Competition and Profitability: Impacts on Stability in Chinese Banking

Abstract

This study contributes to the banking literature by testing the joint impacts of profitability and industry environment on several types of risk (credit risk, liquidity risk, capital risk, and insolvency risk) in a sample of Chinese commercial banks over the period 2003–2015. The results show that a more highly developed banking sector increases the liquidity risk and credit risk of Chinese commercial banks but decreases their capital risk. It is further suggested that profitability may lead to a reduction in credit risk and insolvency risk. The findings from the current study thus have important policy implications in terms of improving stability in the Chinese banking industry.

KeyWords:

• Competition
• Risk
• Profitability
• Chinese Banking

JEL Classifications:

• G21
• C33
• C14

Notes

1 There is some skepticism about these figures, and many analysts have accused Chinese authorities of underreporting bank risk as a way to support confidence in Chinese banks artificially. These data reported by CBRC were thus cross-checked with data collected from Bankscope. The information from Bankscope is sourced by the Bureau Van Dijk from a combination of annual reports, information providers, and regulatory sources, and more than 200 validation controls are applied to the data. The data are checked on an entity-by-entity basis and reviewed regularly. The data used in the current paper are thus not only from CBRC but also from Bankscope and the World Bank database, as this use of different data sources helps guarantee the accuracy of the data.

2 Z-score is calculated as Z=(ROA + E/A)/[σ(ROA)] where ROA is the bank’s return on assets, E/A is the ratio of equity over total assets, and σ(ROA) is the standard deviation of ROA.

3 Please see Appendix for the estimation of Lerner index.

4 Larger ratios indicate that either there is an increase in the value of existing firms listed in the stock market or there is an increase in the number of firms listed in the stock market. Both of these scenarios will encourage investors to invest money in the stock market, and companies will raise funds from the stock market rather than getting bank loans. Therefore, a more highly developed stock market will reduce demand for banking services.

5 Only the controlled variables are discussed in this section, as the impacts of profitability and industry environment on bank risk were discussed in the introduction.

6 The results from all of the additional robustness checks are quantitatively similar to those from the original tests. This supports the assertion that the findings from the original estimations are accurate. The results of these additional tests are thus not reported in order to prevent repetition. However, they are available upon request from the corresponding author.