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Jonathan Yee

The document analyzes whether liberalization and deregulation of China's financial sector has encouraged foreign banking in the country. It examines quantitative data on foreign banks in China to determine if they have successfully entered the market. The author aims to assess if government regulations have specifically promoted foreign bank entry. While China has reformed its banking system and allowed more foreign competition, the document aims to determine if foreign banks have actually benefited and increased their presence or if reforms did not specifically target them.

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Foreign Banks in China: Has liberalisation and deregulation of the financial sector encouraged foreign banking in China. Jonathan James Yee 11th September 2015 Words: 9825
Jonathan James Yee Page 0 List of Abbreviations ABC- Agricultural Bank of China BIS- Department for Business Innovation and Skills BOC- Bank of China CCB- China Construction Bank CCP- Chinese Communist Party CRBC- China Regulatory Banking Commission FDI- Foreign Direct Investment GDP- Gross Domestic Product ICBC- Industrial Commercial Bank of China IFDI- Inward Foreign Direct Investment IPO- Initial Public Offering OFDI- Outward Foreign Direct Investment RBS- Royal Bank of Scotland ROAA- Return on Average Assets ROAE- Return on Average Equity ROA- Return on Assets ROE- Return on Equity SFTZ- Shanghai Free Trade Zone USD- United States Dollars WFOB- Wholly Foreign Owned Banks WTO- World Trade Organisation
Jonathan James Yee Page 1 Table of Contents Abstract……………………………………………………………………………..……………Page 2 1. Introduction……………………………………………………………………………..…….Page 3 1.1 Research Question, Objectives and Hypothesis……………………………………..Page 6 1.11 Objectives.....................................................................................................Page 6 1.12 Hypothesis…………………………………………………….…..……….Page 6 1.2 Reasons and implications of Research…………………………………………...….Page 7 2. Foreign banking in China……………………………………………………………….….Page 10 3. ReviewofChinese banking system………………………………………………………...Page 16 3.1 Brief History……………………………………………………………………..…Page 16 3.2 Current Environment……………………………………………………….………Page 18 3.3 5-year plan and foreign banking……………………………………………………Page 23 3.31 10th 5-year plan……………………………………………………...……Page 24 3.32 11th 5-year plan………………………………………………….………..Page 25 3.33 12th 5-year plan……………………………………………………..…….Page 26 4. Methodology…………………………………………………………………………………Page 28 4.1 Data…………………………………………………………………...…………….Page 29 4.2 Variables……………………………………………………………………...…….Page 30 4.3 Method………………………………………………………...……………………Page 31 5. Results………………………………………………………………………………………..Page 34 5.1 Foreign Banking isolated……………………………………………………...……Page 34 5.11 Analysis of foreign banking isolated……………………………….…….Page 41 5.2 Comparison of foreign banking and Chinese banking……………………………..Page 42 5.21 Analysis of comparison of foreign banking and Chinese banking……….Page 43 5.3 Correlation between foreign banks and Chinese Banks………………………...…Page 44 5.31 Analysis correlation of foreign banks and Chinese Banks…………….…Page 46 6. Conclusion and Limitations…………………………………………………….………..…Page 47 6.1 Conclusion …………………………………………………………………………Page 47 6.2 Limitations …………………………………………………………………………Page 49 Appendix…………………………………………………………………………….………….Page 50 References………………………………………………………..………………………..……Page 54
Jonathan James Yee Page 2 Abstract The gradual deregulation of the financial sector in China has been an invitation for foreign banks to gain their first steps into the market. There have been multiple waves of liberalisation and deregulation targeting foreign banks in particular. Using data from Bankscope, to identify the penetration of banks since deregulations occurred, we have been able to assess whether this is the case and if there has been a large inflow of foreign banks as was expected. It was found, that despite common logic, due to the lowering of barriers to a much sought after market that the increase in foreign banks has been unsubstantial and that foreign banking growth was in line with the rest of the sector. Therefore, despite efforts of deregulation and liberalisation, little progress has been made by foreign banks in China and they have fallen short of the opportunities available.
Jonathan James Yee Page 3 1) Introduction In the past few decades, China has made great efforts to become competitive on a global scale, and has successfully done so in terms of their GDP, as it set to become the largest economy by 2024 (HIS,2015). However, economic growth in the long run is highly dependent on financial development, as it aids investment, spreads risk and provides liquidity. (UN, 2006). The role of the financial sector within countries is to optimise the allocation of scarce funds where they are demanded, while maximising returns for investors by spreading risk (Elliot, D and Yan, K, 2013). China has failed at doing this effectively, consequently leading to its financial sector as being categorised as ‘deep but narrow’. This is due to the ratio of financial assets to GDP increasing, but being primarily concentrated in the banking sector. The banking sector has an 80% concentration of all financial services in China, with the top 5 banks holding half of the loan market (Naughton, 2007). Hence, China’s financial system has come under scrutiny not only abroad but domestically due to the lack of diversity in the sector. Much research has been focused on how the country has liberalised their banks and transitioned from a state owned monopolistic structure. It has made efforts to further diversify the financial sector, in order to make it a more competitive, market orientated, commercial structure.
Jonathan James Yee Page 4 There has been extensive news coverage of the reforms guided by the 5-year plans and China’s ‘big four’ banks. These top four banks have become the top four banks globally in terms of pre-tax profit. ICBC also holds the position of the world’s largest bank in terms of assets while the other three still lie within the top ten. This result has arisen at an incredible pace, as the market mechanisms in the banking sector were only introduced in 1986. (Bankerdatabase, 2015) Prior to 2001 foreign banks were only allowed to conduct businesses in two cities and were only to provide services to foreign firms and individuals. Since the 10th 5-year plan the government has made efforts to loosen controls over the banking sector and introduce more foreign competition into the economy. (He and Fan, 2004) In this short space of time the Chinese Communist Party (CCP), has introduced multiple waves of reform and liberalisation, to achieve more competition by selling shares of the state owned banks and allowing more foreign banks to compete in China. Although the presence of the state is slowly dissolving away from the large banks, they still play a major role in almost every aspect of finance in China, including the outward movements of Chinese banks as they try to gain market share abroad. (Martin, 2012) The CCP’s liberalisation of banks has allowed the Chinese banks to venture abroad, which has been a widely discussed topic of study due to the impact the banks could have abroad, stemming from their sheer size, political clout and the uncertainty they bring along with them. (Allen et al, 2005)
Jonathan James Yee Page 5 The majority of Chinese banks are expanding primarily into the Middle East, Asia and Latin America, in order to facilitate the large number of Chinese firms already present there, (follow the client). They are slowly making inroads into Europe and North America in order to gain internationalisation of assets for stability. An example being the purchase of The Bank of East Asia’s US subsidiary in 2012, by ICBC, resulting in it becoming the majority shareholder. This was seen as a big turning point as ICBC became the first Chinese institution to assume control of an American bank. (Calkins, 2013) This occurred as a result of the ‘going out policy’, which was instated in the early 2000’s, resulting in a huge surge of OFDI. OFDI now exceeds IFDI in China. (The Economist, 2009) The sum of Chinese banking abroad is now in the sum of USD1.2Trillion, with 18 Chinese institutions having set up 1127 branches in 57 different countries by the end of 2013. (CRBC, 2013) With the rapid expansions of Chinese banks abroad reciprocal treatment for foreign banks in China is of course to be expected. (economist.com, 2009) However, there are only 41 foreign banks present in China, which currently span 69 cities in 27 provinces. Despite this somewhat impressive figure, only 6 are able to issue RMB financial bonds and a meagre 3 have the authorisation to issue credit cards. (EY, 2014) This paper aims to assess the Chinese banking sector and compare foreign banking performance to Chinese banks performance in order to see whether the regulations have helped foreign banks specifically. If regulations have been successful foreign banks in China should thrive, and make gains in terms of market saturation in China.
Jonathan James Yee Page 6 1.1) ResearchQuestion, Objective and Hypothesis Has liberalisation and deregulation of the financial sector specifically encouraged foreign banking in China? 1.11) The Objectives of this paper are: 1) To analyse the changes to the economic environment of foreign banking in China. 2) To collect quantitative data, showing foreign banks in China, and whether or not they have been successful in entering the market. 3) To analyse whether or not government regulations have specifically allowed foreign entry of banks. 1.12) Hypothesis Hypothesis 1: The success of foreign banking has grown from the year 2001 onwards. Hypothesis 2: The government has specifically encouraged foreign banking in China. A fully defined null and alternative hypothesis has not been outlined here as the paper aims to take a more inductive approach.
Jonathan James Yee Page 7 1.2) Reasons and implications of research The highly important composition of foreign banking has gone mostly unnoticed due to the rapid expansion of Chinese banks abroad. The details of the reforms concerning foreign banks are also rather vague and therefore, at present, the literature is somewhat scarce. Therefore, to further advance future literature and discover the effects of the liberalisation of the banking sector in China, additional research must be undertaken. As the banking sector is so large and plays such a vital role in China, further study must be made into the advances made by foreign banks in China. While initial research has been undertaken on the motivations and modes of entry of the foreign banks into China, very few have followed up on their success or failures. Most actions in the economic planning of China, would all point to the viability of more foreign banks in the market. These actions include, the ascension to the WTO, the content of the past and current 5 years plans, the movement of Chinese banks abroad and availability of Chinese banks to foreigners on the stock exchange. (Hess, 2014) In theory, the power of the Big Four state owned banks should be diluted with the movement of foreign entrants. This is due to foreign banks having the skills to operate with efficiency and quality, whilst offering a complete range of products. As discussed before, China has been subject to a great amount of FDI and therefore foreign firms doing business in China will also, most likely, opt for foreign services; due to their familiarity and trust worthiness. This in turn, should push local banks to provide a more complete service and raise its efficiency. (Lin, Cai, Li, p290).
Jonathan James Yee Page 8 The importance of foreign banks increasingly grows, as the RMB is gaining momentum in its internationalisation and it will be these institutions, which help the transition of this historic move. (Reuters, 2012) The financial sector in China is one of the few areas in the economy where reform is in its relative infancy and is still undergoing major changes. Therefore, further research is needed to follow up on whether or not foreign banks have gained momentum over the past years. This will primarily be in terms of their total assets, net income, equity and their volume of deposits and loans. The research aims to show whether new regulations, from 2001 to 2014, have been effective in increasing competition in China, as was their goal.(Fu and Heffernan, 2006) Or was it just a façade to show cooperation to the international markets, while still maintaining tight controls over the financial sector? The paper does not aim to prove that the liberalisation of the banking sector is the definitive reason for any movements in the composition of banks in the financial sector. As current reforms are still in progress and therefore no definitive answer can be given. However, by looking at past trends and analysis of the compiled data, it may provide us with some implication of its role, past, present and give us some insights to the future of banking in Chin
Jonathan James Yee Page 9 The following section will be a review of the literature, which questions the importance of internationalisation of foreign banks to the economic environment. This, along with a brief history of the financial sector, will help us to understand clearly the obstacles and pressures placed upon the government to open up the banking sector to the international market. The methodology of the research will be clarified and the interpretation of the results will be explored further. Finally, the limitations and the future areas of research will be explored as a conclusion to the paper.
Jonathan James Yee Page 10 2) Foreign Banking in China To understand why this topic is of great importance we must assess the importance of companies going global and the importance of having foreign banks competing in the local market. With increasing globalisation comes the need for increased international capital markets to help facilitate international trade. This helps aid the investment required when firms wish to venture abroad and help provide liquidity to the domestic market. However this can only be achieved if countries lower their barriers and loosen their rules, in order to aid target markets. (Hill, 2014) China’s loosening and restructuring of economic legislation through the 5-year plan should therefore encourage, to a certain extent, entrants of foreign entities. Economic legislation refers to direct legislation and administrative regulations of entry into a specific market or industry. (Joskow and Rose, 1989) The department for Business Innovation and Skills (BIS), also states that, ‘ high quality and efficient economic infrastructure plays a vital role in supporting a competitive and growing economy, by providing services on which all businesses and citizens depend on’. Continued improvement of economic regulation is vital for infrastructure investment and can facilitate more investment than through privatisation. This aids a countries infrastructure growth and its international competitiveness. (BIS, 2011)
Jonathan James Yee Page 11 In relation to an oligopolistic market, such as China’s banking sector, BIS states that it limits effective competition, and therefore regulation needs to be adapted in order to promote fairness and protect consumers’ interest. (BIS, 2011) Having added competition from foreign firms is advantageous as it increases the supply of capital in the country and therefore, the cost of borrowing is usually lower. This can be done using indirect commercial banking methods or direct investment banking methods. If the investment banking system is needed, having an international firm present, allows for a wider range of opportunities therefore, spreading the risk in a portfolio. (McKinsey, 2011) Foreign banks in China can deliver this by providing greater professionalism, wider product knowledge, a customer-centric service, managers trained internationally, wider product selection, a global network and a strong reliable brand name. These are all key components, which demonstrate the importance of foreign banking growth in China. Of course it simultaneously brings added pressures to domestic banks, however if introduced correctly this added pressure could result in higher quality products at a cheaper price and a push in innovation. (PWC, 2012) If the investment opportunities are limited to just the domestic field, this will place pressure on supply, in turn making the rate of return lower on investment. Also, if a financial crisis were to happen domestically, a trickle effect could impact other investments, as the risk have not been spread across multiple arenas. (Hill, 2014)
Jonathan James Yee Page 12 This is the problem that the Shanghai stock exchange is currently facing (August, 2015), as the majority of the stocks listed are A-shares, which can only be sold to domestic investors. Therefore, when the shock slump in the stock market, caused by the devaluation of the RMB occurred, it sent the value spiralling downwards. (Economist, 2015) Diversifying across multiple stock markets helps reduce the risk, as different stock markets responding to different factors. Therefore, a crisis on the Shanghai stock exchange may not necessarily affect the stock on the New York Stock exchange. Of course, as the world becomes more integrated through globalisation, technology and further deregulation continues, the relationship between stock markets, are becoming more interdependent. As the 2008 financial crisis exhibited, an impact in one country can dissipate extremely quickly around the world. (Hill, 2014) Other costs caused by foreign entrants into the Chinese financial markets are that to domestic banks. Domestic banks need to lower costs to compete with foreign banks, which have a better reputation, in turn making them unprofitable. (PWC, 2012) Therefore, overall the benefits are great, especially to a country like China, which wishes to have more political clout in the global economic stage. However, rightly so, the government should keep a close watch on the firms entering the economy, especially large foreign firms which sometimes have more economic power than some national governments. Deregulation must be monitored and controlled to have its desired effects.
Jonathan James Yee Page 13 As it is beneficial to open up a country to foreign banks, the foreign banks themselves must also have an incentive for venturing into overseas territories. In a research paper by Claessens, Demirguc-Knut and Huzinga, they empirically tested the effects of foreign banking in 80 countries using data from Bankscope. Their research came to the conclusion that in developing countries, foreign banks have higher interest margins, profitability and tax payments than their domestic counterparts. Therefore, their research shows that it is consistent with other literature and that in the long run more foreign banks may improve the domestic climate, especially for customers. They also found that it was the number of banks, which entered that, was deemed to be important to competition in the domestic market. This is an important point and therefore will be further explored in regards to the research undertaken in this paper. (Claessens et al,2000) Foreign banks would be favourable in China as they provide global networks and trading expertise, which although Chinese banks, are gaining strength in, they are still far behind in terms of global scale. However, foreign banks have been able to provide this as funding highly depends on deposits, which are difficult to come by due to domestic competition. Consequently, foreign banks require strong support from home. 30 out of 35 banks stating that the parent company as the main source. Other methods of funding are highly restricted in China, as only a few foreign banks have been given approval to issue bonds. (PWC, 2013)
Jonathan James Yee Page 14 As well as typical deposit and loan banking, foreign banks can utilise their comparative advantage abroad by tapping into niche markets. China’s undiversified banking sector provides foreign banks to utilise their expertise in areas such as wealth management, investment banking, Internet banking and credit cards. According to KPMG’s report on foreign banking, by the end of 2004 foreign banks were able to introduce three times the amount of new products than domestic banks. This competition is also expected to increase banking efficiency and will create spill overs. (KPMG, 2014) As the banks tend to all be in close proximity of one another, hiring and firing of staff will cause innovation, knowledge and technology transfers from one bank to another. This has been demonstrated to be true with many knowledge parks, for example Silicon Valley. The Shanghai Free Trade Zone may also grow into a knowledge park if its goal of becoming an international financial centre (IFC) is realised. (EY,2014) Although, in the short run foreign banks may increase domestic banks cost, it is shown that in the long run they may reduce them. This has been attributed to the spill over effects strengthening the competition, which will force banks to lower costs to be competitive, and therefore be beneficial to consumers. (Allen, et al, 2011) In recent surveys of foreign banks in China the regulatory environment is seen as the most difficult aspect of doing business in China with finding good personnel and competition from domestic banks being additional hurdles. (PWC, 2013) Further domestic competition in
Jonathan James Yee Page 15 China increased in 2014 when regulators further approved 5 new privately owned banks. This was followed by the loosening of regulations for RMB licenses for foreign banks. (EY, 2014) This may set to change however, with the new 12th five year plan pointing towards favourable firms in biotechnology, new energy, high tech manufacturing and computing innovation. Foreign banking expertise in these fields may be needed and therefore readjustment to the regulations may need to change. Foreign banks have a proven track record with risk management and corporate governance, which will help strengthen banking regulations in China. This is a goal of the most recent 5-year plan and therefore would be interesting to see if these have come into any effect. Much of the regulatory change has been driven by the US and EU, such as the Dodd Frank, Basel III and the Recovery and Resolution Planning. This will simultaneously help the Chinese banking environment and create opportunities for foreign banks. (PWC, 2012) The literature suggests, in a magnitude of ways that allowing foreign banking in China would be a benefit for the Chinese economy, foreign banks themselves and for consumers. The evidence suggests that Chinese has made a great deal of effort to liberalise the banking sector and allow foreign entrants. This may be from a great deal of pressure from the WTO however, as there are still many provisions in place which, discourage foreign entrants. The aim is to discover whether foreign banks or the Chinese government has prevailed.
Jonathan James Yee Page 16 3) Review of Chinese Banking System To understand how foreign banks can achieve the internationalisation goals they wish to, we must assess China’s past history to understand why the financial sector’s environment has arrived at its current destination. We must also assess the present environment and the 5- year plans to uncover the opportunities available to foreign banks currently and in the future. 3.1) Brief History On the 1st of October 1949, after decades of civil war, China finally established itself as a new country with a new leader. The People’s Republic of China, under the leadership of Mao Zedong, transformed the economy into one which aimed to become an independent country utilising communist methods. To do so, Mao insisted that the route of heavy industry was the preferred method, due to most of the world’s most powerful economies at that time adopting this path. (Lin et al, 2003) As it was not in China’s comparative advantage to adopt this method, all decisions needed to be enforced by the central government. In order to channel funds into heavy industries the financial sector was nationalised. Nationalising the financial sector, including foreign banks, which had established themselves in China, was completed by 1952 when the People’s Bank of China became the national bank, channelling funds into industries based on political goals rather than market orientation. (Lin, 2011)
Jonathan James Yee Page 17 In 1953, the first 5-year plan was devised with much of the focus being on collective ownership in agriculture and in industry, with continual focus on investment to heavy industry, which accounted for 85% of all investment. Mao’s persistence, even through catastrophic events such as the Great leap forward continued till his death in 1978. (Naughton, 2011) After Mao’s death, China’s leadership was undertaken by Deng Xiaoping, who looked to create more economic growth. In order to do so, he slowly transitioned the economy from a command economy to one with more market characteristics. In light of this, financing could no longer be purely allocated from one bank and therefore special banks were set up in order to fund specific industries. (Lin et al, 2003, Zhang, 2006)) In 1979 the government diversified the banking industry by placing China Construction Bank under the control of the state council thus assuming more commercial banking functions. Along with this, the establishment of The Bank of China (foreign exchange) and The Agricultural Bank of China (agricultural sector), further diversified the sector. The final establishment of a task specific state bank took place in 1984, with the establishment of The Industrial Commercial Bank of China (ICBC), to fund industrial and commercial businesses. All the banks came under the supervision of the People’s Bank of China, which now acted as the central bank and therefore had control over monetary and banking policy. (Turner et al, 2012) To further increase competition the specialisation of banks was abolished allowing the banks to assume other forms of credit accumulation in 1986. This, along with the introduction of interbank lending to aid liquidity, further commercialised the banks, while in turn leaving
Jonathan James Yee Page 18 them with an oligopolistic nature. After this point there was not much movement in terms of foreign banks until the 10th 5-year plan in 2001, the year China ascended to the WTO. 3.2) Current Environment Prior to China’s admittance into the WTO, lengthy negotiations were undertaken with the US and the European Union, where by an agreement was made that China would fully allow foreign banks into the domestic market. China took this in their stride and allowed gradual entry by foreign banks into China before it had even reached the agreed 5-year period. In the same year China entered into the WTO, 157 foreign bank branches were already authorised to conduct business within China and the number increased to 192 by 2004. Foreign banks were only allowed to operate branches if they had a minimum deposit of RMB 1 Million, and were only allowed to serve corporate clients. (He and Fan, 2004) Over time, to further release the stresses of the People’s Bank of China, regulatory commissions were set up to supervise different sectors. The China Banking Regulatory Commission (CBRC) being formed in 2003, to regulate the banking sector. Not only was this to release the stresses to the central bank but to also prove to the WTO that the country could abide by international rules and regulations and further strengthen their financial sector. With the WTO agreement, came the further inclusion of foreign banks allowing them to open up branches in China other than special economic zones such and Shanghai and Shenzhen. (Xu, 2011) Now facing immense pressure from competition, the state owned banks now started restructuring and listing on the stock exchange, to gain more capital and gain foreign
Jonathan James Yee Page 19 expertise rather than going into direct competition with them. They have controlled the amount of foreign investors by listing the shares in Hong Kong (H-shares), which are available to foreign investors and in Shanghai (A-shares) only available to domestic investors. (Naughton, p471, 2011) Despite the listings the government still owns the majority of shares for all 4 of the banks, with the lowest (CCB) still being nearly 60%. (Bankerdatabase, 2015) By listing on the stock exchange, many foreign banks have bought a large amount of shares in the Chinese banks, which may in turn indirectly influence entrances of foreign banks as a whole entity and result in partnerships with Chinese banks instead. For example, after listing in 2005, Bank of America owns 11.4% of CCB, followed by listings in 2006 by BOC and ICBC, resulting in a 10% ownership to RBS and 15.9% by Goldman Sachs respectively. Finally, after one of the largest IPO’s in stock market history Goldman Sachs now has a 3.3% share of ABC. (dbsreasearch, fas.ord, goldmansachs, jonathan yee) As well as foreign branches, foreign acquisitions of banks were becoming more regular after the ascension to the WTO. Although, the equity could only amount to a maximum of 25% many foreign banks preferred this method rather than setting up branches in the early years of the WTO ascension. This may be due to the foreign banks trying to target banks, which already have a strong gain of a local market instead of pitting themselves directly against them. This is turn builds their business networks, complementary public relations and access to market information. In a period where full access to foreign banks was
Jonathan James Yee Page 20 still restricted, this method seemed to be a more viable option to foreign banks. (He and Fan 2004) Despite this, only one bank (Hang Seng Bank) went close to the 25% limit, by acquiring 24.8% of Fujian Industrial Bank LTD. All acquisitions were on average around 10%, showing that foreign banks did not make much movement in the years prior to it being fully open. (He and Fan, 2004) On the 11th of December 2006, China officially allowed foreign institutions the same rights as domestic banks. Foreign banks were now allowed to extend the bank branches across China if they followed the previous rule of RMB 1million minimum deposits and were also a wholly foreign owned enterprise or a banking subsidiary. Along with this in order to obtain a license, the banks also needed approval from home regulators, international track record, evidence of profit making ability and have established a comprehensive policy and procedure guideline. (EY, 2014) However, as a stipulation, wholly foreign owned banks (WFOB), must ensure that registered capital should be equivalent to RMB 1 Billion and those branches should have a working capital of RMB 100 million. The application for approval also takes 6 months with a further 2 months for a formal approval, where a list of key executives, accounting manuals, capital verification, financial statements and other documents must be provided to the CBRC. (KPMG, 2006) Foreign banks can also only accept fixed deposits of more than RMB 1 million putting them at a clear disadvantage, as this is far above average of a typical saver. Although, theoretically it is within the WTO guidelines, it does put domestic banks at an advantage. (Jeffries, 2011)
Jonathan James Yee Page 21 This carries on to date, with the granting of and RMB license taking up to 3 years and the CRBC restricts foreign banks opening multiple branches at the same time. This process is arduous and very drawn out and hence will take a number of months or even years to prepare and obtain a licence, and therefore we see that the increase in bank branches is very minimal. (PWC, 2012) After the 5-year grace period had finished and foreign banks were allowed to enter as WFOBs the composition of the banking sector started to change. This, in turn, was the start of the new 11th 5-year plan in which the new government’s goal was to reform the banking sector as a whole, rather than giving special privileges to just foreign banks. A major set up is the New Shanghai Free Trade Zone (SFTZ), which will allow open trade in in international goods and services along with more open foreign investments. This pilot scheme is then set to extend later to Tianjin and Guangdong. (Deloitte, 2015) However, many foreign banks have still not chosen to set up here due to the lengthy procedures and the extreme costs. Some banks are said to have spent US$2million to US$10million in order to set up a mandatory accounting systems required by regulators. The products firms can offer in the SFTZ are still unclear and have not been able to reach its potential due to the RMB internationalisation and interest rate liberalisation still being an on going process. (EY, 2014)
Jonathan James Yee Page 22 As it stands the current form of the banking sector is shown in the diagram below: Diagram 1 Source: (Queen’s business review, 2013 and Jonathan Yee,2014)
Jonathan James Yee Page 23 3.3) 5 -year plan and banking As much of the liberalisation policies to target industries are outlined in the 5-year plan, a brief summary of each plan and its financial goals will be briefly explored. As previously mentioned the first 5-year plan occurred in 1953, as an outline for the CCP’s economic goals. It is officially known as the 5-year plan for National Economic and Social Development. Its goals are to, ‘map the direction of future development and set targets’. This is aimed at providing key infrastructure projects, distribution of production and to contribute to the national economy. (NDRC, 2006) Until recently the 5-year plans have been primarily focused on export-import growth, and other primary and secondary sectors, due to China’s competitive advantage, thus holding back on the service sector. The financial sector has been heavily guarded by the Chinese government and no significant implications for foreign firms were made prior to the ascension to the WTO in 2001. Therefore the short extract will be from the 10th 5-year plan as this is the start of the dataset used in the research (2001).
Jonathan James Yee Page 24 3.31) 10th 5-year plan (2001-2005) Delivered on the 5th March 2001, Zhu Rongji delivered the outline of the 10th 5-year plan. The government’s main goals in the 10th 5-year plan were not focused on the financial sector but however it did provide some foundations in order to tackle this in the future. As 2001 was the year China finally ascended into the WTO, the government took steps to improve the legal environment and government administration. (NDRC, 2006) The attention at the time was still primarily on the export-import side of trade and economic growth, however they were aware that in order to accelerate this, developing services such as banking, accounting and law needed to be improved. As this period was a time of high FDI, the emphasis was on how they could better utilise the foreign funds and investment, was a key issue, in particular making it more attractive to investors to turn their attention to Central and Western China. (China.org.cn) In order to perform the macroeconomic policies they had to divert the change in wholly owned state owned banks to a more commercial function to support the economic situation. Thus, they simultaneously had to encourage small and medium banks to have a more active role while fully utilising the new policy banks, in order for the state owned banks to have a more commercial presence. (NDRC, 2001) To make this viable another key element of the tenth 5-year plan was the safety of financial institutions and their supervision. Zhu Rongji states that a system of evaluation and accountability are to be implemented and diffuse any potential financial risks that may occur. (Gov.cn, 2001)
Jonathan James Yee Page 25 3.32) 11th 5-year plan (2006-2010) The time period from 2006 onwards is extremely important for this research due to the agreement with the WTO to allow inclusion of foreign banks in China to have the same national treatment as domestic banks. This particular 5-year plan was seen as ‘revolutionary’, as it veered away from the typical fast economic growth plans which allowed ‘some people to get rich first’. (Asia Times, 2005) Instead under Hu Jintao the aim was to close the gap between the rich and poor as the inequalities between the two classes grew extremely wide. The new administration now saw it as the time to implement the ‘common prosperity’ once talked about by Deng Xiaoping. (Fan, C, 2006) Within the 11th five year plan statement given by Ma Kai, the chairman of China’s National Development and Reform Commission, one of the key points was the further deepening of the market economy system. He emphasized that in order to do so, further reforms in the areas of, ‘administrative governance, state owned enterprises, taxation, finance, science and technology, education and public health,’ were the main criteria. He further reiterated this point by emphasising that it would be the government’s top priority to speed up the improvement of these areas to facilitate the socialist market economic system. (NDRC, 2006) There is only a minute mention of small and medium financial enterprises to have new ownership types, primarily private banks. This, along with other wide-ranging governmental reforms mostly in the form of reducing red tape and bureaucracy. This is in
Jonathan James Yee Page 26 order to assist tax reforms, which are due to take place however there were no specific implications to the extent to the reforms. Therefore, in essence, this is the first time the government was not trying to directly enforce ideals onto any priority sectors but rather allow more market forces to play a bigger role. They were aiming to do this more domestically through the forces of demand and supply and rely less on foreign investment due to its huge reliance on foreign trade to the amount of 70% of GDP at the time (2005). (Naughton, The New Common Economic Programme) The contradiction of less foreign investment at the same time allowing more foreign banking entities into China will be interesting to observe, and to see which one has more prevalence. 3.33) 12th 5-year plan (2011-2015) In the 12th 5-year plan released by the State Council, the financial sector clearly played a big role as the plan for the development and reform of the financial sector were jointly undertaken by the People’s bank of China, The Chinese Banking Regulatory Commission, the China Securities Regulatory Commission, China Insurance Regulatory Commission and the State Administration for Foreign Exchange. (China Briefing, 2012) The importance of protecting and developing a strong and stable financial sector became paramount after the global financial crisis. China endured the global financial crisis and in light of the meltdown abroad further enhanced their risk prevention and additional strengthened control and supervision of the financial sector. China saw itself now
Jonathan James Yee Page 27 having a critical role in the international field of finance and it was one of the few countries able to absorb such a critical blow to worldwide banking. (CSRC, 2011) By this reform period, all the Big Four banks had successfully listed on the stock exchange, improving shareholder reform and improving corporate governance. This allowed for the government to establish the banking sector into ‘layers’, dependant on their goals, such as policy banks, commercial banks, national joint stock commercial banks and other small and medium sized banks. (Martin, 2012) The focus was to also push the commercial banks into the international markets to increase global competitiveness and establish a wider portfolio by ‘going out’. Simultaneously domestic banks were encouraged to cooperate with foreign institutions by accepting low-interest foreign loans to improve external debts in cross border activities. This is also to facilitate China being more vocal in the global financial arena. China wishes to interact in global economic governance by enhancing macroeconomic and financial policy with other major economies. (British Chamber of Commerce, 2011) New and further banking reforms were put in place during this 5-year plan, through new regulatory standards, instruments and risk identification. The capital adequacy ratio was to be strictly obeyed to follow international levels. (CRSC, 2011) By assessing the content of each 5-year plan we should expect that there was little movement from the 10th 5-year plan, moderate movement from the 11th 5-year plan and a big leap from the 12th 5-year plan.
Jonathan James Yee Page 28 4) Methodology This paper has utilised a qualitative method with an inductive approach following a positivist paradigm. A qualitative method uses information that may not be immediately quantifiable unless coded and is usually not descriptive (Sekaran, Bougie, 2009) The positive approach uses data, which can be obtained using neutral observations. This research achieves its goal by using data from Bankscope. (Gill and Johnson, 2012) This approach has been employed as the banking sector in China is extremely large and the data is particularly sensitive. Trying to obtain the data oneself would be time consuming, costly and unreliable and therefore using secondary data is appropriate.(Saunders, Lewis et al, 2012) Bankscope is a comprehensive database used by 90% of the world’s top 1000 banks, containing financial information for more than 29,000 banks globally. Its reputable name and data therefore allows for others to continue the research post this paper if desired. (Bankscope, 2015)
Jonathan James Yee Page 29 4.1) Data Collection As previously mentioned the data collected was secondary data from Bankscope, to give an impartial and reliable interpretation of the results. The data from Bankscope is aggregate data and separated into each individual bank. Therefore, for the purpose of my research and have compiled the data to form a separate compilation of results for foreign banks and all other banks in China. All information is compiled from the year 2001 to 2014, as 2001 is the start of the 10th year plan and 2014 being the last available and recent year of data. Foreign banks in China in this study are classified as banks that have a foreign shareholder which holds at least 51% of the stake. A full list of foreign banks can be seen in the appendix. According to Joskow and Rose there are four empirical methods for measuring the effects of regulation; Comparing regulated and unregulated firms or markets, using variations of the intensity of regulation, using controlled environment experiments and creating structural simulation of models for a regulatory environment. (Joskow and Rose, 1989) In this study we shall be adopting the approach of comparing the more regulated foreign banking sector with the less regulated domestic competitors. This method is appropriate as the nature of regulatory constraints the firms are subject to, are attributed to regulation and the differences between in performance are attributed to regulation.
Jonathan James Yee Page 30 This will take place on a time series scale as we wish to look at the time period ranging from 2001-2014. Time series can identify regulatory change over time or time periods. The variables chosen to demonstrate the change over time are typical accounting calculations which are globally used to show business performance. The list and definitions of the variables are shown below. 4.2) Variables Equity- is the amount left over when the liabilities have been subtracted from the assets. In essence it is the ownership of the asset once the debt has been paid off. (Investopedia.com) Total Assets- are an economic value of all the assets the entity has at a particular time. The assets are exploited over time into order to receive a return for the entity. This may include, cash, inventory, fixed assets and so on. (Accountingtools.com) Net Income- are a company’s total earnings minus any expenses paid in a given time period. It can be used to show how profitable a company is over time. (Investopedia.com) Return on Assets (ROA) – or return on investment, illustrates how profitable a company is in relation to its assets, by showing how much investment has been converted into income. It is usually calculated as Net Income divided by Total Assets and displayed as a percentage. (Investopedia.com)
Jonathan James Yee Page 31 Return on Equity (ROE) – is similar to ROA but instead shows how much money has been returned in turn for the investment received. It is useful for comparing profitability and is displayed as a percentage. (Investopedia.com) Return on Average Assets (ROAA) and Return on Average Equity (ROAE) - is also shown here to give a comparable view of profitability which is easier to gauge. They show the average return of the time period. (Investopedia.com) Net Loans – is the total amount of loans given to out to customers minus any unearned interest and possible losses. (Santander.com) This paper has compiled the data from each year to compare foreign banks to domestic banks to show how much each group possesses in terms of- • Share of Total Assets • Share of Net Income • Share of Equity 4.3) Method To display this and form the data analysis Microsot Excel, SigmaXL and SPSS software will be used in order to examine the results. First, the preliminary results will be given to show foreign banking’s growth isolated from the market. Secondly the proportion of each group’s market share of Total Assets, Net Income and Equity will be shown to demonstrate if foreign banking has depleted any of the domestic markets hold. Finally, the results of the two sectors will be compared and correlated in order to show their relationship
Jonathan James Yee Page 32 with each other. This will be done using Pearson’s correlation to show if the two are in line or whether foreign banking growth has deviated from the rest of the market. Pearson’s Correlation measures the strength between two variables by its linear association. The strength of the correlation is shown by the coefficient ‘r’ ranging from -1 to 1. For a positive relationship the coefficient ‘r’ should be above 0.5. To show whether or not, it is statistically significant or not, I have chosen a significance level of 0.01. If the resulting value is above the significance value, than the results are statistically insignificant. (Leard.com) The formula for the Pearson Correlation is show below where ‘x’ is foreign banks, ‘y’ is Chinese banks and ‘n’ is the number observations. (stat.mwich.edu) The assumptions of the data for a Pearson Correlation are that the data is interval or ratio data. For the data set in this paper we are using interval data therefore making the Pearson Correlation appropriate. The Pearson Correlation is also appropriate for this paper as it does not require a dependant or independent variable. As we are using data which is to be compared and not dependant on each other it further justifies the use of the Pearson correlation.
Jonathan James Yee Page 33 However, the requirement of normal distribution is not fulfilled and therefore we must transform our data in order to form normality. Therefore, we have utilised the SigmaXL program in order to transform the data into Normal distribution using the Box-Cox Method. The Box Cox method transforms data to form a normal distribution by applying a Lambda value to identify the power to which the data should be raised. This was achieved by using the SigmaXL software in combination with Microsoft Excel. (http://www.isixsigma.com/) In order to get a fairer result as the values from foreign banking and Chinese banking are vastly different I have also Logged both results to 10 (Log10), before applying the Box- Cox Method. After the Box-Cox method was applied, I further checked the distribution of all results in SPSS, using the Shapiro-Wilks method. The Shapiro-Wilks is a test of normality which is suitable for a small sample. As our sample was of 14 observations it is an appropriate method. All variables passed the normality test with a significance value of 0.5. (Leard.com) After the variables were transformed and normally distributed all requirements of the Pearson correlation test were fulfilled and therefore applicable for use with our data, to show the correlation between foreign banking and Chinese banking.
Jonathan James Yee Page 34 5) Results First the preliminary results will be given to show foreign banking’s growth isolated from the market. Secondly the proportion of each group’s market share of Total Assets, Net Income and Equity will be shown to demonstrate if foreign banking has depleted any of the domestic markets hold. Finally the results of the two sectors will be compared and correlated in order to show their relationship with each other. This will be done using Pearson’s correlation to show if the two are in line or whether the 5-year plan has not specifically targeted foreign banking growth but just the growth of banking in general. 5.1) Foreign banking isolated results In this section we will cover the progress of foreign banks in China, by isolating and displaying only their results away from the rest of the banking sector in China. This will give a rough guideline to their development and will give clarity to the results later in the paper. This will be shown using the variables described above, with all results being shown in United States Dollars (USD) thousands or in percentages.
Jonathan James Yee Page 35 Graph 1 (Source: Bankscope) Graph 2 (Source; Bankscope) 0 100000000 200000000 300000000 400000000 500000000 600000000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 TotalAssetsUSD(thousands) Year Foreign Banking Total Assets USD (thousands)
Jonathan James Yee Page 36 Graph 1 and 2 are time series graphs showing the trend of total assets and equity respectively, of all 41 foreign banks in China combined. From the graph we can see that during the early 2000’s when China first eased in new regulations, the total assets and equity of foreign firms barely grew. Growth only takes place from 2006 onwards, when the foreign banks were granted the same rights as Chinese banks. (Xu, 2011) From then onwards it has been a steady upward rise for foreign banks in terms of their assets and equity in China showing healthy progression. The steepest areas of growth are also in 2006 and 2011, the years in which a new 5 year plan was implemented. This may be evidence of the 5-year plan’s power in foreign banking policy. The total amounts of both assets and equity are also very similar reaching a high of US$543018451.2 thousand of assets and US$48662267.71 thousand of equity. Graph 3 (Source; Bankscope) 0 500000 1000000 1500000 2000000 2500000 3000000 3500000 4000000 4500000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 USD(thousands) Year Foreign Banking Net Income USD (thousands)
Jonathan James Yee Page 37 Graph 3 illustrates the net income of the foreign banks in China from 2001. We can see that similarly to assets and equity, that there was little movement from 2001-2006, when China first entered into the WTO. Furthermore, like assets and equity, a steep positive jump of net income came after 2006 when the WTO regulations stipulating equal treatment occurred. However, unlike assets and equity, net income has shown more volatility with spikes and crashes. Much of it is in line with the global financial crisis, showing the vulnerability of foreign banks to external pressures. This may be due to the foreign banks performance abroad affecting their worldwide operations, displaying the dangers of globalisation. Despite the global financial crisis, a rapid recovery was made and the increase from 2010 to 2011 was the largest in the whole time series. This may also be due to the 5-year plan, as seen in previous results. If it were as a result of the 5- year plan, from the net income perspective, the 12th 5- year plan has been the most successful. Graph 4 (Source; Bankscope)
Jonathan James Yee Page 38 Graph 5 (Source; Bankscope) Graph 4 and 5 display the Return on Equity and Return on Average Equity of foreign banks in China. From the Return on Equity Graph 4 we can see that the returns from the early years were quite great with a sharp dip and then levelling off. This doesn’t seem to be healthy but when looking on the Return on Average Equity that it does follow the market trend and that therefore, on average there are returns being made to the equity in each time period. Overall however, the cumulative return to equity has been slow.
Jonathan James Yee Page 39 Graph 6 (Source; Bankscope) Graph 7 (Source; Bankscope)
Jonathan James Yee Page 40 Graph 6 and 7 display the Return on Assets and Return on Average Assets of foreign banks in China. From the Return on Assets Graph 6, we can see that it is extremely erratic and that there is no real trend. However, as time goes on it does seem to be transforming into an area of more stability with results stabilising from 2011 onwards; the start of the 12th 5- year plan. When assessing the Return on Average Assets, the results seem more consistent with the other results with it following market trends. We can see that year on year the Return on Average Assets are improving, proving to investors, that their investment is being put to good use. Graph 8 (Source; Bankscope) 0 50000000 100000000 150000000 200000000 250000000 300000000 350000000 400000000 450000000 500000000 20012002200320042005200620072008200920102011201220132014 USD(thousands) Year Net Loan and Deposits of Foreign Banks Net Loans Deposits
Jonathan James Yee Page 41 Graph 8 displays the commercial ability of the foreign banking sector in China. We can see that net loans and the deposits are rising year on year since 2006, when foreign banks were allowed more prevalence in China. This is a key indicator showing they are increasing competition in the market by providing and accepting funds from customers, which is one of the key functions of commercial banking. This increase in competition is vital for the efficiency in China, as the top four banks have such an oligopolistic strangle hold on the commercial banking market. 5.11) Analysis of Foreign Banking Isolated The foreign banks isolated results show that in terms of all variables, that from 2001 to 2006, there were almost no improvements made by foreign banks in China. All the growth has been since the mandatory WTO requirement of treating foreign firms at the same level as Chinese firms. Therefore, we can see that the influence of the WTO has been extremely powerful. However, other aspects must have also contributed to the successful growth of foreign banks in China as there is still continued growth in foreign banking in China. This has been seen even despite the global financial crisis of 2008. Although affected by the crisis the foreign banking sector was able to bounce back soon after and have seen the biggest growth since the 12th 5-year plan started in 2011. From these results we can see that foreign banking is making continuous gains in the Chinese banking market and that they are improving competition in China as Loans and Deposits into the market are also increasing.
Jonathan James Yee Page 42 5.2) Share of Market Results Table 1 (Source; Bankscope) Table 2 (Source; Bankscope) Table 3 (Source; Bankscope) Total Assets Year 2001 2002 2003 2004 2005 2006 2007 Percent Foreign 0.032998737 0.035383817 0.02624105 0.067660726 0.236062337 0.467827431 1.424185276 Percent China 99.96700126 99.96461618 99.973759 99.93233927 99.76393766 99.53217257 98.57581472 Year 2008 2009 2010 2011 2012 2013 2014 Percent Foreign 1.334558824 1.301781109 1.46134047 1.797403763 1.684302571 1.747204817 1.759813343 Percent China 98.66544118 98.69821889 98.5386595 98.20259624 98.31569743 98.25279518 98.24018666 Net Income Year 2001 2002 2003 2004 2005 2006 2007 Percent Foreign 0.035105888 0.076154263 0.02815934 0.004610775 0.269993615 0.942883237 1.032086562 Percent China 99.96489411 99.92384574 99.9718407 99.99538922 99.73000639 99.05711676 98.96791344 Year 2008 2009 2010 2011 2012 2013 2014 Percent Foreign 1.727589701 0.973738456 0.91475248 1.74051187 1.519038031 1.287139401 1.475430118 Percent China 98.2724103 99.02626154 99.0852475 98.25948813 98.48096197 98.7128606 98.52456988 Equity Year 2001 2002 2003 2004 2005 2006 2007 Percent Foreign 0.572783252 1.718910622 1.54150046 1.639727234 0.683988701 0.900019806 4.511899992 Percent China 99.42721675 98.28108938 98.4584995 98.36027277 99.3160113 99.09998019 95.48810001 Year 2008 2009 2010 2011 2012 2013 2014 Percent Foreign 2.907909908 3.287794857 3.00978802 3.259306292 2.949101345 2.895842033 2.817649362 Percent China 97.09209009 96.71220514 96.990212 96.74069371 97.05089865 97.10415797 97.18235064
Jonathan James Yee Page 43 5.21) Analysis of Share of Market Results In this section we will now compare the foreign banks to the rest of the Chinese banking sector, in order to uncover the extent of their success observed, when the result were isolated. We have done so by revealing the total market share of total assets, equity and net income. The results of all three are extremely similar, and therefore they will be analysed together. In 2001 we can see that the percentage of foreign banks in China was almost non- existent. As time progresses we do see improvement of foreign banks share of the market in all three of the results, especially the sharp rise in 2006. However, the results and growth in relation to the isolated growth is extremely minute. The market share in all three areas is still extremely dominated by the Chinese banks. The foreign banks have gained less than two per cent of market share in terms of total assets and net income and just under three per cent in equity. This result is extremely small showing that foreign banks, although growing are just keeping up with the growth of all other firms in the market. The market share of the foreign banks also dropped in 2011, which is contrary to the results shown when isolated. Therefore, this must mean that the 12th 5-year plan has allowed for growth of the whole sector but Chinese banks have taken advantage of the opportunity to outperform foreign banks in China.
Jonathan James Yee Page 44 To further test whether or not this is true we shall perform the Pearson correlation test. If the results of both the foreign banks and Chinese banks are highly correlated it would mean that the liberalisation and deregulation of the financial sector and aided all banks in China and not specifically the foreign banks. If however, there is no correlation between the two than we would be possible to show that the positive results shown from the foreign banking isolated section is a result of the change is regulations and liberalisation, are a result of them targeting just foreign banks, opposed to affecting the whole industry. 5.3) Pearson Correlation Results Pearson correlation of Assets results Correlations Foreign Assets China Assets Foreign Assets Pearson Correlation 1 .978** Sig. (2-tailed) .000 N 14 14 China Assets Pearson Correlation .978** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed). Pearson correlation of Net Income results Correlations Foreign Net Income China Net Income China Net Income Pearson Correlation 1 .961** Sig. (2-tailed) .000 N 14 14 China Net Income Pearson Correlation .961** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed).
Jonathan James Yee Page 45 Pearson correlation of Equity results Correlations Foreign Equity China Foreign Equity Pearson Correlation 1 .977** Sig. (2-tailed) .000 N 14 14 China Equity Pearson Correlation .977** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed). Pearson Correlation of Net Loans Results Correlations Foreign Loans China Loans Foreign Loans Pearson Correlation 1 .966** Sig. (2-tailed) .000 N 14 14 China Loans Pearson Correlation .966** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed). Pearson Correlation of Deposits Results Correlations Foreign Deposits China Deposits Foreign Deposits Pearson Correlation 1 .972** Sig. (2-tailed) .000 N 14 14 China Deposits Pearson Correlation .972** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed).
Jonathan James Yee Page 46 Analysis of Pearson Correlations In the same way that the shares of markets results were all extremely similar to each other, so are all the Pearson correlation results. Therefore, we have also grouped all of them together in the analysis. The Pearson correlations are comprised of assets, net income, equity, net loans and deposits. All the results show that there is a positive relationship between each of the variables, and that they all have a strong correlation. All the ‘r’ values are extremely close to 1, with 1 being the perfect correlation. They all satisfy the 0.01 level of significance too, as the ‘a’ is below it, hence showing the results are significant. (Leard.com) As all the results show a positive correlation for all the variables, it displays that the deregulation and liberalisation of the financial sector has not specifically targeted foreign banks to develop and increase competition in the sector but has instead allowed for the growth of the banking sector in general. The close correlation of both sectors through years also shows that they have followed similar paths from 2001-2014, and there has not been much deviation between the two sectors. This is further backed up by the market share results where we see the market share and composition has not changed much since 2001. So despite the positive results and growth shown by the foreign banks in China, it must be true that domestic banking has also followed suit, for the results of the correlation to be so similar. If foreign banking were to being making greater progress due to the deregulations and liberalisation of the market, there would have been a negative correlation between the two in the Pearson correlation results.
Jonathan James Yee Page 47 6) Conclusion and Limitations 6.1) Conclusions This paper examines the role of regulation in China and whether or not the deregulation and liberalisation of the financial sector has specifically allowed foreign banks in China to enter and grow in the market. By comparing and following both the trends of foreign banks in China and the domestic banks, we are able to evaluate the extent of growth in foreign banking. Once shown in correlation with the domestic banks we were also able to gauge whether or not the change in the regulatory environment has aided the foreign banks, as was the intention. From the initial findings the results were found to be extremely optimistic, and the growth rate from 2006 onwards, of almost every variable was positive. This was very much in line with most of the literature, which supported that foreign banking in China would be beneficially and hence once China, has deregulated the financial environment that many waves of foreign banks would pursue the huge market. The literature also suggests the added competition would dilute the powers of domestic banks, and in particular the ‘Big Four’ state owned banks. If this were the case the growth of foreign banks must grow, as the initial results show, while the domestic strangle hold of the market decreases. However, when further investigations were carried out it was found that foreign banks, in reality, did not make much progress in terms of market share. Over the 13-year period the increase in market share in terms of net income was just over 1%. Therefore, the extent of the deregulation and
Jonathan James Yee Page 48 liberalisation, although has allowed for growth of foreign banks, has not put it at any further advantage compared to the rest of the market. This is further reiterated when the Pearson correlation is applied to both foreign banks and domestic banks. The results show that through the years the foreign banks have not deviated from domestic banks much, as the correlation between the two is extremely strong. The results imply that the growth of both the foreign banks and domestic banks are closely related and are growing at the same rate. In essence, foreign banks have not made improvements, as they should, due to the deregulation and in nominal terms. Foreign banks now make up 41 out of a total 241 banks, which is a 17% proportion of the market. Therefore the 1.48% of total assets in the market is quite disappointing and goes against most of the literature, which would support their growth in the Chinese market. As most globalisation theories such as the Ricardian and Hecsher-Ohlin models, along with much of the literature in this paper, support and encourage internationalisation, China must ensure that further deregulation and liberalisation occurs as the current practices have still not enabled foreign banks in China to reach their full potential. (Feenstra et al, 2014) This is not just a benefit for the domestic and global economies growth as a whole, but also to the countries consumers. Especially as the wealth of the people continually grows, they will demand new investment opportunities and more sophisticated banking to keep their money safe. Foreign banks are the key for this transition and will intensify more global financial innovations. (IMF, 2011)
Jonathan James Yee Page 49 6.2) Limitations Due to the liberalisation and deregulation of the financial sector being rather recent, the study is limited. The total number of samples is also quite low due to the economic environment of China and the oligopolistic nature of the banking sector. Another limitation is that the economic environment of a dual state and market mechanisms is quite unique. Therefore using a comparative method such as that suggested by Jaskow and Rose may not provide the same results. The study also does not take into account other forms of foreign entry such as subsidiaries, mergers, acquisitions and minority shareholdings. These have a substantial impact of the activity of foreign banks in China For future research, a longer time frame with a larger sample would allow for greater results, as well as combining the results for mergers, acquisitions, minority shareholdings and subsidiaries. The results of the findings will also be interesting when the new 5- year plan will commences in 2016 and when the Shanghai Free Trade Zone and the other planned zones such as Tianjin and Guangdong, have evolved to their full extent.
Jonathan James Yee Page 50 Appendix List of foreign banks used in the study Bank Name China Zheshang Bank Co Ltd City HANGZHOU Shanghai Rural Commercial Bank SHANGHAI HSBC Bank (China) Co Ltd SHANGHAI Bank of East Asia (China) Ltd SHANGHAI Standard Chartered Bank (China) Ltd SHANGHAI Citibank (China) Co Ltd SHANGHAI Bank of Tokyo Mitsubishi UFJ (China) Ltd SHANGHAI Hang Seng Bank (China) Limited SHANGHAI Sumitomo Mitsui Banking Corporation (China) Limited SHANGHAI DBS BANK (China) Limited SHANGHAI Mizuho Bank (China) Ltd SHANGHAI Deutsche Bank (China) Co Ltd BEIJING Fubon Bank (China) Co., Ltd SHANGHAI BNP Paribas (China) SHANGHAI OCBC Bank (China) Limited SHANGHAI United Overseas Bank (China) Limited SHANGHAI Australia and New Zealand Bank (China) Company Limited SHANGHAI Hana Bank (China) Company Ltd BEIJING JP Morgan Chase Bank (China) Co Ltd BEIJING
Jonathan James Yee Page 51 Toyota Motor Finance (China) Company Limited BEIJING Wing Hang Bank (China) Ltd SHENZHEN Volkswagen Finance (China) Co. Ltd BEIJING Shinhan Bank (China) Limited BEIJING Societe Generale (China) Limited BEIJING Woori Bank (China) Ltd BEIJING Bangkok Bank (China) Co Ltd SHANGHAI Industrial Bank of Korea (China) Limited TIANJIN Royal Bank of Scotland (China) Co Ltd (The) SHANGHAI Minsheng Securities Co., Ltd BEIJING KEB Bank (China) Co, Ltd. TIANJIN Credit Agricole CIB (China) SHANGHAI Bank of Montreal (China) Co Ltd BEIJING Metropolitan Bank (China) Ltd JIANGSU East West Bank (China) Limited SHANGHAI Bank Sinopac (China) Ltd NANJING Morgan Stanley Bank International (China) Limited ZHUHAI UBS (China) Limited BEIJING VOLVO AUTOMOTIVE FINANCE (China) LIMITED BEIJING Allied Commercial Bank XIAMEN Lujiazui International Trust Co., Ltd Shaanxi Fuping BEA Rural Bank Corporation. (Source: bankscope)
Jonathan James Yee Page 52 Aggregate Statistics of Box-Cox Transformation Assets Deposits Plan foreignassets foreignlog10 foreignboxcox chinaassets chinalog10 chinaboxcox 2001 283018.95 5.45 1029.10 857382981.20 8.93 56889.00 2002 515550.97 5.71 1245.50 1456509192.00 9.16 64604.00 2003 736444.35 5.87 1389.50 2805723210.00 9.45 75285.00 2004 2242839.84 6.35 1921.20 3312589837.00 9.52 78203.00 2005 9906571.89 7.00 2853.80 4186684887.00 9.62 82470.00 2006 24387924.39 7.39 3565.10 5188629263.00 9.72 86542.00 2007 110159820.80 8.04 5046.00 7624776267.00 9.88 94248.00 2008 139941574.60 8.15 5318.00 10346038660.00 10.01 100741.00 2009 168473582.90 8.23 5536.50 12773301476.00 10.11 105429.00 2010 232832652.00 8.37 5933.60 15699980850.00 10.20 110186.00 2011 354489555.00 8.55 6481.30 19367821161.00 10.29 115202.00 2012 400258879.10 8.60 6646.30 23363813330.00 10.37 119836.00 2013 481872459.40 8.68 6904.70 27097748124.00 10.43 123604.00 2014 543018451.20 8.73 7075.00 30313575137.00 10.48 126516.00 Plan foreigndeposits foreignlog10 foreignboxcox chinadeposits chinalog10 chinaboxcox 2001 142573.40 5.15 873.31 522203629.00 8.72 50355.00 2002 320764.53 5.51 1147.40 1044092283.00 9.02 59666.00 2003 461361.20 5.66 1289.50 2260921240.00 9.35 71623.00 2004 1744558.27 6.24 1925.70 2570627135.00 9.41 73783.00 2005 8702312.91 6.94 2983.50 2977666096.00 9.47 76320.00 2006 18700621.15 7.27 3619.10 3657168527.00 9.56 79984.00 2007 93578703.08 7.97 5288.00 5663564649.00 9.75 88249.00 2008 117928744.80 8.07 5568.60 7654502132.00 9.88 94329.00 2009 140965227.80 8.15 5792.80 9816197925.00 9.99 99598.00 2010 197215426.30 8.29 6233.00 12300083317.00 10.09 104577.00 2011 303254059.40 8.48 6833.70 15370203669.00 10.19 109689.00 2012 338031515.20 8.53 6992.00 18761541512.00 10.27 114431.00 2013 404910599.50 8.61 7261.30 21707378727.00 10.34 118002.00 2014 461424491.00 8.66 7461.00 24394059524.00 10.39 120923.00
Jonathan James Yee Page 53 Equity Loans Net Income Plan foreignequity foreignlog10 foreignboxcox chinaequity chinalog10chinaboxcox 2001 78847.81 4.90 652.89 13686884.13 7.14 18508.00 2002 189985.73 5.28 886.99 10862696.72 7.04 17243.00 2003 263003.51 5.42 987.88 16798522.69 7.23 19691.00 2004 444932.81 5.65 1169.00 26689629.45 7.43 22588.00 2005 1030309.21 6.01 1509.00 149602181.20 8.17 36511.00 2006 2010072.86 6.30 1829.00 221326441.70 8.35 40471.00 2007 10485921.58 7.02 2839.30 221919974.00 8.35 40499.00 2008 13705188.31 7.14 3036.10 457601996.00 8.66 48721.00 2009 18388195.60 7.26 3263.80 540898390.10 8.73 50798.00 2010 22682086.96 7.36 3434.20 730928693.40 8.86 54716.00 2011 31752160.39 7.50 3721.10 942447793.50 8.97 58209.00 2012 37223644.60 7.57 3862.80 1224979319.00 9.09 61997.00 2013 43670870.91 7.64 4009.30 1464383450.00 9.17 64687.00 2014 48662267.71 7.69 4110.90 1678389663.00 9.22 66805.00 Plan foreignloans foreignlog10 foreignboxcox chinaloans chinalog10 chinaboxcox 2001 116702.69 5.07 2052.90 285114193.00 8.46 43209.00 2002 307772.08 5.49 2987.70 566908131.40 8.75 51394.00 2003 446971.53 5.65 3425.50 1254519459.00 9.10 62351.00 2004 1244534.48 6.10 4890.80 1453466449.00 9.16 64572.00 2005 6430977.33 6.81 8227.60 1642756441.00 9.22 66468.00 2006 15986009.17 7.20 10728.00 1963004100.00 9.29 69304.00 2007 62370165.85 7.79 15543.00 2989419341.00 9.48 76389.00 2008 75777468.53 7.88 16351.00 3954676969.00 9.60 81415.00 2009 88854985.31 7.95 17037.00 5338515119.00 9.73 87094.00 2010 119611247.50 8.08 18377.00 6616256786.00 9.82 91347.00 2011 163279604.10 8.21 19867.00 8110644460.00 9.91 95535.00 2012 184448934.80 8.27 20477.00 9862338808.00 9.99 99699.00 2013 217109501.10 8.34 21314.00 11646049944.00 10.07 103353.00 2014 234205195.40 8.37 21713.00 12828743815.00 10.11 105528.00 Plan foreignnetincome foreignlog10 foreignboxcox chinanetincome chinalog10 chinaboxcox 2001 753.72 2.88 32.02 2146240.14 6.33 10176.00 2002 3133.61 3.50 60.66 4111678.91 6.61 12657.00 2003 3544.46 3.55 63.76 12583602.74 7.10 18040.00 2004 771.72 2.89 32.40 16736437.79 7.22 19669.00 2005 55008.76 4.74 164.70 20319086.82 7.31 20843.00 2006 253554.09 5.40 253.12 26637802.40 7.43 22575.00 2007 523717.07 5.72 304.81 50219804.67 7.70 27083.00 2008 1251903.19 6.10 376.11 71213404.16 7.85 29858.00 2009 861420.48 5.94 344.25 87603862.61 7.94 31608.00 2010 1147218.18 6.06 368.49 124265743.80 8.09 34746.00 2011 3026342.66 6.48 459.38 170850245.80 8.23 37817.00 2012 3313038.31 6.52 468.58 214788039.10 8.33 40156.00 2013 3361717.56 6.53 470.07 257815708.70 8.41 42103.00 2014 4097136.55 6.61 490.68 273593856.90 8.44 42753.00
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Dissertation publish

  • 1. Foreign Banks in China: Has liberalisation and deregulation of the financial sector encouraged foreign banking in China. Jonathan James Yee 11th September 2015 Words: 9825
  • 2. Jonathan James Yee Page 0 List of Abbreviations ABC- Agricultural Bank of China BIS- Department for Business Innovation and Skills BOC- Bank of China CCB- China Construction Bank CCP- Chinese Communist Party CRBC- China Regulatory Banking Commission FDI- Foreign Direct Investment GDP- Gross Domestic Product ICBC- Industrial Commercial Bank of China IFDI- Inward Foreign Direct Investment IPO- Initial Public Offering OFDI- Outward Foreign Direct Investment RBS- Royal Bank of Scotland ROAA- Return on Average Assets ROAE- Return on Average Equity ROA- Return on Assets ROE- Return on Equity SFTZ- Shanghai Free Trade Zone USD- United States Dollars WFOB- Wholly Foreign Owned Banks WTO- World Trade Organisation
  • 3. Jonathan James Yee Page 1 Table of Contents Abstract……………………………………………………………………………..……………Page 2 1. Introduction……………………………………………………………………………..…….Page 3 1.1 Research Question, Objectives and Hypothesis……………………………………..Page 6 1.11 Objectives.....................................................................................................Page 6 1.12 Hypothesis…………………………………………………….…..……….Page 6 1.2 Reasons and implications of Research…………………………………………...….Page 7 2. Foreign banking in China……………………………………………………………….….Page 10 3. ReviewofChinese banking system………………………………………………………...Page 16 3.1 Brief History……………………………………………………………………..…Page 16 3.2 Current Environment……………………………………………………….………Page 18 3.3 5-year plan and foreign banking……………………………………………………Page 23 3.31 10th 5-year plan……………………………………………………...……Page 24 3.32 11th 5-year plan………………………………………………….………..Page 25 3.33 12th 5-year plan……………………………………………………..…….Page 26 4. Methodology…………………………………………………………………………………Page 28 4.1 Data…………………………………………………………………...…………….Page 29 4.2 Variables……………………………………………………………………...…….Page 30 4.3 Method………………………………………………………...……………………Page 31 5. Results………………………………………………………………………………………..Page 34 5.1 Foreign Banking isolated……………………………………………………...……Page 34 5.11 Analysis of foreign banking isolated……………………………….…….Page 41 5.2 Comparison of foreign banking and Chinese banking……………………………..Page 42 5.21 Analysis of comparison of foreign banking and Chinese banking……….Page 43 5.3 Correlation between foreign banks and Chinese Banks………………………...…Page 44 5.31 Analysis correlation of foreign banks and Chinese Banks…………….…Page 46 6. Conclusion and Limitations…………………………………………………….………..…Page 47 6.1 Conclusion …………………………………………………………………………Page 47 6.2 Limitations …………………………………………………………………………Page 49 Appendix…………………………………………………………………………….………….Page 50 References………………………………………………………..………………………..……Page 54
  • 4. Jonathan James Yee Page 2 Abstract The gradual deregulation of the financial sector in China has been an invitation for foreign banks to gain their first steps into the market. There have been multiple waves of liberalisation and deregulation targeting foreign banks in particular. Using data from Bankscope, to identify the penetration of banks since deregulations occurred, we have been able to assess whether this is the case and if there has been a large inflow of foreign banks as was expected. It was found, that despite common logic, due to the lowering of barriers to a much sought after market that the increase in foreign banks has been unsubstantial and that foreign banking growth was in line with the rest of the sector. Therefore, despite efforts of deregulation and liberalisation, little progress has been made by foreign banks in China and they have fallen short of the opportunities available.
  • 5. Jonathan James Yee Page 3 1) Introduction In the past few decades, China has made great efforts to become competitive on a global scale, and has successfully done so in terms of their GDP, as it set to become the largest economy by 2024 (HIS,2015). However, economic growth in the long run is highly dependent on financial development, as it aids investment, spreads risk and provides liquidity. (UN, 2006). The role of the financial sector within countries is to optimise the allocation of scarce funds where they are demanded, while maximising returns for investors by spreading risk (Elliot, D and Yan, K, 2013). China has failed at doing this effectively, consequently leading to its financial sector as being categorised as ‘deep but narrow’. This is due to the ratio of financial assets to GDP increasing, but being primarily concentrated in the banking sector. The banking sector has an 80% concentration of all financial services in China, with the top 5 banks holding half of the loan market (Naughton, 2007). Hence, China’s financial system has come under scrutiny not only abroad but domestically due to the lack of diversity in the sector. Much research has been focused on how the country has liberalised their banks and transitioned from a state owned monopolistic structure. It has made efforts to further diversify the financial sector, in order to make it a more competitive, market orientated, commercial structure.
  • 6. Jonathan James Yee Page 4 There has been extensive news coverage of the reforms guided by the 5-year plans and China’s ‘big four’ banks. These top four banks have become the top four banks globally in terms of pre-tax profit. ICBC also holds the position of the world’s largest bank in terms of assets while the other three still lie within the top ten. This result has arisen at an incredible pace, as the market mechanisms in the banking sector were only introduced in 1986. (Bankerdatabase, 2015) Prior to 2001 foreign banks were only allowed to conduct businesses in two cities and were only to provide services to foreign firms and individuals. Since the 10th 5-year plan the government has made efforts to loosen controls over the banking sector and introduce more foreign competition into the economy. (He and Fan, 2004) In this short space of time the Chinese Communist Party (CCP), has introduced multiple waves of reform and liberalisation, to achieve more competition by selling shares of the state owned banks and allowing more foreign banks to compete in China. Although the presence of the state is slowly dissolving away from the large banks, they still play a major role in almost every aspect of finance in China, including the outward movements of Chinese banks as they try to gain market share abroad. (Martin, 2012) The CCP’s liberalisation of banks has allowed the Chinese banks to venture abroad, which has been a widely discussed topic of study due to the impact the banks could have abroad, stemming from their sheer size, political clout and the uncertainty they bring along with them. (Allen et al, 2005)
  • 7. Jonathan James Yee Page 5 The majority of Chinese banks are expanding primarily into the Middle East, Asia and Latin America, in order to facilitate the large number of Chinese firms already present there, (follow the client). They are slowly making inroads into Europe and North America in order to gain internationalisation of assets for stability. An example being the purchase of The Bank of East Asia’s US subsidiary in 2012, by ICBC, resulting in it becoming the majority shareholder. This was seen as a big turning point as ICBC became the first Chinese institution to assume control of an American bank. (Calkins, 2013) This occurred as a result of the ‘going out policy’, which was instated in the early 2000’s, resulting in a huge surge of OFDI. OFDI now exceeds IFDI in China. (The Economist, 2009) The sum of Chinese banking abroad is now in the sum of USD1.2Trillion, with 18 Chinese institutions having set up 1127 branches in 57 different countries by the end of 2013. (CRBC, 2013) With the rapid expansions of Chinese banks abroad reciprocal treatment for foreign banks in China is of course to be expected. (economist.com, 2009) However, there are only 41 foreign banks present in China, which currently span 69 cities in 27 provinces. Despite this somewhat impressive figure, only 6 are able to issue RMB financial bonds and a meagre 3 have the authorisation to issue credit cards. (EY, 2014) This paper aims to assess the Chinese banking sector and compare foreign banking performance to Chinese banks performance in order to see whether the regulations have helped foreign banks specifically. If regulations have been successful foreign banks in China should thrive, and make gains in terms of market saturation in China.
  • 8. Jonathan James Yee Page 6 1.1) ResearchQuestion, Objective and Hypothesis Has liberalisation and deregulation of the financial sector specifically encouraged foreign banking in China? 1.11) The Objectives of this paper are: 1) To analyse the changes to the economic environment of foreign banking in China. 2) To collect quantitative data, showing foreign banks in China, and whether or not they have been successful in entering the market. 3) To analyse whether or not government regulations have specifically allowed foreign entry of banks. 1.12) Hypothesis Hypothesis 1: The success of foreign banking has grown from the year 2001 onwards. Hypothesis 2: The government has specifically encouraged foreign banking in China. A fully defined null and alternative hypothesis has not been outlined here as the paper aims to take a more inductive approach.
  • 9. Jonathan James Yee Page 7 1.2) Reasons and implications of research The highly important composition of foreign banking has gone mostly unnoticed due to the rapid expansion of Chinese banks abroad. The details of the reforms concerning foreign banks are also rather vague and therefore, at present, the literature is somewhat scarce. Therefore, to further advance future literature and discover the effects of the liberalisation of the banking sector in China, additional research must be undertaken. As the banking sector is so large and plays such a vital role in China, further study must be made into the advances made by foreign banks in China. While initial research has been undertaken on the motivations and modes of entry of the foreign banks into China, very few have followed up on their success or failures. Most actions in the economic planning of China, would all point to the viability of more foreign banks in the market. These actions include, the ascension to the WTO, the content of the past and current 5 years plans, the movement of Chinese banks abroad and availability of Chinese banks to foreigners on the stock exchange. (Hess, 2014) In theory, the power of the Big Four state owned banks should be diluted with the movement of foreign entrants. This is due to foreign banks having the skills to operate with efficiency and quality, whilst offering a complete range of products. As discussed before, China has been subject to a great amount of FDI and therefore foreign firms doing business in China will also, most likely, opt for foreign services; due to their familiarity and trust worthiness. This in turn, should push local banks to provide a more complete service and raise its efficiency. (Lin, Cai, Li, p290).
  • 10. Jonathan James Yee Page 8 The importance of foreign banks increasingly grows, as the RMB is gaining momentum in its internationalisation and it will be these institutions, which help the transition of this historic move. (Reuters, 2012) The financial sector in China is one of the few areas in the economy where reform is in its relative infancy and is still undergoing major changes. Therefore, further research is needed to follow up on whether or not foreign banks have gained momentum over the past years. This will primarily be in terms of their total assets, net income, equity and their volume of deposits and loans. The research aims to show whether new regulations, from 2001 to 2014, have been effective in increasing competition in China, as was their goal.(Fu and Heffernan, 2006) Or was it just a façade to show cooperation to the international markets, while still maintaining tight controls over the financial sector? The paper does not aim to prove that the liberalisation of the banking sector is the definitive reason for any movements in the composition of banks in the financial sector. As current reforms are still in progress and therefore no definitive answer can be given. However, by looking at past trends and analysis of the compiled data, it may provide us with some implication of its role, past, present and give us some insights to the future of banking in Chin
  • 11. Jonathan James Yee Page 9 The following section will be a review of the literature, which questions the importance of internationalisation of foreign banks to the economic environment. This, along with a brief history of the financial sector, will help us to understand clearly the obstacles and pressures placed upon the government to open up the banking sector to the international market. The methodology of the research will be clarified and the interpretation of the results will be explored further. Finally, the limitations and the future areas of research will be explored as a conclusion to the paper.
  • 12. Jonathan James Yee Page 10 2) Foreign Banking in China To understand why this topic is of great importance we must assess the importance of companies going global and the importance of having foreign banks competing in the local market. With increasing globalisation comes the need for increased international capital markets to help facilitate international trade. This helps aid the investment required when firms wish to venture abroad and help provide liquidity to the domestic market. However this can only be achieved if countries lower their barriers and loosen their rules, in order to aid target markets. (Hill, 2014) China’s loosening and restructuring of economic legislation through the 5-year plan should therefore encourage, to a certain extent, entrants of foreign entities. Economic legislation refers to direct legislation and administrative regulations of entry into a specific market or industry. (Joskow and Rose, 1989) The department for Business Innovation and Skills (BIS), also states that, ‘ high quality and efficient economic infrastructure plays a vital role in supporting a competitive and growing economy, by providing services on which all businesses and citizens depend on’. Continued improvement of economic regulation is vital for infrastructure investment and can facilitate more investment than through privatisation. This aids a countries infrastructure growth and its international competitiveness. (BIS, 2011)
  • 13. Jonathan James Yee Page 11 In relation to an oligopolistic market, such as China’s banking sector, BIS states that it limits effective competition, and therefore regulation needs to be adapted in order to promote fairness and protect consumers’ interest. (BIS, 2011) Having added competition from foreign firms is advantageous as it increases the supply of capital in the country and therefore, the cost of borrowing is usually lower. This can be done using indirect commercial banking methods or direct investment banking methods. If the investment banking system is needed, having an international firm present, allows for a wider range of opportunities therefore, spreading the risk in a portfolio. (McKinsey, 2011) Foreign banks in China can deliver this by providing greater professionalism, wider product knowledge, a customer-centric service, managers trained internationally, wider product selection, a global network and a strong reliable brand name. These are all key components, which demonstrate the importance of foreign banking growth in China. Of course it simultaneously brings added pressures to domestic banks, however if introduced correctly this added pressure could result in higher quality products at a cheaper price and a push in innovation. (PWC, 2012) If the investment opportunities are limited to just the domestic field, this will place pressure on supply, in turn making the rate of return lower on investment. Also, if a financial crisis were to happen domestically, a trickle effect could impact other investments, as the risk have not been spread across multiple arenas. (Hill, 2014)
  • 14. Jonathan James Yee Page 12 This is the problem that the Shanghai stock exchange is currently facing (August, 2015), as the majority of the stocks listed are A-shares, which can only be sold to domestic investors. Therefore, when the shock slump in the stock market, caused by the devaluation of the RMB occurred, it sent the value spiralling downwards. (Economist, 2015) Diversifying across multiple stock markets helps reduce the risk, as different stock markets responding to different factors. Therefore, a crisis on the Shanghai stock exchange may not necessarily affect the stock on the New York Stock exchange. Of course, as the world becomes more integrated through globalisation, technology and further deregulation continues, the relationship between stock markets, are becoming more interdependent. As the 2008 financial crisis exhibited, an impact in one country can dissipate extremely quickly around the world. (Hill, 2014) Other costs caused by foreign entrants into the Chinese financial markets are that to domestic banks. Domestic banks need to lower costs to compete with foreign banks, which have a better reputation, in turn making them unprofitable. (PWC, 2012) Therefore, overall the benefits are great, especially to a country like China, which wishes to have more political clout in the global economic stage. However, rightly so, the government should keep a close watch on the firms entering the economy, especially large foreign firms which sometimes have more economic power than some national governments. Deregulation must be monitored and controlled to have its desired effects.
  • 15. Jonathan James Yee Page 13 As it is beneficial to open up a country to foreign banks, the foreign banks themselves must also have an incentive for venturing into overseas territories. In a research paper by Claessens, Demirguc-Knut and Huzinga, they empirically tested the effects of foreign banking in 80 countries using data from Bankscope. Their research came to the conclusion that in developing countries, foreign banks have higher interest margins, profitability and tax payments than their domestic counterparts. Therefore, their research shows that it is consistent with other literature and that in the long run more foreign banks may improve the domestic climate, especially for customers. They also found that it was the number of banks, which entered that, was deemed to be important to competition in the domestic market. This is an important point and therefore will be further explored in regards to the research undertaken in this paper. (Claessens et al,2000) Foreign banks would be favourable in China as they provide global networks and trading expertise, which although Chinese banks, are gaining strength in, they are still far behind in terms of global scale. However, foreign banks have been able to provide this as funding highly depends on deposits, which are difficult to come by due to domestic competition. Consequently, foreign banks require strong support from home. 30 out of 35 banks stating that the parent company as the main source. Other methods of funding are highly restricted in China, as only a few foreign banks have been given approval to issue bonds. (PWC, 2013)
  • 16. Jonathan James Yee Page 14 As well as typical deposit and loan banking, foreign banks can utilise their comparative advantage abroad by tapping into niche markets. China’s undiversified banking sector provides foreign banks to utilise their expertise in areas such as wealth management, investment banking, Internet banking and credit cards. According to KPMG’s report on foreign banking, by the end of 2004 foreign banks were able to introduce three times the amount of new products than domestic banks. This competition is also expected to increase banking efficiency and will create spill overs. (KPMG, 2014) As the banks tend to all be in close proximity of one another, hiring and firing of staff will cause innovation, knowledge and technology transfers from one bank to another. This has been demonstrated to be true with many knowledge parks, for example Silicon Valley. The Shanghai Free Trade Zone may also grow into a knowledge park if its goal of becoming an international financial centre (IFC) is realised. (EY,2014) Although, in the short run foreign banks may increase domestic banks cost, it is shown that in the long run they may reduce them. This has been attributed to the spill over effects strengthening the competition, which will force banks to lower costs to be competitive, and therefore be beneficial to consumers. (Allen, et al, 2011) In recent surveys of foreign banks in China the regulatory environment is seen as the most difficult aspect of doing business in China with finding good personnel and competition from domestic banks being additional hurdles. (PWC, 2013) Further domestic competition in
  • 17. Jonathan James Yee Page 15 China increased in 2014 when regulators further approved 5 new privately owned banks. This was followed by the loosening of regulations for RMB licenses for foreign banks. (EY, 2014) This may set to change however, with the new 12th five year plan pointing towards favourable firms in biotechnology, new energy, high tech manufacturing and computing innovation. Foreign banking expertise in these fields may be needed and therefore readjustment to the regulations may need to change. Foreign banks have a proven track record with risk management and corporate governance, which will help strengthen banking regulations in China. This is a goal of the most recent 5-year plan and therefore would be interesting to see if these have come into any effect. Much of the regulatory change has been driven by the US and EU, such as the Dodd Frank, Basel III and the Recovery and Resolution Planning. This will simultaneously help the Chinese banking environment and create opportunities for foreign banks. (PWC, 2012) The literature suggests, in a magnitude of ways that allowing foreign banking in China would be a benefit for the Chinese economy, foreign banks themselves and for consumers. The evidence suggests that Chinese has made a great deal of effort to liberalise the banking sector and allow foreign entrants. This may be from a great deal of pressure from the WTO however, as there are still many provisions in place which, discourage foreign entrants. The aim is to discover whether foreign banks or the Chinese government has prevailed.
  • 18. Jonathan James Yee Page 16 3) Review of Chinese Banking System To understand how foreign banks can achieve the internationalisation goals they wish to, we must assess China’s past history to understand why the financial sector’s environment has arrived at its current destination. We must also assess the present environment and the 5- year plans to uncover the opportunities available to foreign banks currently and in the future. 3.1) Brief History On the 1st of October 1949, after decades of civil war, China finally established itself as a new country with a new leader. The People’s Republic of China, under the leadership of Mao Zedong, transformed the economy into one which aimed to become an independent country utilising communist methods. To do so, Mao insisted that the route of heavy industry was the preferred method, due to most of the world’s most powerful economies at that time adopting this path. (Lin et al, 2003) As it was not in China’s comparative advantage to adopt this method, all decisions needed to be enforced by the central government. In order to channel funds into heavy industries the financial sector was nationalised. Nationalising the financial sector, including foreign banks, which had established themselves in China, was completed by 1952 when the People’s Bank of China became the national bank, channelling funds into industries based on political goals rather than market orientation. (Lin, 2011)
  • 19. Jonathan James Yee Page 17 In 1953, the first 5-year plan was devised with much of the focus being on collective ownership in agriculture and in industry, with continual focus on investment to heavy industry, which accounted for 85% of all investment. Mao’s persistence, even through catastrophic events such as the Great leap forward continued till his death in 1978. (Naughton, 2011) After Mao’s death, China’s leadership was undertaken by Deng Xiaoping, who looked to create more economic growth. In order to do so, he slowly transitioned the economy from a command economy to one with more market characteristics. In light of this, financing could no longer be purely allocated from one bank and therefore special banks were set up in order to fund specific industries. (Lin et al, 2003, Zhang, 2006)) In 1979 the government diversified the banking industry by placing China Construction Bank under the control of the state council thus assuming more commercial banking functions. Along with this, the establishment of The Bank of China (foreign exchange) and The Agricultural Bank of China (agricultural sector), further diversified the sector. The final establishment of a task specific state bank took place in 1984, with the establishment of The Industrial Commercial Bank of China (ICBC), to fund industrial and commercial businesses. All the banks came under the supervision of the People’s Bank of China, which now acted as the central bank and therefore had control over monetary and banking policy. (Turner et al, 2012) To further increase competition the specialisation of banks was abolished allowing the banks to assume other forms of credit accumulation in 1986. This, along with the introduction of interbank lending to aid liquidity, further commercialised the banks, while in turn leaving
  • 20. Jonathan James Yee Page 18 them with an oligopolistic nature. After this point there was not much movement in terms of foreign banks until the 10th 5-year plan in 2001, the year China ascended to the WTO. 3.2) Current Environment Prior to China’s admittance into the WTO, lengthy negotiations were undertaken with the US and the European Union, where by an agreement was made that China would fully allow foreign banks into the domestic market. China took this in their stride and allowed gradual entry by foreign banks into China before it had even reached the agreed 5-year period. In the same year China entered into the WTO, 157 foreign bank branches were already authorised to conduct business within China and the number increased to 192 by 2004. Foreign banks were only allowed to operate branches if they had a minimum deposit of RMB 1 Million, and were only allowed to serve corporate clients. (He and Fan, 2004) Over time, to further release the stresses of the People’s Bank of China, regulatory commissions were set up to supervise different sectors. The China Banking Regulatory Commission (CBRC) being formed in 2003, to regulate the banking sector. Not only was this to release the stresses to the central bank but to also prove to the WTO that the country could abide by international rules and regulations and further strengthen their financial sector. With the WTO agreement, came the further inclusion of foreign banks allowing them to open up branches in China other than special economic zones such and Shanghai and Shenzhen. (Xu, 2011) Now facing immense pressure from competition, the state owned banks now started restructuring and listing on the stock exchange, to gain more capital and gain foreign
  • 21. Jonathan James Yee Page 19 expertise rather than going into direct competition with them. They have controlled the amount of foreign investors by listing the shares in Hong Kong (H-shares), which are available to foreign investors and in Shanghai (A-shares) only available to domestic investors. (Naughton, p471, 2011) Despite the listings the government still owns the majority of shares for all 4 of the banks, with the lowest (CCB) still being nearly 60%. (Bankerdatabase, 2015) By listing on the stock exchange, many foreign banks have bought a large amount of shares in the Chinese banks, which may in turn indirectly influence entrances of foreign banks as a whole entity and result in partnerships with Chinese banks instead. For example, after listing in 2005, Bank of America owns 11.4% of CCB, followed by listings in 2006 by BOC and ICBC, resulting in a 10% ownership to RBS and 15.9% by Goldman Sachs respectively. Finally, after one of the largest IPO’s in stock market history Goldman Sachs now has a 3.3% share of ABC. (dbsreasearch, fas.ord, goldmansachs, jonathan yee) As well as foreign branches, foreign acquisitions of banks were becoming more regular after the ascension to the WTO. Although, the equity could only amount to a maximum of 25% many foreign banks preferred this method rather than setting up branches in the early years of the WTO ascension. This may be due to the foreign banks trying to target banks, which already have a strong gain of a local market instead of pitting themselves directly against them. This is turn builds their business networks, complementary public relations and access to market information. In a period where full access to foreign banks was
  • 22. Jonathan James Yee Page 20 still restricted, this method seemed to be a more viable option to foreign banks. (He and Fan 2004) Despite this, only one bank (Hang Seng Bank) went close to the 25% limit, by acquiring 24.8% of Fujian Industrial Bank LTD. All acquisitions were on average around 10%, showing that foreign banks did not make much movement in the years prior to it being fully open. (He and Fan, 2004) On the 11th of December 2006, China officially allowed foreign institutions the same rights as domestic banks. Foreign banks were now allowed to extend the bank branches across China if they followed the previous rule of RMB 1million minimum deposits and were also a wholly foreign owned enterprise or a banking subsidiary. Along with this in order to obtain a license, the banks also needed approval from home regulators, international track record, evidence of profit making ability and have established a comprehensive policy and procedure guideline. (EY, 2014) However, as a stipulation, wholly foreign owned banks (WFOB), must ensure that registered capital should be equivalent to RMB 1 Billion and those branches should have a working capital of RMB 100 million. The application for approval also takes 6 months with a further 2 months for a formal approval, where a list of key executives, accounting manuals, capital verification, financial statements and other documents must be provided to the CBRC. (KPMG, 2006) Foreign banks can also only accept fixed deposits of more than RMB 1 million putting them at a clear disadvantage, as this is far above average of a typical saver. Although, theoretically it is within the WTO guidelines, it does put domestic banks at an advantage. (Jeffries, 2011)
  • 23. Jonathan James Yee Page 21 This carries on to date, with the granting of and RMB license taking up to 3 years and the CRBC restricts foreign banks opening multiple branches at the same time. This process is arduous and very drawn out and hence will take a number of months or even years to prepare and obtain a licence, and therefore we see that the increase in bank branches is very minimal. (PWC, 2012) After the 5-year grace period had finished and foreign banks were allowed to enter as WFOBs the composition of the banking sector started to change. This, in turn, was the start of the new 11th 5-year plan in which the new government’s goal was to reform the banking sector as a whole, rather than giving special privileges to just foreign banks. A major set up is the New Shanghai Free Trade Zone (SFTZ), which will allow open trade in in international goods and services along with more open foreign investments. This pilot scheme is then set to extend later to Tianjin and Guangdong. (Deloitte, 2015) However, many foreign banks have still not chosen to set up here due to the lengthy procedures and the extreme costs. Some banks are said to have spent US$2million to US$10million in order to set up a mandatory accounting systems required by regulators. The products firms can offer in the SFTZ are still unclear and have not been able to reach its potential due to the RMB internationalisation and interest rate liberalisation still being an on going process. (EY, 2014)
  • 24. Jonathan James Yee Page 22 As it stands the current form of the banking sector is shown in the diagram below: Diagram 1 Source: (Queen’s business review, 2013 and Jonathan Yee,2014)
  • 25. Jonathan James Yee Page 23 3.3) 5 -year plan and banking As much of the liberalisation policies to target industries are outlined in the 5-year plan, a brief summary of each plan and its financial goals will be briefly explored. As previously mentioned the first 5-year plan occurred in 1953, as an outline for the CCP’s economic goals. It is officially known as the 5-year plan for National Economic and Social Development. Its goals are to, ‘map the direction of future development and set targets’. This is aimed at providing key infrastructure projects, distribution of production and to contribute to the national economy. (NDRC, 2006) Until recently the 5-year plans have been primarily focused on export-import growth, and other primary and secondary sectors, due to China’s competitive advantage, thus holding back on the service sector. The financial sector has been heavily guarded by the Chinese government and no significant implications for foreign firms were made prior to the ascension to the WTO in 2001. Therefore the short extract will be from the 10th 5-year plan as this is the start of the dataset used in the research (2001).
  • 26. Jonathan James Yee Page 24 3.31) 10th 5-year plan (2001-2005) Delivered on the 5th March 2001, Zhu Rongji delivered the outline of the 10th 5-year plan. The government’s main goals in the 10th 5-year plan were not focused on the financial sector but however it did provide some foundations in order to tackle this in the future. As 2001 was the year China finally ascended into the WTO, the government took steps to improve the legal environment and government administration. (NDRC, 2006) The attention at the time was still primarily on the export-import side of trade and economic growth, however they were aware that in order to accelerate this, developing services such as banking, accounting and law needed to be improved. As this period was a time of high FDI, the emphasis was on how they could better utilise the foreign funds and investment, was a key issue, in particular making it more attractive to investors to turn their attention to Central and Western China. (China.org.cn) In order to perform the macroeconomic policies they had to divert the change in wholly owned state owned banks to a more commercial function to support the economic situation. Thus, they simultaneously had to encourage small and medium banks to have a more active role while fully utilising the new policy banks, in order for the state owned banks to have a more commercial presence. (NDRC, 2001) To make this viable another key element of the tenth 5-year plan was the safety of financial institutions and their supervision. Zhu Rongji states that a system of evaluation and accountability are to be implemented and diffuse any potential financial risks that may occur. (Gov.cn, 2001)
  • 27. Jonathan James Yee Page 25 3.32) 11th 5-year plan (2006-2010) The time period from 2006 onwards is extremely important for this research due to the agreement with the WTO to allow inclusion of foreign banks in China to have the same national treatment as domestic banks. This particular 5-year plan was seen as ‘revolutionary’, as it veered away from the typical fast economic growth plans which allowed ‘some people to get rich first’. (Asia Times, 2005) Instead under Hu Jintao the aim was to close the gap between the rich and poor as the inequalities between the two classes grew extremely wide. The new administration now saw it as the time to implement the ‘common prosperity’ once talked about by Deng Xiaoping. (Fan, C, 2006) Within the 11th five year plan statement given by Ma Kai, the chairman of China’s National Development and Reform Commission, one of the key points was the further deepening of the market economy system. He emphasized that in order to do so, further reforms in the areas of, ‘administrative governance, state owned enterprises, taxation, finance, science and technology, education and public health,’ were the main criteria. He further reiterated this point by emphasising that it would be the government’s top priority to speed up the improvement of these areas to facilitate the socialist market economic system. (NDRC, 2006) There is only a minute mention of small and medium financial enterprises to have new ownership types, primarily private banks. This, along with other wide-ranging governmental reforms mostly in the form of reducing red tape and bureaucracy. This is in
  • 28. Jonathan James Yee Page 26 order to assist tax reforms, which are due to take place however there were no specific implications to the extent to the reforms. Therefore, in essence, this is the first time the government was not trying to directly enforce ideals onto any priority sectors but rather allow more market forces to play a bigger role. They were aiming to do this more domestically through the forces of demand and supply and rely less on foreign investment due to its huge reliance on foreign trade to the amount of 70% of GDP at the time (2005). (Naughton, The New Common Economic Programme) The contradiction of less foreign investment at the same time allowing more foreign banking entities into China will be interesting to observe, and to see which one has more prevalence. 3.33) 12th 5-year plan (2011-2015) In the 12th 5-year plan released by the State Council, the financial sector clearly played a big role as the plan for the development and reform of the financial sector were jointly undertaken by the People’s bank of China, The Chinese Banking Regulatory Commission, the China Securities Regulatory Commission, China Insurance Regulatory Commission and the State Administration for Foreign Exchange. (China Briefing, 2012) The importance of protecting and developing a strong and stable financial sector became paramount after the global financial crisis. China endured the global financial crisis and in light of the meltdown abroad further enhanced their risk prevention and additional strengthened control and supervision of the financial sector. China saw itself now
  • 29. Jonathan James Yee Page 27 having a critical role in the international field of finance and it was one of the few countries able to absorb such a critical blow to worldwide banking. (CSRC, 2011) By this reform period, all the Big Four banks had successfully listed on the stock exchange, improving shareholder reform and improving corporate governance. This allowed for the government to establish the banking sector into ‘layers’, dependant on their goals, such as policy banks, commercial banks, national joint stock commercial banks and other small and medium sized banks. (Martin, 2012) The focus was to also push the commercial banks into the international markets to increase global competitiveness and establish a wider portfolio by ‘going out’. Simultaneously domestic banks were encouraged to cooperate with foreign institutions by accepting low-interest foreign loans to improve external debts in cross border activities. This is also to facilitate China being more vocal in the global financial arena. China wishes to interact in global economic governance by enhancing macroeconomic and financial policy with other major economies. (British Chamber of Commerce, 2011) New and further banking reforms were put in place during this 5-year plan, through new regulatory standards, instruments and risk identification. The capital adequacy ratio was to be strictly obeyed to follow international levels. (CRSC, 2011) By assessing the content of each 5-year plan we should expect that there was little movement from the 10th 5-year plan, moderate movement from the 11th 5-year plan and a big leap from the 12th 5-year plan.
  • 30. Jonathan James Yee Page 28 4) Methodology This paper has utilised a qualitative method with an inductive approach following a positivist paradigm. A qualitative method uses information that may not be immediately quantifiable unless coded and is usually not descriptive (Sekaran, Bougie, 2009) The positive approach uses data, which can be obtained using neutral observations. This research achieves its goal by using data from Bankscope. (Gill and Johnson, 2012) This approach has been employed as the banking sector in China is extremely large and the data is particularly sensitive. Trying to obtain the data oneself would be time consuming, costly and unreliable and therefore using secondary data is appropriate.(Saunders, Lewis et al, 2012) Bankscope is a comprehensive database used by 90% of the world’s top 1000 banks, containing financial information for more than 29,000 banks globally. Its reputable name and data therefore allows for others to continue the research post this paper if desired. (Bankscope, 2015)
  • 31. Jonathan James Yee Page 29 4.1) Data Collection As previously mentioned the data collected was secondary data from Bankscope, to give an impartial and reliable interpretation of the results. The data from Bankscope is aggregate data and separated into each individual bank. Therefore, for the purpose of my research and have compiled the data to form a separate compilation of results for foreign banks and all other banks in China. All information is compiled from the year 2001 to 2014, as 2001 is the start of the 10th year plan and 2014 being the last available and recent year of data. Foreign banks in China in this study are classified as banks that have a foreign shareholder which holds at least 51% of the stake. A full list of foreign banks can be seen in the appendix. According to Joskow and Rose there are four empirical methods for measuring the effects of regulation; Comparing regulated and unregulated firms or markets, using variations of the intensity of regulation, using controlled environment experiments and creating structural simulation of models for a regulatory environment. (Joskow and Rose, 1989) In this study we shall be adopting the approach of comparing the more regulated foreign banking sector with the less regulated domestic competitors. This method is appropriate as the nature of regulatory constraints the firms are subject to, are attributed to regulation and the differences between in performance are attributed to regulation.
  • 32. Jonathan James Yee Page 30 This will take place on a time series scale as we wish to look at the time period ranging from 2001-2014. Time series can identify regulatory change over time or time periods. The variables chosen to demonstrate the change over time are typical accounting calculations which are globally used to show business performance. The list and definitions of the variables are shown below. 4.2) Variables Equity- is the amount left over when the liabilities have been subtracted from the assets. In essence it is the ownership of the asset once the debt has been paid off. (Investopedia.com) Total Assets- are an economic value of all the assets the entity has at a particular time. The assets are exploited over time into order to receive a return for the entity. This may include, cash, inventory, fixed assets and so on. (Accountingtools.com) Net Income- are a company’s total earnings minus any expenses paid in a given time period. It can be used to show how profitable a company is over time. (Investopedia.com) Return on Assets (ROA) – or return on investment, illustrates how profitable a company is in relation to its assets, by showing how much investment has been converted into income. It is usually calculated as Net Income divided by Total Assets and displayed as a percentage. (Investopedia.com)
  • 33. Jonathan James Yee Page 31 Return on Equity (ROE) – is similar to ROA but instead shows how much money has been returned in turn for the investment received. It is useful for comparing profitability and is displayed as a percentage. (Investopedia.com) Return on Average Assets (ROAA) and Return on Average Equity (ROAE) - is also shown here to give a comparable view of profitability which is easier to gauge. They show the average return of the time period. (Investopedia.com) Net Loans – is the total amount of loans given to out to customers minus any unearned interest and possible losses. (Santander.com) This paper has compiled the data from each year to compare foreign banks to domestic banks to show how much each group possesses in terms of- • Share of Total Assets • Share of Net Income • Share of Equity 4.3) Method To display this and form the data analysis Microsot Excel, SigmaXL and SPSS software will be used in order to examine the results. First, the preliminary results will be given to show foreign banking’s growth isolated from the market. Secondly the proportion of each group’s market share of Total Assets, Net Income and Equity will be shown to demonstrate if foreign banking has depleted any of the domestic markets hold. Finally, the results of the two sectors will be compared and correlated in order to show their relationship
  • 34. Jonathan James Yee Page 32 with each other. This will be done using Pearson’s correlation to show if the two are in line or whether foreign banking growth has deviated from the rest of the market. Pearson’s Correlation measures the strength between two variables by its linear association. The strength of the correlation is shown by the coefficient ‘r’ ranging from -1 to 1. For a positive relationship the coefficient ‘r’ should be above 0.5. To show whether or not, it is statistically significant or not, I have chosen a significance level of 0.01. If the resulting value is above the significance value, than the results are statistically insignificant. (Leard.com) The formula for the Pearson Correlation is show below where ‘x’ is foreign banks, ‘y’ is Chinese banks and ‘n’ is the number observations. (stat.mwich.edu) The assumptions of the data for a Pearson Correlation are that the data is interval or ratio data. For the data set in this paper we are using interval data therefore making the Pearson Correlation appropriate. The Pearson Correlation is also appropriate for this paper as it does not require a dependant or independent variable. As we are using data which is to be compared and not dependant on each other it further justifies the use of the Pearson correlation.
  • 35. Jonathan James Yee Page 33 However, the requirement of normal distribution is not fulfilled and therefore we must transform our data in order to form normality. Therefore, we have utilised the SigmaXL program in order to transform the data into Normal distribution using the Box-Cox Method. The Box Cox method transforms data to form a normal distribution by applying a Lambda value to identify the power to which the data should be raised. This was achieved by using the SigmaXL software in combination with Microsoft Excel. (http://www.isixsigma.com/) In order to get a fairer result as the values from foreign banking and Chinese banking are vastly different I have also Logged both results to 10 (Log10), before applying the Box- Cox Method. After the Box-Cox method was applied, I further checked the distribution of all results in SPSS, using the Shapiro-Wilks method. The Shapiro-Wilks is a test of normality which is suitable for a small sample. As our sample was of 14 observations it is an appropriate method. All variables passed the normality test with a significance value of 0.5. (Leard.com) After the variables were transformed and normally distributed all requirements of the Pearson correlation test were fulfilled and therefore applicable for use with our data, to show the correlation between foreign banking and Chinese banking.
  • 36. Jonathan James Yee Page 34 5) Results First the preliminary results will be given to show foreign banking’s growth isolated from the market. Secondly the proportion of each group’s market share of Total Assets, Net Income and Equity will be shown to demonstrate if foreign banking has depleted any of the domestic markets hold. Finally the results of the two sectors will be compared and correlated in order to show their relationship with each other. This will be done using Pearson’s correlation to show if the two are in line or whether the 5-year plan has not specifically targeted foreign banking growth but just the growth of banking in general. 5.1) Foreign banking isolated results In this section we will cover the progress of foreign banks in China, by isolating and displaying only their results away from the rest of the banking sector in China. This will give a rough guideline to their development and will give clarity to the results later in the paper. This will be shown using the variables described above, with all results being shown in United States Dollars (USD) thousands or in percentages.
  • 37. Jonathan James Yee Page 35 Graph 1 (Source: Bankscope) Graph 2 (Source; Bankscope) 0 100000000 200000000 300000000 400000000 500000000 600000000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 TotalAssetsUSD(thousands) Year Foreign Banking Total Assets USD (thousands)
  • 38. Jonathan James Yee Page 36 Graph 1 and 2 are time series graphs showing the trend of total assets and equity respectively, of all 41 foreign banks in China combined. From the graph we can see that during the early 2000’s when China first eased in new regulations, the total assets and equity of foreign firms barely grew. Growth only takes place from 2006 onwards, when the foreign banks were granted the same rights as Chinese banks. (Xu, 2011) From then onwards it has been a steady upward rise for foreign banks in terms of their assets and equity in China showing healthy progression. The steepest areas of growth are also in 2006 and 2011, the years in which a new 5 year plan was implemented. This may be evidence of the 5-year plan’s power in foreign banking policy. The total amounts of both assets and equity are also very similar reaching a high of US$543018451.2 thousand of assets and US$48662267.71 thousand of equity. Graph 3 (Source; Bankscope) 0 500000 1000000 1500000 2000000 2500000 3000000 3500000 4000000 4500000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 USD(thousands) Year Foreign Banking Net Income USD (thousands)
  • 39. Jonathan James Yee Page 37 Graph 3 illustrates the net income of the foreign banks in China from 2001. We can see that similarly to assets and equity, that there was little movement from 2001-2006, when China first entered into the WTO. Furthermore, like assets and equity, a steep positive jump of net income came after 2006 when the WTO regulations stipulating equal treatment occurred. However, unlike assets and equity, net income has shown more volatility with spikes and crashes. Much of it is in line with the global financial crisis, showing the vulnerability of foreign banks to external pressures. This may be due to the foreign banks performance abroad affecting their worldwide operations, displaying the dangers of globalisation. Despite the global financial crisis, a rapid recovery was made and the increase from 2010 to 2011 was the largest in the whole time series. This may also be due to the 5-year plan, as seen in previous results. If it were as a result of the 5- year plan, from the net income perspective, the 12th 5- year plan has been the most successful. Graph 4 (Source; Bankscope)
  • 40. Jonathan James Yee Page 38 Graph 5 (Source; Bankscope) Graph 4 and 5 display the Return on Equity and Return on Average Equity of foreign banks in China. From the Return on Equity Graph 4 we can see that the returns from the early years were quite great with a sharp dip and then levelling off. This doesn’t seem to be healthy but when looking on the Return on Average Equity that it does follow the market trend and that therefore, on average there are returns being made to the equity in each time period. Overall however, the cumulative return to equity has been slow.
  • 41. Jonathan James Yee Page 39 Graph 6 (Source; Bankscope) Graph 7 (Source; Bankscope)
  • 42. Jonathan James Yee Page 40 Graph 6 and 7 display the Return on Assets and Return on Average Assets of foreign banks in China. From the Return on Assets Graph 6, we can see that it is extremely erratic and that there is no real trend. However, as time goes on it does seem to be transforming into an area of more stability with results stabilising from 2011 onwards; the start of the 12th 5- year plan. When assessing the Return on Average Assets, the results seem more consistent with the other results with it following market trends. We can see that year on year the Return on Average Assets are improving, proving to investors, that their investment is being put to good use. Graph 8 (Source; Bankscope) 0 50000000 100000000 150000000 200000000 250000000 300000000 350000000 400000000 450000000 500000000 20012002200320042005200620072008200920102011201220132014 USD(thousands) Year Net Loan and Deposits of Foreign Banks Net Loans Deposits
  • 43. Jonathan James Yee Page 41 Graph 8 displays the commercial ability of the foreign banking sector in China. We can see that net loans and the deposits are rising year on year since 2006, when foreign banks were allowed more prevalence in China. This is a key indicator showing they are increasing competition in the market by providing and accepting funds from customers, which is one of the key functions of commercial banking. This increase in competition is vital for the efficiency in China, as the top four banks have such an oligopolistic strangle hold on the commercial banking market. 5.11) Analysis of Foreign Banking Isolated The foreign banks isolated results show that in terms of all variables, that from 2001 to 2006, there were almost no improvements made by foreign banks in China. All the growth has been since the mandatory WTO requirement of treating foreign firms at the same level as Chinese firms. Therefore, we can see that the influence of the WTO has been extremely powerful. However, other aspects must have also contributed to the successful growth of foreign banks in China as there is still continued growth in foreign banking in China. This has been seen even despite the global financial crisis of 2008. Although affected by the crisis the foreign banking sector was able to bounce back soon after and have seen the biggest growth since the 12th 5-year plan started in 2011. From these results we can see that foreign banking is making continuous gains in the Chinese banking market and that they are improving competition in China as Loans and Deposits into the market are also increasing.
  • 44. Jonathan James Yee Page 42 5.2) Share of Market Results Table 1 (Source; Bankscope) Table 2 (Source; Bankscope) Table 3 (Source; Bankscope) Total Assets Year 2001 2002 2003 2004 2005 2006 2007 Percent Foreign 0.032998737 0.035383817 0.02624105 0.067660726 0.236062337 0.467827431 1.424185276 Percent China 99.96700126 99.96461618 99.973759 99.93233927 99.76393766 99.53217257 98.57581472 Year 2008 2009 2010 2011 2012 2013 2014 Percent Foreign 1.334558824 1.301781109 1.46134047 1.797403763 1.684302571 1.747204817 1.759813343 Percent China 98.66544118 98.69821889 98.5386595 98.20259624 98.31569743 98.25279518 98.24018666 Net Income Year 2001 2002 2003 2004 2005 2006 2007 Percent Foreign 0.035105888 0.076154263 0.02815934 0.004610775 0.269993615 0.942883237 1.032086562 Percent China 99.96489411 99.92384574 99.9718407 99.99538922 99.73000639 99.05711676 98.96791344 Year 2008 2009 2010 2011 2012 2013 2014 Percent Foreign 1.727589701 0.973738456 0.91475248 1.74051187 1.519038031 1.287139401 1.475430118 Percent China 98.2724103 99.02626154 99.0852475 98.25948813 98.48096197 98.7128606 98.52456988 Equity Year 2001 2002 2003 2004 2005 2006 2007 Percent Foreign 0.572783252 1.718910622 1.54150046 1.639727234 0.683988701 0.900019806 4.511899992 Percent China 99.42721675 98.28108938 98.4584995 98.36027277 99.3160113 99.09998019 95.48810001 Year 2008 2009 2010 2011 2012 2013 2014 Percent Foreign 2.907909908 3.287794857 3.00978802 3.259306292 2.949101345 2.895842033 2.817649362 Percent China 97.09209009 96.71220514 96.990212 96.74069371 97.05089865 97.10415797 97.18235064
  • 45. Jonathan James Yee Page 43 5.21) Analysis of Share of Market Results In this section we will now compare the foreign banks to the rest of the Chinese banking sector, in order to uncover the extent of their success observed, when the result were isolated. We have done so by revealing the total market share of total assets, equity and net income. The results of all three are extremely similar, and therefore they will be analysed together. In 2001 we can see that the percentage of foreign banks in China was almost non- existent. As time progresses we do see improvement of foreign banks share of the market in all three of the results, especially the sharp rise in 2006. However, the results and growth in relation to the isolated growth is extremely minute. The market share in all three areas is still extremely dominated by the Chinese banks. The foreign banks have gained less than two per cent of market share in terms of total assets and net income and just under three per cent in equity. This result is extremely small showing that foreign banks, although growing are just keeping up with the growth of all other firms in the market. The market share of the foreign banks also dropped in 2011, which is contrary to the results shown when isolated. Therefore, this must mean that the 12th 5-year plan has allowed for growth of the whole sector but Chinese banks have taken advantage of the opportunity to outperform foreign banks in China.
  • 46. Jonathan James Yee Page 44 To further test whether or not this is true we shall perform the Pearson correlation test. If the results of both the foreign banks and Chinese banks are highly correlated it would mean that the liberalisation and deregulation of the financial sector and aided all banks in China and not specifically the foreign banks. If however, there is no correlation between the two than we would be possible to show that the positive results shown from the foreign banking isolated section is a result of the change is regulations and liberalisation, are a result of them targeting just foreign banks, opposed to affecting the whole industry. 5.3) Pearson Correlation Results Pearson correlation of Assets results Correlations Foreign Assets China Assets Foreign Assets Pearson Correlation 1 .978** Sig. (2-tailed) .000 N 14 14 China Assets Pearson Correlation .978** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed). Pearson correlation of Net Income results Correlations Foreign Net Income China Net Income China Net Income Pearson Correlation 1 .961** Sig. (2-tailed) .000 N 14 14 China Net Income Pearson Correlation .961** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed).
  • 47. Jonathan James Yee Page 45 Pearson correlation of Equity results Correlations Foreign Equity China Foreign Equity Pearson Correlation 1 .977** Sig. (2-tailed) .000 N 14 14 China Equity Pearson Correlation .977** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed). Pearson Correlation of Net Loans Results Correlations Foreign Loans China Loans Foreign Loans Pearson Correlation 1 .966** Sig. (2-tailed) .000 N 14 14 China Loans Pearson Correlation .966** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed). Pearson Correlation of Deposits Results Correlations Foreign Deposits China Deposits Foreign Deposits Pearson Correlation 1 .972** Sig. (2-tailed) .000 N 14 14 China Deposits Pearson Correlation .972** 1 Sig. (2-tailed) .000 N 14 14 **. Correlation is significant at the 0.01 level (2-tailed).
  • 48. Jonathan James Yee Page 46 Analysis of Pearson Correlations In the same way that the shares of markets results were all extremely similar to each other, so are all the Pearson correlation results. Therefore, we have also grouped all of them together in the analysis. The Pearson correlations are comprised of assets, net income, equity, net loans and deposits. All the results show that there is a positive relationship between each of the variables, and that they all have a strong correlation. All the ‘r’ values are extremely close to 1, with 1 being the perfect correlation. They all satisfy the 0.01 level of significance too, as the ‘a’ is below it, hence showing the results are significant. (Leard.com) As all the results show a positive correlation for all the variables, it displays that the deregulation and liberalisation of the financial sector has not specifically targeted foreign banks to develop and increase competition in the sector but has instead allowed for the growth of the banking sector in general. The close correlation of both sectors through years also shows that they have followed similar paths from 2001-2014, and there has not been much deviation between the two sectors. This is further backed up by the market share results where we see the market share and composition has not changed much since 2001. So despite the positive results and growth shown by the foreign banks in China, it must be true that domestic banking has also followed suit, for the results of the correlation to be so similar. If foreign banking were to being making greater progress due to the deregulations and liberalisation of the market, there would have been a negative correlation between the two in the Pearson correlation results.
  • 49. Jonathan James Yee Page 47 6) Conclusion and Limitations 6.1) Conclusions This paper examines the role of regulation in China and whether or not the deregulation and liberalisation of the financial sector has specifically allowed foreign banks in China to enter and grow in the market. By comparing and following both the trends of foreign banks in China and the domestic banks, we are able to evaluate the extent of growth in foreign banking. Once shown in correlation with the domestic banks we were also able to gauge whether or not the change in the regulatory environment has aided the foreign banks, as was the intention. From the initial findings the results were found to be extremely optimistic, and the growth rate from 2006 onwards, of almost every variable was positive. This was very much in line with most of the literature, which supported that foreign banking in China would be beneficially and hence once China, has deregulated the financial environment that many waves of foreign banks would pursue the huge market. The literature also suggests the added competition would dilute the powers of domestic banks, and in particular the ‘Big Four’ state owned banks. If this were the case the growth of foreign banks must grow, as the initial results show, while the domestic strangle hold of the market decreases. However, when further investigations were carried out it was found that foreign banks, in reality, did not make much progress in terms of market share. Over the 13-year period the increase in market share in terms of net income was just over 1%. Therefore, the extent of the deregulation and
  • 50. Jonathan James Yee Page 48 liberalisation, although has allowed for growth of foreign banks, has not put it at any further advantage compared to the rest of the market. This is further reiterated when the Pearson correlation is applied to both foreign banks and domestic banks. The results show that through the years the foreign banks have not deviated from domestic banks much, as the correlation between the two is extremely strong. The results imply that the growth of both the foreign banks and domestic banks are closely related and are growing at the same rate. In essence, foreign banks have not made improvements, as they should, due to the deregulation and in nominal terms. Foreign banks now make up 41 out of a total 241 banks, which is a 17% proportion of the market. Therefore the 1.48% of total assets in the market is quite disappointing and goes against most of the literature, which would support their growth in the Chinese market. As most globalisation theories such as the Ricardian and Hecsher-Ohlin models, along with much of the literature in this paper, support and encourage internationalisation, China must ensure that further deregulation and liberalisation occurs as the current practices have still not enabled foreign banks in China to reach their full potential. (Feenstra et al, 2014) This is not just a benefit for the domestic and global economies growth as a whole, but also to the countries consumers. Especially as the wealth of the people continually grows, they will demand new investment opportunities and more sophisticated banking to keep their money safe. Foreign banks are the key for this transition and will intensify more global financial innovations. (IMF, 2011)
  • 51. Jonathan James Yee Page 49 6.2) Limitations Due to the liberalisation and deregulation of the financial sector being rather recent, the study is limited. The total number of samples is also quite low due to the economic environment of China and the oligopolistic nature of the banking sector. Another limitation is that the economic environment of a dual state and market mechanisms is quite unique. Therefore using a comparative method such as that suggested by Jaskow and Rose may not provide the same results. The study also does not take into account other forms of foreign entry such as subsidiaries, mergers, acquisitions and minority shareholdings. These have a substantial impact of the activity of foreign banks in China For future research, a longer time frame with a larger sample would allow for greater results, as well as combining the results for mergers, acquisitions, minority shareholdings and subsidiaries. The results of the findings will also be interesting when the new 5- year plan will commences in 2016 and when the Shanghai Free Trade Zone and the other planned zones such as Tianjin and Guangdong, have evolved to their full extent.
  • 52. Jonathan James Yee Page 50 Appendix List of foreign banks used in the study Bank Name China Zheshang Bank Co Ltd City HANGZHOU Shanghai Rural Commercial Bank SHANGHAI HSBC Bank (China) Co Ltd SHANGHAI Bank of East Asia (China) Ltd SHANGHAI Standard Chartered Bank (China) Ltd SHANGHAI Citibank (China) Co Ltd SHANGHAI Bank of Tokyo Mitsubishi UFJ (China) Ltd SHANGHAI Hang Seng Bank (China) Limited SHANGHAI Sumitomo Mitsui Banking Corporation (China) Limited SHANGHAI DBS BANK (China) Limited SHANGHAI Mizuho Bank (China) Ltd SHANGHAI Deutsche Bank (China) Co Ltd BEIJING Fubon Bank (China) Co., Ltd SHANGHAI BNP Paribas (China) SHANGHAI OCBC Bank (China) Limited SHANGHAI United Overseas Bank (China) Limited SHANGHAI Australia and New Zealand Bank (China) Company Limited SHANGHAI Hana Bank (China) Company Ltd BEIJING JP Morgan Chase Bank (China) Co Ltd BEIJING
  • 53. Jonathan James Yee Page 51 Toyota Motor Finance (China) Company Limited BEIJING Wing Hang Bank (China) Ltd SHENZHEN Volkswagen Finance (China) Co. Ltd BEIJING Shinhan Bank (China) Limited BEIJING Societe Generale (China) Limited BEIJING Woori Bank (China) Ltd BEIJING Bangkok Bank (China) Co Ltd SHANGHAI Industrial Bank of Korea (China) Limited TIANJIN Royal Bank of Scotland (China) Co Ltd (The) SHANGHAI Minsheng Securities Co., Ltd BEIJING KEB Bank (China) Co, Ltd. TIANJIN Credit Agricole CIB (China) SHANGHAI Bank of Montreal (China) Co Ltd BEIJING Metropolitan Bank (China) Ltd JIANGSU East West Bank (China) Limited SHANGHAI Bank Sinopac (China) Ltd NANJING Morgan Stanley Bank International (China) Limited ZHUHAI UBS (China) Limited BEIJING VOLVO AUTOMOTIVE FINANCE (China) LIMITED BEIJING Allied Commercial Bank XIAMEN Lujiazui International Trust Co., Ltd Shaanxi Fuping BEA Rural Bank Corporation. (Source: bankscope)
  • 54. Jonathan James Yee Page 52 Aggregate Statistics of Box-Cox Transformation Assets Deposits Plan foreignassets foreignlog10 foreignboxcox chinaassets chinalog10 chinaboxcox 2001 283018.95 5.45 1029.10 857382981.20 8.93 56889.00 2002 515550.97 5.71 1245.50 1456509192.00 9.16 64604.00 2003 736444.35 5.87 1389.50 2805723210.00 9.45 75285.00 2004 2242839.84 6.35 1921.20 3312589837.00 9.52 78203.00 2005 9906571.89 7.00 2853.80 4186684887.00 9.62 82470.00 2006 24387924.39 7.39 3565.10 5188629263.00 9.72 86542.00 2007 110159820.80 8.04 5046.00 7624776267.00 9.88 94248.00 2008 139941574.60 8.15 5318.00 10346038660.00 10.01 100741.00 2009 168473582.90 8.23 5536.50 12773301476.00 10.11 105429.00 2010 232832652.00 8.37 5933.60 15699980850.00 10.20 110186.00 2011 354489555.00 8.55 6481.30 19367821161.00 10.29 115202.00 2012 400258879.10 8.60 6646.30 23363813330.00 10.37 119836.00 2013 481872459.40 8.68 6904.70 27097748124.00 10.43 123604.00 2014 543018451.20 8.73 7075.00 30313575137.00 10.48 126516.00 Plan foreigndeposits foreignlog10 foreignboxcox chinadeposits chinalog10 chinaboxcox 2001 142573.40 5.15 873.31 522203629.00 8.72 50355.00 2002 320764.53 5.51 1147.40 1044092283.00 9.02 59666.00 2003 461361.20 5.66 1289.50 2260921240.00 9.35 71623.00 2004 1744558.27 6.24 1925.70 2570627135.00 9.41 73783.00 2005 8702312.91 6.94 2983.50 2977666096.00 9.47 76320.00 2006 18700621.15 7.27 3619.10 3657168527.00 9.56 79984.00 2007 93578703.08 7.97 5288.00 5663564649.00 9.75 88249.00 2008 117928744.80 8.07 5568.60 7654502132.00 9.88 94329.00 2009 140965227.80 8.15 5792.80 9816197925.00 9.99 99598.00 2010 197215426.30 8.29 6233.00 12300083317.00 10.09 104577.00 2011 303254059.40 8.48 6833.70 15370203669.00 10.19 109689.00 2012 338031515.20 8.53 6992.00 18761541512.00 10.27 114431.00 2013 404910599.50 8.61 7261.30 21707378727.00 10.34 118002.00 2014 461424491.00 8.66 7461.00 24394059524.00 10.39 120923.00
  • 55. Jonathan James Yee Page 53 Equity Loans Net Income Plan foreignequity foreignlog10 foreignboxcox chinaequity chinalog10chinaboxcox 2001 78847.81 4.90 652.89 13686884.13 7.14 18508.00 2002 189985.73 5.28 886.99 10862696.72 7.04 17243.00 2003 263003.51 5.42 987.88 16798522.69 7.23 19691.00 2004 444932.81 5.65 1169.00 26689629.45 7.43 22588.00 2005 1030309.21 6.01 1509.00 149602181.20 8.17 36511.00 2006 2010072.86 6.30 1829.00 221326441.70 8.35 40471.00 2007 10485921.58 7.02 2839.30 221919974.00 8.35 40499.00 2008 13705188.31 7.14 3036.10 457601996.00 8.66 48721.00 2009 18388195.60 7.26 3263.80 540898390.10 8.73 50798.00 2010 22682086.96 7.36 3434.20 730928693.40 8.86 54716.00 2011 31752160.39 7.50 3721.10 942447793.50 8.97 58209.00 2012 37223644.60 7.57 3862.80 1224979319.00 9.09 61997.00 2013 43670870.91 7.64 4009.30 1464383450.00 9.17 64687.00 2014 48662267.71 7.69 4110.90 1678389663.00 9.22 66805.00 Plan foreignloans foreignlog10 foreignboxcox chinaloans chinalog10 chinaboxcox 2001 116702.69 5.07 2052.90 285114193.00 8.46 43209.00 2002 307772.08 5.49 2987.70 566908131.40 8.75 51394.00 2003 446971.53 5.65 3425.50 1254519459.00 9.10 62351.00 2004 1244534.48 6.10 4890.80 1453466449.00 9.16 64572.00 2005 6430977.33 6.81 8227.60 1642756441.00 9.22 66468.00 2006 15986009.17 7.20 10728.00 1963004100.00 9.29 69304.00 2007 62370165.85 7.79 15543.00 2989419341.00 9.48 76389.00 2008 75777468.53 7.88 16351.00 3954676969.00 9.60 81415.00 2009 88854985.31 7.95 17037.00 5338515119.00 9.73 87094.00 2010 119611247.50 8.08 18377.00 6616256786.00 9.82 91347.00 2011 163279604.10 8.21 19867.00 8110644460.00 9.91 95535.00 2012 184448934.80 8.27 20477.00 9862338808.00 9.99 99699.00 2013 217109501.10 8.34 21314.00 11646049944.00 10.07 103353.00 2014 234205195.40 8.37 21713.00 12828743815.00 10.11 105528.00 Plan foreignnetincome foreignlog10 foreignboxcox chinanetincome chinalog10 chinaboxcox 2001 753.72 2.88 32.02 2146240.14 6.33 10176.00 2002 3133.61 3.50 60.66 4111678.91 6.61 12657.00 2003 3544.46 3.55 63.76 12583602.74 7.10 18040.00 2004 771.72 2.89 32.40 16736437.79 7.22 19669.00 2005 55008.76 4.74 164.70 20319086.82 7.31 20843.00 2006 253554.09 5.40 253.12 26637802.40 7.43 22575.00 2007 523717.07 5.72 304.81 50219804.67 7.70 27083.00 2008 1251903.19 6.10 376.11 71213404.16 7.85 29858.00 2009 861420.48 5.94 344.25 87603862.61 7.94 31608.00 2010 1147218.18 6.06 368.49 124265743.80 8.09 34746.00 2011 3026342.66 6.48 459.38 170850245.80 8.23 37817.00 2012 3313038.31 6.52 468.58 214788039.10 8.33 40156.00 2013 3361717.56 6.53 470.07 257815708.70 8.41 42103.00 2014 4097136.55 6.61 490.68 273593856.90 8.44 42753.00
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