultural, aesthetic etc, not just economic)
2) marginal utility theory, inc the law of diminishing marginal utility

Key point, Menger saw economics as a study of individual choices, a study of human action based on both intuitive structure (theory) and empirical analysis.

Actually here's a good summary of the whole foundation to Austrian School:

TrueEconomics said...

Now, my own view - I am Austrian at heart, as to me:
1) Economics is the study of individual choice constrained by collectively-determined environment
2) Economics is powerless as a data-mining exercise, but has real power when data and theory are informing each other
3) Human action is definitive of everything we see in social sciences.

However, I recognize that
A) Tools of analysis evolve and as they do, theoretical methods are evolving at different speed. This means that sometimes, theoretical foundation is laid 'imperfectly' - not in alignment with empirical analysis. Which means that sometimes, theory has to follow empirical observations and sometimes lead them.
B) As our understanding of the world evolves, our models take longer time to catch up - e.g behavioral economics still lack same rigor of theoretical basis as more developed economics, sometimes stylized results must be accepted due to limits of mathematics we deploy etc.
C) The world is not 'perfect' - in a sense that models and choices and behavior change. 'Irrationality' and other 'behavioral' choices and actions are still human (some might say they are more human than rational choices).

Many other things come to mind. But, frankly, I doubt Mises and Popper and Hayek would have had much of a problem accepting that which is today being paraded around as 'proof' that Austrians were 'wrong'.

TrueEconomics said...

I am not sure this explains... :-) count it as 'thinking out loud'?

A.K.A. Damo Mackerel said...

Dear Dr Gurdgiev, thank you very much for your response and taking the time to do so.

I'm trying to self educate myself about economics. I'm also looking over this site

Anonymous said...

Dear Dr. Gurdgiev:

Where do you think are areas of possible further reform in China's banking sector, and how realistic are these reforms going to be?

Thank you,