Efficiency Spillovers of Foreign Direct Investment in the Chinese Banking System

Abstract

This research suggests that the efficiency spillovers of foreign banks in China have played an integral role in transforming the fragile banking system into a relatively robust one. Stochastic frontier analysis is employed to analyze the efficiency of the Chinese banks during 2001–2007 with the data of 126 banks. The study suggests that the presence of foreign banks has helped improve the overall profitability of the Chinese banks and has also effectively constrained the scale of loans. The findings manifest the importance of efficiency spillovers which can be brought to an economy in transition by cautious financial liberalization.

Keywords:

• Commercial bank
• efficiency
• spillover
• foreign direct investment
• stochastic frontier analysis

JEL CLASSIFICATION::

• G21
• D24
• D62
• F21
• C13

Acknowledgements

The research has benefited from the insightful and constructive suggestions of Weidong Chen at the Bank of China, and Haoruo Zhang, Kai Fan, and Wei Song at the Industrial and Commercial Bank of China. The authors are grateful to the comments on the earlier versions of this article from Tina Y. Xu at Hull University, Xiaolan Fu at Oxford University, Liming Wang at University College Dublin, Yizhe Dong at Loughborough University, and the participants of the 20th Annual Conference of the Chinese Economist Association (UK/Europe) in Dublin, July 2009, and the International Conference on “China and the Changing Landscape of the World Economy” in Beijing, September 2009.

Notes

1. Traditionally, there were four mega-sized state-owned banks, which were referred to as “Big Four,” namely the Industrial and Commercial Bank of China, China Construction Bank, the Bank of China, and the Agricultural Bank of China. After 2006, the China Banking Regulatory Commission added the Bank of Communications to the list of “large-sized state-controlled banks,” after which “Big Five” replaced “Big Four” as the jargon employed in the Chinese banking sector to denote the top five mega-sized banks.

2. Source: Chinese Academy of Finance, Almanac of China's Finance and Banking (in Chinese), 1994.

3. Source: People's Bank of China, Report on the International Financial Market (in Chinese), March 2009.

4. Source: China Banking Regulatory Commission, The 2008 Annual Report of China Banking Regulatory Commission, p. 45 (http://www.cbrc.gov.cn/)

5. Source: China Banking Regulatory Commission, http://www.cbrc.gov.cn/. Data were accessed on 16 January 2009.

6. The dramatic decline of bank loans was mainly due to the credit constraints tightened by the former Premier Zhu Rongji when he was in power during 1998 and 2003 (Shih, 2008). Apart from that, the regression model in this study also statistically confirms the cooling effect of foreign competition on domestic banks’ loans.