Article Review:
What Will Happen in the World’s Largest Nation?
Article Review: Bank Ownership and Efficiency in China:
What Will Happen in the World’s Largest Nation?
This article (a draft, notably) was written in 2005, and starts off with the report that China was “partially privatizing” three of its four largest banks and opening them to foreign ownership. The article presents data claiming to demonstrate that allowing foreign ownership would increase “efficiency” levels in the banking sector generally. The article also includes a brief yet interesting history of the Chinese banking system.
Ten years later, the article can be critiqued from several angles. First, how good was the article (including the data) when written in 2005? Second, were its predictions accurate? And third, how relevant is it in 2016?
How Good Was the Article in 2005?
Though co-written by a member of the Federal Reserve’s Board of Governors, the article has many shortcomings.
Misleading
Then, the introduction claims a direct link between reform in the banking sector and national growth rates: “[H]igh growth rates cannot continue indefinitely without significant reform of the banking system and the legal/financial infrastructure” (Berger, Hasan and Zhou, 2005, p.2). “Another recent analysis of China suggests that an inefficient banking sector and poor legal/financial infrastructure may already be restraining growth and development” (Berger, A., Hasan, I., and Zhou, M., 2005, p.3). These are indeed very interesting questions. Unfortunately, they are left hanging right there in the introduction, and never addressed, much less answered.
Moving on again, we are told that “[p]otential policy implications of these findings are also discussed.” (Berger, A., Hasan, I., and Zhou, M., 2005, p.1). Such policy discussion, however, is not forthcoming.
So while suggesting lofty goals at the outset, the article settles on a much less ambitious analysis, which might be paraphrased like this: would a communist, state-owned banking system possibly be made more efficient with introduction of some foreign ownership? Many people would probably be willing to say “yes” to that question, even in the absence of complex translog and regression analysis.
Predictions
The article also makes some important predictions – but they are unrelated to the article’s core premise and the data presented. For example: “At its current pace, China is projected by some to surpass the U.S. and become the world’s largest economy in another decade.” Or (as noted above): “high growth rates cannot continue indefinitely without significant reform of the banking system and the legal/financial infrastructure.” Or (on the subject of China’s high savings rates and trade surpluses): “it seems unlikely that such large imbalances will persist and be sufficient to allow for inefficient credit allocation and high growth to continue indefinitely.” Or (on the subject of lending practices): “[i]t also seems unlikely that high growth for the Chinese economy can persist indefinitely based in substantial part on alternative funding means for just this one sector of the economy”. Or (on the subject of banking reform): “Recent news suggests that significant reform of the banking system is occurring that may significantly affect bank efficiency, and may presage further reforms”. Or, finally: “the ‘globalization’ of the Chinese banking industry appears to have begun in earnest” (Berger, A., Hasan, I., and Zhou, M., 2005, pp. 1-5).
Those are all important predictions, but again, they are unrelated to the article’s core premise and the results presented, so their relevance within the article is questionable. And in any case, like the interesting questions mentioned above, these predictions are for the most part not addressed further in the article.
What is the Article Really About?
After much fanfare in the introductory sections, then, the authors finally get around to telling us the essence of the article:
Our main empirical focus is on the effects of minority foreign ownership. The results suggest that such ownership increases the efficiency of the state-owned banks and the private, domestic banks that have such ownership. These findings is holds for both profit and cost efficiencies. (Berger, A., Hasan, I., and Zhou, M., 2005, p.5).
Sources
First, while the article may have been intended for an academic audience, the results (in the charts) and the analysis (mostly in 4.2) are quite complex and arguably understandable only by experts in translog and regression analysis. While the survey-type data in Table 1 is clear enough, a lesser reader would have great difficulty drawing meaningful conclusions from Tables 4 and 5 in particular.
Secondly, there are questions as to the reliability of the raw data collected:
The basic data source is Bankscope - Fitch's International Bank Database, whenever Bankscope doesn’t provide enough information or has questionable values, we collect or double-check the data from other official sources as best as we can, such as Almanac of China’s Finance and Banking, 1994-2004; Yearly Statistics Book of China’s Economics, each individual bank’s website which provides the bank’s financial statement and ownership structures, etc. (Berger, A., Hasan, I., and Zhou, M., 2005, p.15).
In other words, in assembling the raw data, there was a subjective involvement of the authors in deciding if Bankscope did not provide enough information or “has questionable values.” The “go-to” sources in those cases were Chinese government databases. Anecdotally, the Chinese have been known to manipulate official data.
Moving on, there are some assumptions which are not fully explained. For example, “[W]e acknowledge the possibility that some of the banks we identify as majority private, domestic banks may be more than 50% state-owned if the government or state-owned enterprises own most of the outstanding shares” (Berger, A., Hasan, I., and Zhou, M., 2005, p.16). Then there is this:
We also rearrange the residuals in ascending order, so that the bank with the highest profit function residual is given the highest rank of 1. The profit efficiency ranks may be considered to be the more accurate indicator of the quality of the management of the institution, at least for private institutions, given that profit efficiency is the more general concept and that the managerial goals are more likely achieved by higher profits than lower costs (Berger, A., Hasan, I., and Zhou, M., 2005, p.17).
In both of these cases, the lines between state-owned and private banks are being blurred by assumptions, and yet that very distinction lies at the heart of this report. There are other examples of assumptions which are not satisfactorily explained.
Were the 2005 Predictions Accurate?
While the authors’ various predictions were not really addressed in the article, if they turned out to be accurate in their own right, that would be meaningful despite other possible weaknesses in the article as a whole.
Growth
China may have surpassed the USA as the world’s largest economy according to some measurements, but the USA is still considered number one by most methods (Wright, 2014). At the same time, China’s growth has indeed slowed down in recent years (Magnier, 2015). According to The World Bank “China’s economic growth continues to moderate, in 2014 gross domestic product (GDP) expanded by 7.4 percent, within the government’s indicative growth target of about 7.5 percent for the year, but sharply slower than the 10 percent annual growth rate China averaged for three consecutive decades” (The World Bank, 2015, p. 2).
Banking Reform
The article predicted a new wave of banking reform and the globalisation of China’s banking industry. While there have been a series of minor reforms, however, China’s banking sector is still very much state-dominated.
For example, “[f]oreign lenders have long complained about regulations fettering their growth in China, where they controlled only 1.7 per cent of total banking assets at the end of 2013” (Wildau, 2014). The communist party leaders’ pledge to “expand the openness of the financial sector and deepen the openness of the banking industry” was mostly symbolic, and ‘[m]any foreign bankers have now resigned themselves to playing a small role in China’s domestic market” (Wildau).
In short, foreign ownership of Chinese banks has not grown as predicted by the article. For one thing, foreign banks can own no more than 20% of a domestic bank. “That rules out acquisitions, condemning them to build their Chinese businesses from scratch when domestic rivals boast thousands of branches. HSBC has the most branches of any foreign bank in China: 160. Bank of Communications has 2,690” (The Economist, 2014).
This is despite China’s promise in December 2006, five years after joining the WTO, to remove geographic restrictions on overseas banks and allow them to start yuan lending and deposit services, as well as issue credit cards (Bloomberg News, 2012). But after more than a decade, foreign banks are still subject to a protracted approval process – and flat-out denials on licences – that has yet to show signs of lightening (Weinland, 2015). In summary, it is unlikely that many new foreign banking entities will enter the mainland China market over the next five years (Ernst & Young, 2015, p. 7).
Link Between Growth and Banking Reform
So the Chinese economy is clearly slowing down, and banking reforms have been slower than expected. Is there a link between the two, as predicted by the article (though the article itself offers no real help here)?
There are many factors explaining China’s slowing growth rates (The World Bank, 2015). Some observers have looked at the need for (or the ongoing delays in) banking reform as part of the explanation. According to PricewaterhouseCooper’s annual report on China “[t]he development of alternative forms of financing for SOEs and large private firms will also allow banks to shift focus to new opportunities for profitable lending to SMEs that are currently excluded from the formal lending system” (PricewaterhouseCooper 2015, p.53). The article makes a very similar point (Berger, A., Hasan, I., and Zhou, M., 2005, pp.3-4). And the World Bank itself (in a joint study with the IMF) has also commented on bank reform (or lack thereof) as a factor in China’s long-term growth.
China’s financial system reform efforts have had positive results. Reforms accelerated since 2003, with the Chinese government adopting a series of policies to enhance financial sector’s resilience and, on the structural side, strengthening a large part of domestic financial institutions and improving market confidence (World Bank and International Monetary Fund, 2011, p.1).
The World Bank report goes on to suggest that lack of competition and state-ownership is an important factor holding back China’s banking system generally. There are surely more examples. In short, to its authors’ credit, the article’s suggestion of a link between bank reform and long-term economic growth (while not fully pursued within the article itself) is meaningful, and other credible observers including international financial institutions have been studying and commenting on the same concept over the past several years.
Relevance in 2016
Looking at the core premise and analysis of the article, it can be said again that these are very narrow in scope. In layman’s terms, the authors go through an awful lot of trouble to prove the arguably instinctive point that a state-run banking system will become more efficient through reform, including introduction of foreign ownership. The point is well-taken, but many readers of the article would likely be no more convinced of it, upon completing the article, than they were upon reading the first few lines.
At the same time, while the article accurately predicted certain developments, it missed on others. Those that it got right were arguably pretty obvious (e.g., a slower growth rate in China). And in any case, the predictions, accurate or not, were not the central theme of the article.
And so the article has not improved with age. As to China’s role in the world economy, so many things have happened during the past ten years, on such a large scale, that this article seems to suffer from lack of relevance today even more so than it did when written.
References
Davies, P., 2012. Foreign Banks Fail to Grow in China. Financial Times. Available at: <http://www.ft.com/intl/cms/s/0/fa94d72a-294d-11e2-86d7-00144feabdc0.html#axzz3vzo4SswC> [Accessed 31 Dec. 2015].
Ernst & Young, 2015. Future directions for foreign banks in China 2014.
Foreign Banks Still Getting Shut Out of China. Bloomberg News, 2012. Available at:
<http://business.financialpost.com/news/foreign-banks-still-getting-shut-out-of-china> [Accessed 31 Dec. 2015].
Lenders of Little Resort. 2014. The Economist. Available at:
<http://www.economist.com/news/finance-and-economics/21605920-china-enticing-elusive-market-foreign-banks-lenders-little-resort >[Accessed 31 Dec. 2015].
Magnier, M. 2015. China Economic Growth Falls Below 7% for First Time Since 2009. The Wall Street Journal. Available at: <http://www.wsj.com/articles/china-economic-growth-falls-below-7-for-first-time-since-2009-1445221368> [Accessed 31 Dec. 2015].
Maysami, R. Foreign Banks in China: Critical Success Factors and Lessons Learnt. Available through: University of North Carolina. <www.uncp.edu> [Accessed 31 Dec. 2015].
PricewaterhouseCoopers Limited, 2015. Banking and Finance in China: the Outlook for 2015.
PricewaterhouseCoopers Limited, 2014. Foreign Banks in China 2013.
Weinland, D., 2015. Puff, Not Wind of Change for Foreign Banks in China in 2015. South China Morning Post. Available at: <http://www.scmp.com/business/banking-finance/article/1721745/puff-not-wind-change-foreign-banks-china-2015> [Accessed 31 Dec. 2015].
Wildau, G. 2014. China Eases Rules for Foreign Banks. Financial Times. Available at:
<http://www.ft.com/cms/s/0/b0ccedda-88e1-11e4-ad5b-00144feabdc0.html#axzz3vzo4SswC> [Accessed 31 Dec. 2015].
World Bank and International Monetary Fund, 2011. China, Financial Sector Assessment.
World Bank, 2015. China Economic Update.
Wright. T. (2014). China’s Economy Surpassing U.S.? Well, Yes and No. The Wall Street Journal. Available at: <http://blogs.wsj.com/economics/2014/04/30/chinas-economy-surpassing-u-s-well-yes-and-no/> [Accessed 31 Dec. 2015].
