How Did the Introduction of Deposit Insurance Affect Chinese Banks? An Investigation of Its Wealth Effects

ABSTRACT

The latest introduction of deposit insurance in China gives us a chance to explore the stock market reaction to the major regulatory policy change in banking. Our results show the average abnormal returns of all listed banks in China are significantly negative on the announcement day. It indicates the introduction of deposit insurance has an adverse wealth effect on the banking industry in China. We also find that among bank characteristics such as asset size, z-score, and ROE, only size has a statistically significant positive impact on the abnormal returns of the Chinese listed banks on the announcement day. The results mean the introduction of deposit insurance in China creates a redistribution of wealth from small banks to those with larger size.

KEY WORDS:

• deposit insurance
• announcement
• wealth effect
• event study
• China

Acknowledgments

We thank Jianhao Lin, Qiangqiang Xu, Ye Lin, and Xiuxia Liang for help in accessing data. We would like to thank Kajitani Kai, Tomoko Aizawa, Koji Yoneda, Yajing Liu, Masao Ojima at the Research Institute of Economics and Business Management of Kobe University for the helpful discussions. We also appreciate the valuable comments we received from two anonymous referees. The article has benefited from presentation at the 2017 IFABS Asia conference for the insightful comments. Jianjun Sun is grateful to the Research Institute of Economics and Business Administration of Kobe University for hosting his visit. Jianjun Sun is indebted to Hitomi Takahashi, Junyi Shen, Laixun Zhao, and Yajing Liu for their excellent help during his visit.

Supplementary Materials

Supplementary data for this article can be accessed here.

Notes

^1. Strategic investors are defined as those investors who would contribute not only capital but also independent foreign directors to bank governance and bring in foreign management skills and new products, resulting in the improvement of efficiency and returns on investment. However, there are still various restrictions on them, such as ownership proportion and holding period. Sun, Harimaya, and Yamori (2013) analyze the effect of the strategic investors on Chinese bank efficiencies.

^2. Currently, the People’s Bank of China continues to set the range (upper and lower bounds, or base rate and floating range) within which interest rates can be set.

^3. Other institutions include policy banks, the postal savings, finance companies, trust and investment companies, and financial leasing companies.

^4. A national holiday occurred during May 1–3, 2015. Hence, we compute the equivalent amount in U.S. dollars based on exchange rate on May 4, 2015.

^5. See the draft http://www.pbc.gov.cn/rmyh/105253/2809462/index.html and the Act http://www.gov.cn/zhengce/content/2015-03/31/content_9562.htm for the changes.

^6. The data source is China’s Banking Development Report 2015, published by the China Banking Regulatory Commission.

^7. On the sample selection of China’s security sector, see the Supplementary Material, available online.

^8. In the interests of space and continuous reading, the full empirical results of the securities firms are not reported here. They are available upon request.

^9. Although we failed to discover the official regulation on premium rate in China, Zhou Xiaochuan, the governor of China’s central bank, said the premium rate was 0.01% to 0.02% of annual deposits in China (see http://finance.sina.com.cn/money/bank/cb_2015/). The deposit balance and net profit of the whole banking industry in China were 98,340,000 million of RMB Yuan (roughly 16,071,254 million of U.S. dollars, at 6.1190 RMB Yuan each dollar on December 31, 2014) and 1,550,000 million of RMB Yuan (roughly 253,309 million of U.S. dollars) at the end of 2014 (China Banking Development Report 2014, by the China Banking Regulatory Commission; see http://www.cbrc.gov.cn/chinese/home/docViewPage/110203.html), respectively. Assuming premium rates of 0.01%–0.02% of annual deposits for different types of banks, China’s banks would have to make a premium payment of 9834 million of RMB Yuan (roughly 1607 million of U.S. dollars) to 19,668 million of RMB Yuan (roughly 3214 million of U.S. dollars) in total in terms of the deposit balance at the end of 2014. This reduces the earnings of China’s banks for 2014 by 0.63% to 1.26% on average.

^10. Long and Ervin (2000) define $HC3$ as ${\left(X^{\prime }X\right)}^{-1}{X}^{\prime }diag\left({\omega }_1,\dots ,{\omega }_n\right)X{\left(X^{\prime }X\right)}^{-1}$, where ${\omega }_i={\hat{\epsilon }}_i^2/{\left(1-h_{ii}\right)}^2$, $h_{ii}=x_i{\left(X^{\prime }X\right)}^{-1}{x}_i^{\prime }$.

^11. The coefficient on asset size −0.0115. The corresponding OLS, HC3 and bootstrap standard errors are 0.0098, 0.0080, and 0.0100, respectively. For brevity, the full empirical results are not reported here. They are available upon request.

^12. Despite so, however, we still attribute the findings that bank’ size mitigates the negative effect to the introduction of deposit insurance on the event day in China. It is based on the following inference. If the argument that larger banks are naturally able to better deal with adverse shocks than smaller ones is valid, it is reasonable for us to check for whether or not adverse shocks occur when an effect reflecting the argument is observed on some day. If two or more adverse shocks are detected on the day, we could not draw a conclusion that some adverse shock causes the effect. However, if only one adverse shock is found, it appears plausible that this shock results in the effect. In this research, we observed an effect that reflects size mitigating negative response on the event day and only one significantly adverse event occurred on the same day. Hence, it is reasonable that the empirical results that adverse influence is lower for big banks than small ones is caused by the first official announcement of introduction of deposit insurance in China.

^13. See Figure S1, Table S1 and Table S2. They are available online.

Additional information

Funding

Jianjun Sun's research is financially supported by two research grants from NSFC [the Numbers of Grants are 71761010 and 71461007].