Characteristics Of The Banking Sector

Published Date: 02 Nov 2017

ASB - 4407

Individual report

Performance of banking sector of China in recent years

Subhash Malhotra, abp0b2

500325218

Bangor Business school

Bangor university

Abstract

The banking sector of China still follows its traditional methods and beliefs. The government still has the control of the banking sector China. Unlike other banking sectors the china's banking sector decisions are taken by the government of the country and not partial owners or the stake holders of the banks because of the reason that the major part of the banking sector is owned by its state government. Entry of foreign banks in the banking sector of china has become easier after the entry of WTO in the china's banking sector. The entry of WTO might change the performance of the banking sector as the depositors might choose the other available options in the market.

Overview

Since 1978 China's economic reforms have produced and held economic growth, and led to rise in the real income and living standards of the country, china's economy has transformed from an insular economy to a trading economy. China has got a population of 1.3 billion but still it became the world's second largest economy with its GDP rising about 10% every year. The banking sector of china has a very important contribution in the nation's GDP.

Characteristics of the banking sector:

The section will focus on the characteristics of the banking industry with the view of current developments and growth within the market.

Ownership and market structure

The privatization within the banks which were previously owned by the government of china in the last decade has changed the structure and ownership of Chinese banking system drastically. The reforms of 1978 set up a two tier banking system in China which transformed People`s bank of China (PBC) into the central bank of China and it also led to establishment of specialized banks which included four SCB's.

ABC (The agriculture Bank of China)

BOC (The bank of China)

CCB (China construction bank, 1996)

ICBC (The industrial and commercial Bank of China)

The government also introduced small regional banks in different economic zones and also set up some credit corporations in rural areas named rural credit cooperatives and urban credit cooperatives. In the year 1994, the Agriculture development bank of China, China development bank and China import-export bank were started by the government of China as policy makers.

The state government of China owns almost 90% of the total assets of the banks. The large national and international commercial banks which use to provide retail and wholesale banking services were also owned by the state government of China. The large commercial banks that are listed in the Hong Kong stock exchange holds 48.5% of the total Chinese assets. The state government still has a major share in the ownership of large commercial banks of china the government has 83.1%,60.1%,70.7% and 67.8% of ownership in agriculture bank of china, China construction bank, The industrial and commercial bank of china and The bank of China respectively. Rural financial institutions such as rural mutual cooperatives, village and township banks as well as small lending companies were started recently and these institutions owns a 10% of total banking assets. Approximately 400 rural financial institutions are working in this sector.

One more bank i.e. Postal saving bank plays an important role in the banking sector of china which has more than 70% of its branches in the rural areas of the country and it was started in the year 2007 and has become the 5th largest bank by providing services to the rural customers. The government of china has also encouraged the foreign investors to invest in the country's banking sector by privatizing the banks which were previously owned by the state government. This privatization has led to entry of nearly forty incorporated foreign banks and more than ninety foreign bank branches in the market.

The policy banks which were started in 1994, had an aim of separating two different types of lending that is commercial lending and policy lending. As said earlier agriculture development bank and export import banks are those banks which work as policy lending institutions. However, there functions and workings are much like commercial banks. In the year the agriculture development bank and export import bank which earlier worked as policy lending banks were now allowed to accept deposits from the corporate clients and were now known as commercial joint stock institutions. The small non-financial institutions such as auto financing companies, customer finance, financing enterprise groups and leasing companies had nearly 2% of the banking assets out all these non financial institutions the trust companies got the highest attention in the last financial year.

Market size

There were total of 3769 banks in the Chinese banking market out of which 250 are commercial banks and they had more 196,000 outlets to carry out their businesses and had a staff of 2.9 million working for them. The Chinese banks made new loans of 7.75 trillion RMB in the first eleven months of the year 2012 exceeding the total of 7.47 trillion RMB worth of loans issued in the year 2011.

Market share

Although there are variety of banks in the china's banking market but the Chinese. These five banks hold the major part of assets China's banking market. These five major banks are agricultural bank of China, Bank of China, Bank of communication, China construction bank and the industrial and commercial bank of china. Other than these five major banks there are 12 major joint stock commercial banks and these banks hold a small but considerable portion of the china's banking market i.e. 15.6% it is a small share of the market if considered individually. The city commercial banks in China plays a minor role in the national financial market by holding a share of 8.2% of the banking market. Other than the commercial city banks, major five equitized banks and the joint stock commercial banks there are 3300 rural financial institutions which hold third largest share in the banking market which is a small share of the market if calculated individually. These figures of shares in the banking sector of china are also shown in the figure below

Type of bank

Asset value

Market share

Policy banks

7.652 trillion Yuan

8.0%

Equitized banks

46.894 trillion

Yuan

49.2%

City commercial banks

7.853 trillion Yuan

8.2%

Rural commercial banks, rural cooperative banks and rural credit cooperatives

10.658 trillion Yuan

11.2%

Joint stock commercial banks

14.904 trillion Yuan

15.6%

Foreign banks

1.742 trillion Yuan

1.8%

Other banks

5.602 trillion Yuan

5.9%

( )

The Chinese banking market has a wide range of branches of the different categories of banks and Rural Credit Corporation tops the chart with almost 2700 branches in China's banking market. Other than the rural credit corporation the village and township also have an important proportion in china's banking sector with nearly 350 branches all over china other than these two big names there are few others like rural bank with eighty five branches, trust companies-63 and joint stock commercial banks with 12 of its kind.

Talking about the assets of the Chinese banks the People's bank of china which is the central bank of china is the richest bank of china with total assets of about 28.33 trillion Yuan which is equal to 4.5 trillion U.S dollars and it is the highest amongst any central bank all over the world which also makes it the richest central bank of the world. The other top bank in the Chinese banking market is the Industrial and Commercial bank of china this bank has enhanced continuously in all its fields and the result of which is improvement in operations. The industrial and commercial bank of china is performing the best amongst its peers having best asset value of 17.5 trillion Yuan which is highest amongst all the banks worldwide. These were the top two banks of china's banking sector now we will see the assets of the third top bank of china that is the Bank of china at the end of 2012 the total assets of the bank of China were 12.68 trillion Yuan which actually increased by 7.19% than 2011. The top three banks of china has got the assets which actually makes them one out of the richest banks in the world which clearly shows their dominance the Chinese banking market.

Focus

The banking system of china is mainly focused on its activities related to financial intermediation between the borrower and the savers in the Chinese banking market. The income of most of the china's banks is also linked with these intermediary services. In the recent years the business income for the top five banks of china was 84% of the total amount. If the same figures are seen for the top 10 banks then it comes to 96% of the total amount. The major part of funds for the banks in Chinese banking market is sourced from the domestic deposits nearly 70% of the share of the banks. The major part of the deposits that are used by the Chinese banks are from the non-financial corporations and the deposits made by the house-holds accounts for the rest of it. The deposits that banks have to hold on demand at the time of maturity is 45% which is higher in the case of top five banks of the market. The figures show that the business in the Chinese banking market is majorly held by the top banks of china. Although the market is dominated by a few banks but still the growth rate of small and medium size intermediaries have been noticed. The assets side of the banking market shows that 50% of the assets are the domestic loans. The most of the loans provided by the banks are either provided to large or to medium sized state owned enterprises and non-financial corporations. Loans given to the small enterprises just accounts for 20% of total loans, the house-hold loans have a least share in total loans which is just one quarter of total loans and this figure is least in all the banking systems elsewhere in Asia. As per the data collected by people’s bank of China and the other five largest banks in China, the loans in the Chinese banking market has a variety of short-term, medium- term and long-term maturities. This term of lending has increased since the early 2000’s and the reason behind the same is rise in investment project financing. This has indirectly led to discrepancy between bank loans and deposits.

Other than loans the Chinese banks have debt securities as a part of their assets, a major part of which is issued by the government of China and some other financial corporations. The central bank of china holds approximately 15% of the total assets of the bank which are reflected in people’s bank of china reserve requirement and some access reserves. Out of all the different banks of china only the top five Chinese banks which are also located in foreign markets have got some foreign assets which has relatively small shares. Bank of china is an exception as it has 22% of foreign assets whereas the other banks have a share of only 1-7%.

Competition

After the year 1994 which was the year of financial reform in china, the financial system of china changed drastically. After this period the major policy banks of china were established while the other four largest commercial banks which were owned by the state were inspired of becoming independent. It has always been a difficult task for the higher authorities of the country in measuring the competition faced by the china’s banking sector. The higher authorities used HHI and market share index to measure the competition till the initial level and this was the first step. The market’s conflict was also considered an important factor as it was affecting the process straight away. The financial intermediary sector of china has always been a sector of high competition but in recent years, it has decreased due to fall in the market share of foreign banks which happened because of the fall in lending provided by these banks. The rise in the number of merger and acquisitions is a result of high competition. The domestic banks of china has decreased the interest rates which led to an aggressive lending.

Same as most of the banking sectors of the world, china also had monopolistic competition in its banking industry from early 70’s till 1980. After which two tier banking system was adopted so that the resources can be used more effectively and can be allocated in such a way that these resources are used in the best possible way. According to the research done by FU (2009) carried on 76 Chinese banks, china had a monopolistic competition in the market till the perfect competition came into the Chinese market due to the entry of foreign banks as at that time the banking industry of china was fully opened to foreign banks, this happened in the year 2006.

Profitability

The Chinese banking sector retained a high profit because of the expansion of credit and balance sheet and macro-economic policies also played a small part in that. The demand for credit for the purpose of purchasing properties, the demand from the local government and credit creation for an exchange inflows led to the formation of new RMB loans. In the second quarter of 2009, the government encouraged wealth management products which led to disclosure off-balance sheet. The commercial banks of china have retained high profitability with all the commercial banks having 15-20% per annum after tax returns. The high savings rate in china which are also known as robust economic conditions led to increase in the deposits made by the people. This robust economic condition helped the commercial banks in meeting the demand for lending over this period. One more key factor behind the Chinese banks retaining profitability in recent years have been that the number of non-performing loans has decreased and the banks themselves have improved in cost management.

The net interest margin of the banks of china have remained impartially high i.e. from 2.5% to 3% over the recent years which also indicates the profitability of the Chinese banks. These net interest margins were very much low if compared between bench-mark loan and deposit rate. After the removal of non-performing loans from the balance sheets of largest banks of china, the performance of loan portfolio is improving continuously. The non-performing loan declined from 2.4% to 1% from the year 2008 to 2011 for the commercial banks whereas if compared for the banking system as a whole this ratio was 1.8%. The NPL ratio for the commercial banks was low for their residential mortgage loan was 0.3% which was much lower than their other sectors i.e. corporate loans and personal loans which had 1.1% of NPL ratio. The improving performance of the loan department of Chinese banking sector has corresponded with rise in the nominal income and credit in china. This has led to a large number of new loans which have a relatively low chances of non-performance. The fact that the Chinese banks have a strong provision and capital buffers, this clearly shows that it will not be a big problem for the Chinese banks to meet any future rise in non-performing loans or any other shocks to this sector. By the end of year 2011, the provision coverage ratio of the banks of china rose by more than 250%. Most of the commercial banks of china have core capital instruments which improves their ability to meet any future losses. The capital ratio of Chinese commercial banks is maintained above the international regulatory standards but is well below the other emerging banking industries including the industries of Asian region.

Efficiency

As per the findings for developing nations, the foreign banks in developing nations have been more efficient or nearly perform equally as the countries’ domestic banks. Both the private and the foreign banks are more efficient than the banks which are owned by the states, for example, the foreign banks in Europe are found to be highly efficient whereas the private domestic banks and the state owned banks are not as efficient as the foreign banks of Europe. According to the study of Yildirim and Philippatos (2007), there have been different results related to the efficiency of the foreign banks i.e. that foreign banks in transition nations are more cost efficient but are not that efficient in making profit than both type of banks.

A number of studies have been carried out on the efficiency of the Chinese banks in recent years. The results of which have been conflicting. Over the period of 1993 to 2000, a study was conducted in which the top four banks of china were compared to two smaller size state owned joint equity banks in terms of efficiency. The findings of which was that the four big banks and the joint equity banks were cost efficient if compared with medium sized joint equity banks (Chen et al, 2005). According to DU and Girma (2011), the joint stock commercial of china performed much better than the state owned banks. In this research, DU and Girma focused on productivity growth performance and cost efficiency of the commercial banks using a panel of data set. Whereas the study of Rezavanian which studied the effects of the banking reforms introduced and the WTO’s entry on the performance of the banks. This study showed that the foreign banks in china performed much better than the domestic banks of china during the period 1998-2006. This study showed that the performance of international banks improved after the entry of WTO and the profitability and efficiency of domestic reduced post WTO. The concepts of liquidity and profitability are related to each other in the sense that liquidity is a source of profit and also helps during bank failure as it helps in reducing the liability and increasing the asset side in a balance sheet.

Environmental factors driving strategies of China’s banking sector.

Internal and external environmental factors plays a key role in driving the strategies for the Chinese banking sector. These factors includes PESTEL framework. The long term directions to meet the objectives and with the aim to achieve competitive advantages are known as strategies. In the case of Chinese banking market, the evaluation of environmental factors that drives its strategies is done with the help of Potter’s 5 force framework. This framework involves buyer’s power, supplier’s power, and threat of substitution, entry barriers and competitive rivalry. The buyer’s and suppliers have got a special power of influencing the price which can also change the organization’s cost of production, its investment plans. As we know the number of banks have increased rapidly in Chinese banking market, so, now the people of china have more options to explore in terms of bonds, mutual fund and many more. Although the power of Chinese customers has increased but still the rates at which different products are provided are decided by people’s bank of china which is also the central bank of China. As the international banks are now being allowed to operate in china’s banking market, this will lead to an increase in the bargain power of the customers. Substitutes of products and services like mutual funds, bonds, foreign exchanges, FDI may decrease the demand of such services.

Future performance.

Even after 10 years, the china’s banking industry would be dominated by its own firms i.e. the banks of china itself and not any international banks. The future strategies will be driven by non-market environment which is evident from different sources. If the government of china continues with its strategies of allowing the foreign banks for investing in their banking industry then there will be a definite increase in the market share of international banks operating in the Chinese banking industry which would also affect the local Chinese banks in terms of pricing and profitability.

Conclusion:

The Chinese banking industry is growing rapidly and is one of the best performing banking industries in the world but still there are some issues that the Chinese banking sector should take care of and take steps to be less prone to any kind of shocks. The entry of foreign banks has also played a major role in the profitability and efficiency of the domestic banks of china. The banking market of China is majorly covered by the top five banks but which shows that the Chinese banking industry still has a monopolistic banking. The growth rate of Chinese banking market is very high and the good fact is that over the recent years the percentage of non-performing loans has dropped drastically.