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Understanding the High Profitability of Big Chinese Banks © F r a n k f u r t – S c h o o l. d e Conference: International Competition in Banking – Theory and Practice 24-25 of May, 2012, Sumy, Ukraine Prof. Horst Loechel
© F r a n k f u r t – S c h o o l. d e 2 Agenda 1. Chinas financial reform – an overall success 2. Chinese banks: Low efficiency and high profitability 3. Why big Chinese banks are more profitable than their Western peers 4. Research results and further research 5. References (selection)
© F r a n k f u r t – S c h o o l. d e 3 Features of Chinas financial system High intermediation level (but disintermediation under way) State-owned banks dominate (over 50% market share) Segregate banking system (but universal banks under way) Strong regulation and supervision (but gradual liberalisation) Low internationalization level (but internationalization under way) Managed interest and exchange rate system Still immature capital markets (particularly bond markets) Managed capital account
© F r a n k f u r t – S c h o o l. d e 4 Chinas financial sector reform: Gradual approach with Chinese character 20112006200920102003 2004 -2006 2000 Introduction of bad loan asset management companies Announcement by the state council to develop Shanghai into an international financial center by 2020 Internationalization of RMB Internationalization of banks Opening of the market for foreign financial institutes Spin-off of CBRC Recapitalization of big chinese banks Recapitalization of big chinese banks IPOs (partial privatization) IPOs (partial privatization) Strategic foreign investors Strategic foreign investors
© F r a n k f u r t – S c h o o l. d e 5 China: Successful banking reform (I)
© F r a n k f u r t – S c h o o l. d e 6 China: Successful banking reform (II) Global top 10 banks by pre-tax profit 2007-2010
© F r a n k f u r t – S c h o o l. d e 7 The next steps (I) 12 th Five-Year-Plan (2011-2015) Financial market reform will encourage financial innovation, push forward market based reform of interest rates, and expand the use of the Renminbi in cross-border trade. In addition the government is continuing its efforts to make the Renminbi convertible under capital accounts.
© F r a n k f u r t – S c h o o l. d e 8 The next steps (II) Road map of the internationalization of the RMB RMB as:Requirements:Time Schedule: Trade currencyControlled capital account and managed exchange and interest rate system Since 2010 Investment currency (FDI/ODI) Controlled capital account and managed exchange and interest rate system Since 2011 Off-shore portfolio currency (Hong Kong) Controlled capital account and managed exchange and interest rate system Since 2011 Reserve currencyOpen capital account and flexible interest and exchange rate system Probably around 2020 Degree of Internationalisation
© F r a n k f u r t – S c h o o l. d e 9 Chinese Banks: Contradiction of efficiency and profitability Low efficiencyHigh profitability ICBC and CCB ranked No. 1 and No. 2 by pre-tax profit throughout 2008 to 2010 in the Banker global bank ranking Average ROAA of 0.96% for the time period 2003 to 2010 of the big four, more than double of the average level of the top international peer banks (0.45%) No significant correlation between efficiency and profitability in Chinese banks (Feyzioglu 2009) State-owned Chinese commercial banks have low efficiency (García-Herrero et al. 2009) Contradiction between low efficiency and declining NPL-ratio in Chinese state-owned banks (Allen et al. 2012)
© F r a n k f u r t – S c h o o l. d e 10 Chinese banks: Interest margin not correlated with loan quality NormalChina average margin NPL Interest rate margin and NPL-ratio (2003-2010)* Correlation Obs. P value 0.0002 146 0.9978 * all Chinese banks
© F r a n k f u r t – S c h o o l. d e 11 The sources of Chinese banks high profitability Comparison of key financials of the big four Chinese state-owned banks with international peers
© F r a n k f u r t – S c h o o l. d e 12 Back up – Peer selection Source: Bankscope
© F r a n k f u r t – S c h o o l. d e 13 Simulation (I): Why the big Chinese banks are more profitable than their Western peers Margin stressed to international peer level Hypothesis: The average asset return of the big five Chinese banks will fall below the international comparative level if the current high average net interest margin falls to the international peer average level, based on ROAA OLS regression results.
© F r a n k f u r t – S c h o o l. d e 14 Simulation (II): Why the big Chinese banks are more profitable than their Western peers Combined stressed margin and increase in cost income ratio by 20% Hypothesis: The asset return of the big four Chinese banks will fall below the international peer level if the average lending margin shrinks to international peer average level and the CIR ratio driven by personnel expenses increases by 20%, based on ROAA OLS regression results.
© F r a n k f u r t – S c h o o l. d e 15 Identifying the whole picture Personnel cost Margin spread Corporate lending concentration Market power Economic growth
© F r a n k f u r t – S c h o o l. d e 16 Simulation (III): Impact of business diversification Combined stressed margin, cost income ratio and doubling in business diversification 20% Hypothesis: Business diversification can provide a way out of the profitability trap in course of shrinking margin and higher staff costs, based on ROAA OLS regression results.
© F r a n k f u r t – S c h o o l. d e 17 Back up – ROAA OLS regression results
© F r a n k f u r t – S c h o o l. d e 18 Research results so far Despite the successful banking reform the analysis shows that big Chinese banks are making windfall profits due to non-competitive market conditions and market power In a competitive environment their current business model would not be sustainable It also poses an obstacle to the intention to internationalize the RMB
© F r a n k f u r t – S c h o o l. d e 19 Further research CIR-analysis Business model transformation towards universal banks Integrated financial supervision Shadow banking system (informal finance), disintermediation in China Impact of the internationalization of the RMB on banking and finance in China
© F r a n k f u r t – S c h o o l. d e 20 Limitation of the analysis Structural interruptions (e.g. banking reform, financial crisis) Quality of data (e.g. limited observations) Focus on bank-specific determinants only (e.g. impact of market structure and economic growth)
© F r a n k f u r t – S c h o o l. d e 21 Chinas banking and finance industry: The challenges ahead Internationalization of RMB Liberalization of interest and exchange rate system Upgrade of capital markets, esp. corporate bond market Opening of capital account Change of banking business models towards universal banking Vertical integration within banks Consolidation of CCBs and rural banks
© F r a n k f u r t – S c h o o l. d e 22 References (Selection) Allen, F. et al. (2012): Chinas Financial System: Opportunities and Challenges, NBER Working Paper No. 17828. Chang, C. and H. Löchel ed. (2012). Chinas Changing Banking Industry, Frankfurt 2012. Feyzioğlu T. (2009). Does good financial performance mean good financial intermediation in China? IMF Working Paper WP/09/170 García-Herrero A., Gavilá S., Santabárbara D. (2009). What explains the low profitability of Chinese banks? Journal of Banking & Finance 33, 2080–2092. Goddard J., Molyneux P., Wilson J. O. S. (2004). The profitability of European banks: a cross-sectional and dynamic panel analysis. The Manchester School 72, 363-381. Lu Y., Fung H. G., Jiang X. F. (2007). Market structure and pofitability of Chinese banks. The Chinese Economy 40, 100-113. Sufian F., Habibullah M. S. (2010). Assessing the impact of financial crisis on bank performance. ASEAN Economic Bulletin 27, 245-262. Vennet R. V. (2002). Cost and profit efficiency of financial conglomerates and universal banks in Europe. Journal of Money, Credit and Banking 34, 254-282.
© F r a n k f u r t – S c h o o l. d e 23 Contact Prof. Dr. Horst Loechel Frankfurt School of Finance & Management Sonnemannstraße 9-11 D-60314 Frankfurt am Main, Germany E-mail: firstname.lastname@example.org
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