The evolution of commercial banks in China (2006 -2016): performance and risks
Creators: name: HUANG, Ji
Publisher: name: RMIT University
Year: 2024
Subjects: classificationCode: 350204
subject: Financial institutions (incl. banking)

description: This thesis examines the impact of the evolution of commercial banks on their profitability and risk for a panel of 97 Chinese commercial banks that account for 89% of total assets in the banking sector over the period from 2006 to 2016. The motivation for this research originates in the financial crisis and the subsequent initiatives to strengthen the resilience of banks. Previous studies show that a critical factor that helps US banks to take excessive risks before the GFC was the secular decline in their traditional business model of relying on banks¿ interest income (Saunders, 2020) and the over-expansion to market-based activities in securitization and derivatives (US Financial Crisis Inquiry Commission, 2011). While operating under different institutional and economic settings with a relatively underdeveloped financial and banking system, China's commercial banks have also been confronted with a rapid decline in their primary source of income from interest differentials from their traditional banking business based on maturity transformation between short-term deposits and long-term loans, due largely to the deregulation of formerly government-determined interest rates in the early 2000s. However, research on how Chinese commercial banks have responded to the regulatory and market changes and evolved over recent years in terms of the changes in traditional banking and their connectedness to the new business activities at the bank level remains scarce. Given the rising importance of China's economy in global growth and the role of its banking sector in facilitating economic development (Allen et al., 2017), this PhD research is motivated to investigate an understudied area to better understand the performance and risk consequences arising from the evolution of its commercial banks. <br><br>
Based on hand-collected data, this thesis shows that Chinese banks have engaged in six major non-traditional activities and have followed three integrated evolution pathways towards non-bank financial intermediation in terms of interactions of all major non-traditional business.  Based on machine learning techniques, for the first time, three distinct forms of NBFI identified by this study are: the Investment Model (f1) involves financial intermediation between receivable assets and debt funding; the Fee Model (f2)  centers on financial intermediation between non-interest fee activities, unsecured interbank lending and borrowing; and the Repo model (f3) involves financial intermediation between repo-based interbank lending and borrowing. <br><br>
To estimate the impact of banking evolution on performance, we use an econometric methodology, Fully Modified OLS (FMOLS) that accounts for non-stationary trendy data as well as potential endogeneity and auto-correlations in the banking sector of China. The findings of this study indicate that banks developing a higher share of fee income activities and a higher proportion of interbank assets, experience higher returns without incurring significant risks, while banks involving a greater proportion of investment assets and a larger share of trade income are less profitable and more risky. Banks that depend on a larger share of interbank liabilities, and those on debt payables all experience a higher liquidity risk and leverage risk. All three NBFI models are found to be associated with higher liquidity risk, with two models associated with an additional elevated leverage risk. Among them, banks with a new focus on the Repo model (f3) perform the best with higher returns, while those focusing more on the Investment model (f1) perform the worst with a lower return. By comparison, banks moving more to the Fee model (f2) are only safer with lower leverages and insolvency risk without improved returns. While large banks achieve a higher return through Fee model (f2), small banks obtain an enhanced return through Repo model (f3).<br><br>
 This thesis contributes to the development of the financial intermediation literature by developing a novel conceptual framework and empirical method for the analysis of commercial banking evolution in China, the largest banking system in the world. In uncovering new evidence on the evolution of Chinese commercial banks, this study highlights the importance to distinguish different lines of non-traditional businesses when generalizing the effects of non-traditional activities on the bank performance (DeYoung and Torna, 2013), since banks in less developed countries such as China may involve quite different types of new banking business, thus bearing different sets of risk-return characteristics (Ehlers et al., 2018). By investigating into the interactions of all major non-traditional activities, this study also provides new evidence supporting the need for and advantage of an integrated business model analysis that can provide a more integrated view on risks in the banking industry to help build efficient and forward-looking supervision (IMF, 2017).  Our results lend support to the new liquidity regulations as well as the latest initiative to recapitalize small banks to enhance the financial stability in China. <br><br>