in People’s Republic of
China
·
Since the People’s Republic of China (PRC) has adopted an open economic
policy in 1978, the Government has embarked on a series of banking sector
reform programs. The programs of
1980s focused on the establishment of a two-tier banking system comprising
primarily of a central bank and four specialized banks that are owned fully by
the central Government. Once the
two-tier banking system was formed, the Government launched the second wave of banking
sector reforms, consisting of the commercialization of specialized banks and a
separation between policy and commercial lending activities in 1994-1995 and
the management of nonperforming loans (NPLs) of wholly State-owned commercial
banks (WSCBs). Other reform
measures included an attempt to reduce local government intervention, the
removal of credit allocation, interest rate and entry deregulation, and a
gradual tightening of accounting and prudential regulations.
·
Given that PRC’s macroeconomic performance has been remarkably
favorable in the past, the gradual approach adopted by the Government on the
banking sector reforms appears to have been successful on the surface. There are few countries in the world
that have been able to achieve high real GDP growth averaging 10% in the past
two decades and rapid financial deepening, as shown by the ratio of savings to
gross domestic product (GDP) from 26% in 1985 to 120% in 1999 and the ratio of
M2 to GDP from 33% in 1980 to 148% in 1999. The financial deepening was driven mainly by the increase in
bank deposits by households. The
banking sector plays a crucial role in the PRC because it functions as a major
financier for nonfinancial firms.
·
In spite of this favorable macroeconomic performance and financial
deepening, a closer look at this giant economy reveals deep-rooted structural
problems—namely, a poor and deteriorating performance from SOEs has coexisted
with an equally unfavorable performance from the banking sector. Further, the dominance of WSCBs in the
banking sector is one of the most important banking sector reform issues that
should be addressed. Even after
the banking sector reforms, WSCBs’ share has accounted for more than 75% of
total claims on nonfinancial sectors by all deposit money banks and about 70%
of total deposits held by these deposit money banks during 1994-1999. WSCBs are also major recipients of
loans from the PBC, accounting for more than 90% of total borrowing from it.
·
Notwithstanding the banking sector reforms, the overall performance of
the banking sector has not improved much.
Based on the distinction between WSCBs and other commercial banks (OCBs),
it has been found that the performance of WSCBs has been unimpressive compared
with OCBs. A more worrying sign,
on the other hand, is the rapidly deteriorating performance of the OCBs during
1994-2000. Thus, these banking
sector reforms appear not to have led to a noticeable improvement in the
performance of WSCBs.
Nevertheless, WSCBs are not illiquid and they are able to operate in
practice, because households have increasingly deposited their savings at these
banks believing that they are protected by the central Government, which retains
full ownership. Also, the underdeveloped
state of the capital market and other markets has left households no other
choice but to save in banks or government bonds. Although explicit policy lending practices have been reduced,
lending to SOEs still constitutes a large share of WSCBs’ total credit. Credit decisions by WSCBs are often
influenced by central Government’s indirect guidance.
·
A further recent phenomenon is that borrowers find it difficult to
obtain loans from WSCBs in the face of tightened lending practices. PBC continues to control official
lending and deposit rates, preventing WSCBs from operating according to market
principles. While the low lending
interest rate policy aims at subsidizing SOEs, it has given rise to collusive
behavior among financial institutions despite the penalties faced. For example, WSCBs may legally circumvent
interest rate controls by lending to nonbank financial institutions that are
subject to looser interest rate controls, which in turn lend the funds at
higher rates and share the profits with the banks. The fact that black markets exist and their prevailing
lending interest rates are in the range of 100%-200% of regulated lending rates
in some cases indicates that banks have strong incentives to lend at higher
lending rates. Moreover, tight
entry regulations continue to prevail.
·
The equity market has been rapidly growing in recent years, as compared
with the corporate bond market.
The ratio of equity market capitalization to GDP (including A- and
B-shares) grew from 3.9% in 1992 to 53.8% in 2000. Also, the number of listed firms (which include firms that
issue only A-shares, only B-shares, both A- and B-shares, or A and H-shares)
soared from 53 in 1992 to 1,088 in 2000.
As of May 2002, there are 1,169 companies listed at domestic stock
exchanges in PRC. Both these
indicators are comparable to those in advanced countries.
·
In general, Chinese listed firms tend to depend more heavily on
external sources than internal sources (retained earnings) and, among external
sources, more intensively on current liabilities than long-term
liabilities. They hardly issue
corporate bonds and mostly borrow in short-term, indicating that their maturity
mismatch could be substantial. In
addition, while the ratio of equity to total liabilities hardly changed over
the period, capital reserves (such as loan loss provisions set by the
Government) and, to a lesser extent, surplus reserves (such as housing
allowances set by the management) rose rapidly.
·
Based on data of 1,098 listed firms for 1992-2000, this paper has
identified seven features with respect to corporate financing patterns of the
average behavior of listed firms.
First, negotiable equity finance tends to decline as State ownership
increases, as expected. On the
other hand, less distinctive trends as compared with equity finance were traced
in the case of bank loans. Firms
with large State ownership appear to have greater access to bank loans in
1995-1997 and 1998-2000, while firms with small State ownership depend little
on bank loans.
·
Second, the relationship between firms’ asset size and bank loans
showed a clear upward trend in 1992-1994, 1995-1997, and 1998-2000 each, while
that between firms’ asset size and negotiable equity finance exhibited a clear
downward trend throughout the same periods. Thus, small firms appear to have substituted equity finance
for bank loans, while large firms remain dependent on bank loans without significantly
increasing recourse to equity finance.
Moreover, small firms depended heavily on negotiable equity finance
during 1992-1994, but their dependence declined during 1995-1997 and
1998-2000. Also, no clear
intertemporal or dynamic shift from bank loans to equity finance or the other
way round was present for both large and small firms during 1992-2000. The decline in the sum of both bank
loans and equity finance for both types of firms appears to have been offset by
an increase in other sources of funds such as capital and surplus reserves.
·
Third, the relationship between returns on asset (ROA) and bank loans
showed a clear downward trend during 1992-1994, 1995-1997, and 1998-2000 each,
while that between ROA and negotiable equity finance exhibited irregular
patterns for the same periods.
This indicates the prolonged presence of a soft budget constraint for
unprofitable firms. Profitable
firms tended to have greater negotiable equity finance during 1995-1997 and
1998-2000 each, while relying less on bank loans during these two periods—the
presence of an intertemporal shift from bank loans to negotiable equity finance
for profitable firms. Unprofitable
firms also increased negotiable equity finance over the period, but have not
substantially changed the degree of dependence on bank loans.
·
Fourth, a more or less downward trend was observed between the variance
of ROA and bank loans during 1992-1994 and 1995-1997, while a more distinct
upward trend was traced between the variance of ROA and negotiable equity
finance. In other wards, firms
with stable ROA tended to rely more heavily on bank loans than those with
volatile ROA during 1992-1994 and 1995-1997, although firms with volatile ROA significantly
increased dependence on bank loans in 1998-2000. Firms with volatile returns increased dependence on both
bank loans and negotiable equity finance from 1992-1994 to 1998-2000, while
firms with stable returns reduced the dependence on bank loans without
increasing negotiable equity finance over the same period. The increased dependence of firms with
volatile ROA on bank loans appears to support the view that these firms’ soft
budget constraint has emerged in recent years.
·
Fifth, bank loans were relatively more intensively allocated to firms
in unprotected sectors than those in protected sectors (i.e., petrochemicals,
utility, and materials) during 1995-1997 and 1998-2000 each, while the former’s
dependence on negotiable equity finance exceeded that of the latter during
1998-2000. Firms in protected
sectors are generally State monopolies and operate under the direct supervision
and control of the State Council.
As a result, these protected firms often obtain direct subsidies from
the central Government’s budget.
By contrast, firms in unprotected sectors are mostly under the
supervision of provincial or local governments, so they do not receive direct
support from the central Government and many of them have to compete in
domestic markets. Partly reflecting
these differences, there appears a clear intertemporal shift from bank loans to
negotiable equity finance for firms in unprotected sectors during 1995-2000.
·
Sixth, with respect to bank loans there is a clear divergent trend
between firms that were corporatized or established before 1990 (so-called “old”
firms) and those after 1990 (so-called “new” firms). An increase in the dependence of old firms on bank loans
during 1996-2000 appears to support the view that banks increased credit
allocation to old firms. At the
same time, old firms depended more heavily on negotiable equity finance than
new firms. New firms increased
negotiable equity finance while reducing bank loans during 1995-2000,
suggesting an intertemporal shift from bank loans to negotiable equity finance. However, such a shift was not observed
for old firms.
·
Seventh, firms issuing other shares (both A- and B-shares, only
B-shares, or both A- and H-shares) increased both bank loans and negotiable
equity finance as a percentage of total liabilities in recent years, while
firms issuing only A-shares reduced bank loans and increased equity finance
over the period. Since firms
issuing B- and H-shares are subject to more stringent accounting and listing
requirements and thus are generally higher-quality firms, banks may have increased
an incentive to extend more credit to such firms in recent years. Firms issuing only A-shares appear to
have shifted from bank loans to equity finance during 1996-2000, supporting argument
for the presence of the intertemporal shift.
·
To summarize, firms with specific features—firms with large State
ownership, large firms, unprofitable firms, firms with volatile returns, old
firms, and firms issuing other shares—have depended more heavily on bank
loans. Since many of these types
of firms are generally poor performers (Shirai, 2002b), they can be regarded as
facing a soft budget constraint.
Moreover, there is a static inverse relationship between negotiable
equity finance and bank loans for specific types of firms; negotiable equity
finance appears to have been substituted for bank loans for small firms and
profitable firms (except 1992-1994).
This suggests that the establishment of the equity market has
contributed to providing diverse financial sources to small and profitable
firms. Further, there is a clear
intertemporal or dynamic shift from bank loans to negotiable equity finance for
profitable firms, firms in unprotected sectors, new firms, and firms issuing
A-shares over the period. Namely,
the equity market has becoming important for these types of firms.
·
As a next step, regression analysis was performed to assess whether
banks’ lending bias has really existed during 1994-2000. The results have shown that banks’
lending biases have been present especially toward large firms, firms with
large State ownership, and unprofitable firms throughout 1994-2000. Thus, some of these firms appear to
have been facing the soft budget constraint, since they are not necessarily
better performers. Moreover, older
firms gained greater access to bank loans in 1998-2000 as compared with
1994-1997. Given that newly
corporatized or established firms have generally been better performers than
old firms, the results indicate that the lending bias has increased in recent
years in favor of old firms. These results suggest that banking sector reforms
have not improved banks’ risk management to a considerably degree, since banks
loans have been allocated more intensively to specific types of firms
regardless of their performance.
Thus, this paper concludes that banking sector reforms have been
ineffective so far.
·
In additioin, this paper has assessed whether such lending bias has
strengthened or declined after the initial public offerings (IPOs). The results suggest that the
establishment of the two stock exchanges induced old, large, and unprofitable
firms to increase recourse to bank loans after the IPOs on A-shares. The fact that these firms preferred
bank loans over equity finance despite rising stock prices (hence lowering
equity financing cost) may be due to either banks’ providing favorable
financing conditions by collusion or connection, or lack of borrowers’
incentive to diversify their financing sources.
· On the other hand, these results also suggest that firms facing a hard budget constraint—such as new, small, and profitable firms—were able to lower cost of finance by being able to gain access to equity market. Thus, the equity market helped these firms to diversify their financing sources. This role of the equity market has become more important in recent years, given that banks have been under greater pressures to improve their balance sheets under the accession to the World Trade Organization (WTO) and thus reluctant to increase lending activities.
· As for firms with State ownership, their degree of dependence on bank loans has declined after the IPOs on A-shares. It appears that these firms increased total equity finance relative to bank loans by issuing more non-negotiable shares (or those held by the State) than A-shares in order to prevent their management controls from being diluted. However, such behavior was not traced in the case of B-shares. Shirai (2002b) has reported that firms with very large State ownership have been better performers than those in the intermediate range of State ownership due to the latter’s greater opportunities for asset stripping. Therefore, greater control of firms by the State may not be a bad thing in the context of the PRC for the time being. However, the Government should make greater efforts to improve the informational, legal, and judicial infrastructures in order to develop a sound equity market, and at the same time, promote privatization of listed SOEs.