China's Banking Sector and the Attractiveness of Dim Sum Bond

China's banking sector and the attractiveness of Dim Sum Bond Antonello Avino in collaboration with Fjorda Vacchetti and Ludovico Gerli March 2016 Abstract China's banking system has tremendously grown in recent years. `The Big Four' keep dominating the Chinese banking system as well as they are playing an important role all over the world, mentioning in the first four positions of the largest banks ranking. In spite of its expansion, the banking sector is still suffering from serious structural and administrative issues. In order to deeply figure them out, we are going to perform a meticulous analysis of the banking sector, specifying what is the financial system adopted by China, what kinds of banks operate along with the first four banks and how the regulatory system has changed over time. Also, we are going to discuss the `parallel' banking, well-known as `shadow banking', which slowed down the growth of the banking system. Even though financial consequences of the global crisis on china have been extremely smalls, it still possible to focus our attention on changes and development of Chinese structure. This country suffered few losses in the short run whereas many projects (like the stimulus plan on 2008), reorganizations and reforms were planned in order to avoid contrary effects in the long run, both for real and financial economy. Finally, we will give a brief overview of the Dim Sum bond market aimed to internationalize the renminbi currency outside Mainland China and to lower the cost of capital. I Market-oriented or bank-oriented? Economic history and empirical economic analysis showed that the corporate finance was influenced by two different models of government in the financial market: the so-called market-oriented system, and the bank-oriented system or oriented intermediation. The first system is characterized by the prevalence of the market as a form of external financing to companies: in addition to the self-financing, the capital is raised through the issue of shares and bond debt. The securities are freely treated in the market and their price is the most important mechanism to regulate the firm behaviour. In the case of the United States, before the creation of the first railway companies, firms usually drew upon the banking system just for short term needs due to the small size of companies and the basic level of technology. The growing financing needs caused by the expansion of industrial company was given by institutions specialized in long-term financing as mutual savings banks, pension funds, trust companies and the simultaneous explosion of the stock market. An increasing role was played by investment banks specialized in log term activities. These banks were the protagonists of the transformation in the American companies: in addition to providing direct venture capital, they encouraged mergers among customers and focused on supervision, offering financial and organizational advice. The extraordinary expansion of securities issued by public limited companies made the stock market, centralized in Wall Street, the main source of financing. Compared with the second system it shows greater allocative efficiency, the bank-oriented system is associated with the financial affairs of Germany and Japan and those of many continental European countries: the main form of external financing of firms is bank loan. Therefore, banks have played a crucial role in the industrial transformation of these countries. In bank-oriented system banks take the form of not-specialized institutions, as they provide both short and long term funding and support firms taking on their shares in the portfolio and by positioning the remaining to its customers. In this kind of system banks are the center of information disclosure and the stock market has 2 an inefficient and marginal role. It is suitable in case of rapid change and more responsive to technological innovations. We focused our analysis on two kinds of measure to judge whether the Chinese financial system is market- or bank-oriented dominated: firstly we compared the size of the market and the bank contingent to the GDP and secondly we worked out two structure indices, "Structure activity" and "Structure size", that are mathematically equal to the log(market size/bank size). The data in figure 1 support the idea that China should be considered a bank-oriented system. Figure 1: Comparison of financial system China's stock market is smaller than the other countries in the table in terms of the equity traded in the market as well as in terms of market capitalization. Whereas the banking system is significantly important looking to bank credit in function of the GDP. If we consider the German's banking system as a benchmark for bank-oriented approach, China, with a ratio of 1.13, is more bank-oriented than Germany, which has a ratio of 1. Regarding the structure indices, China has a very low value (-2.407) compared with the other countries. The higher the value, the 3 more the system is market-oriented. As a matter of fact, we also reported a graph showing the total deposits in China and United States, which is market-oriented in nature. The high level of deposits in China supports our statement concerning the influence of the banking system. Figure 2: Total deposits in China and United States 4 II China's banking sector Before the beginning of economic reforms in 1978, China's banking sector was largely controlled by the government. Macroeconomic changes required a new banking system more efficient and competitive. Hence, the Chinese government has tried to turn this centralized system into more market-oriented system where different categories of financial institutions and agencies can operate in the marketplace. Of course, banks are not completely autonomous but a genuine step forward has been taken. At present, there are four categories of banks operating in China. The first category involves three banks: the Agricultural Bank of China focusing on agricultural lending, China Development Bank which is responsible for infrastructure projects and Bank and China Exim Bank which provide financial services in order to contribute to the export of high-tech products and import of machinery. These three banks usually have to follow the directives dictated by the State Council. The second category is made up by the equitized banks, that is banks turned into joint-stock companies where the government is the main shareholder. These banks are listed in the table below. Figure 3: China's Equitized Commercial Banks Even though they are no longer whole state-owned, most of their shares are not tradable and held by government authorities as PBOC and MOF. Therefore "equitization" seems very far from the main goal of such a reform; the goal is to make these banks for-profit commercial banks minimizing the government's intervention. 5 The third category involves local banks given by "city commercial banks", village and township banks, rural commercial banks and rural credit cooperative. As the equitized one, these banks were wholly-owned by local governments in the past and were used to locally deal with projects. The number of shares owned by the government has decreased over time: in 2009, just 18,5% of the shares of city commercial banks was owned by local governments. The main shareholders were Chinese banks, foreign banks and bank employees which were limited to 10%. This kind of banks finds quite difficult to compete with the previous categories of banks because of their small size. However, they usually are entrusted with dealing with city's finances and government's pension funds. The competitiveness with the major banks has made such institutions more efficient in China. Finally, the fourth category is composed of "private" commercial banks where the government's shareholding is almost null. The largest bank in this category is China Minsheng Bank and was the first private bank in which the majority of shares was not owned by the government. III Shadow banking "Shadow banking" is a well-known phenomenon in Cina. It involves banks that are unregulated and often unregistered. They provide the same financial services as a traditional bank, though. There are several reasons that made "shadow" banks emerge in the banking system. First of all, they could be attractive because offer a higher interest rate compared with the other banks, roughly 10% per month or higher. However, borrowers usually use underground banks just for short-term credit so that they will surely pay the money back. Also, people could be interested in asking for an unregulated loan as camouflage for "hiding" their wealth from authorities and the traditional loan is likely to require a much longer approval process. Moreover, underground banks could be a good opportunity for foreign firms to enter Chinese system. Hence, China's Ministry of Finance and the State Administration of Foreign Exchange (SAFE) has been paying attention 6 to it. Actually this kind of illegal banking system was encouraged by the Chinese government with the creation of "Credit Guaranteed Agencies". The main purpose of such entities was to facilitate the access to credit for small and medium firms: CGA guarantees that the loan would be paid in case one of the firms is unable to pay back. The system could be highly profitable as we can see in figure 4 and gives an opportunity to start a business getting funds in an unconventional way when it is too difficult to get loans from traditional banks. After the Financial Crisis, these kinds of agencies grew very fast because the government reduces liquidity and, therefore, the availability of bank loan for the small and mid-size company was tightened. The Chinese government only helped the large company with liquidity needs.

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