Bank Competition, Financial Development and Growth of Financially Dependent Industries: Fresh Evidence from China

Abstract

We empirically examine the role of the banking market structure and financial development for the growth of manufacturing and the financially dependent industries in China over the period of 1999–2014. We use both structural and non-structural approaches to assess the banking market structure and relate them to the growth of the manufacturing industries. The results of the study indicate that bank competition inspires industrial growth, particularly the growth of the financially dependent industries. Our findings further suggest that bank concentration undermines the growth of manufacturing industries in general and growth of the financially dependent industries in particular. These results are consistent across a number of sensitivity checks covering alternative measures of financial dependence, institutional factors such as property rights, quality of accounting standards and bank ownership and endogeneity consideration.

Key Words:

• Concentration
• competition
• financial dependence
• financial development
• economic value added
• China

Jel Classification:

• D4
• G2
• L1
• O4

Notes

1 Industries that rely on external sources of finance, such as banks or capital markets, are referred to as “financial dependent industries”. The financial dependence is calculated as “the ratio of the portion of capital expenditure not financed with cash flows from operation to the total capital expenditure” (Rajan & Zingales, 1998).

2 For instance, bank competition and monetary policy transmission (Khan et al., 2016a; Yang & Shao, 2016), financial reforms in China and banks’ cost and profit efficiency (Chan & Karim, 2010; Hsiao et al., 2015), market characteristics and entry mode choices of foreign banks (Li et al., 2013; Yin et al., 2015), market structure and performance relationship in the context of structure conduct performance (SCP), efficient structure (ES), quiet life (QL) and relative market power (RMP) hypotheses (Ye et al., 2012), financial reforms and, financing constraints and investment (Kwong, 2011; Chan et al., 2012), the role of ownership type, size, risk profile, profitability and key environmental changes on bank efficiency (Ariff & Can, 2008).

3 Some recent studies related to economic development and/or financial sector development context of China include Liu et al. (2016), Naghavi and Lau (2016), and Zhang et al. (2016).

4 The PBC performed all the financial functions including currency issuance, exchange rate management, designing the monetary policy, channelling household funds etc. Source: http://www.pbc.gov.cn/publish/main/531/index.html.

5 The Industrial and Commercial Bank of China, the Agricultural Bank of China, China Construction Bank and the Bank of China

6 For example, the focuses of these banks were as follow: Industrial and Commercial Bank of China (urban territories), the Agricultural Bank of China (rural territories), China Construction Bank (investment in capital assets) and the Bank of China (foreign trade).

7 City commercial banks are small joint-stock banks, shares of these banks are held by local governments’ treasuries, state-owned enterprises (SOEs), private business organizations and foreign and local investors. With minimal governments’ interventions, these banks can have better governance than SOCBs (Ferri, 2009).

8 Diverse ownership structure is one of the key features of JSBs with shares held by local governments, SOEs, private business organizations and foreign and local investors. According to Huang and Xiong (2015), these banks are not subject to historical policy lending, therefore, they can operate with a market-oriented approach.

9 The Central Huijin Investment Company Limited was created for this purpose in 2003 through which USD 79 billion worth of capital was injected during 2004, 2005 and 2008. This included USD 45 billion (Bank of China and China Construction Bank in 2004), USD 15 billion (Industrial and Commercial Bank of China in 2005), and USD 19 billion (Agricultural Bank of China in 2008).

10 The extensive discussion on this relationship is given in Rajan and Zingales (1998), all the subsequent studies on this topic show that the financially dependent industries grow more in well-developed financial sectors.

11 http://stat.unido.org/

12 http://www.worldbank.org/en/publication/gfdr/data/global-financial-development-database

13 https://fred.stlouisfed.org/

14 http://www.helgilibrary.com/indicators/main

15 See Cetorelli and Gambera (2001), Claessens and Laeven (2005), Hoxha (2013), and Mitchener and Wheelock (2013).

16 A complete discussion of Panzar–Rosse H-static is beyond the scope of this study. For a detailed discussion see Rosse and Panzar (1977); Panzar and Rosse (1982); Panzar and Rosse (1987).

17 Bank-level control variables and their measures are shown in Table A1 (Appendix).

18 The idea is to allow for a partial adjustment towards the long-run equilibrium, with this adjustment being captured by the inclusion of a lagged dependent variable in the revenue equation. The dynamic GMM estimation i.e. Arellano and Bond performs the first-difference estimation to account for bank-level fixed effects and uses dynamic instruments in the GMM estimation.

19 Calculations of these variables are shown in Table A1 (Appendix)

20 See footnote 6 in Claessens and Laeven (2005) and footnote 4 in Hoxha (2013).

21 Additionally, we simply use the ranking of the industries in the estimation i.e. the highest rank (number) is given to the industry with highest value of financial dependence and the vice versa. The findings from alternative rankings however, are qualitatively similar to those from the dummy variable.

22 For example, the average value of the Lerner index for 23 developed countries in Berger et al. (2009) is 0.22. Similarly, Clerides et al. (2015) report the average Lerner index of 0.33 for 148 countries.

23 The higher values of Lerner index imply more market power and less competition.

24 The higher values of PRH (values closer to 1) indicate more competition and low market power.

25 Data on industry sales were collected from the UNIDO.

26 Data on the share of state-owned and foreign banks have been collected from then annual report of China Banking Regulatory Commission, 2003–2014, and GFDD World Bank.