Durham E-Theses Income Diversication of Chinese Banks: Performance, Risk and Eciency QU, ZHIXIAN How to cite: QU, ZHIXIAN (2018) Income Diversication of Chinese Banks: Performance, Risk and Eciency, Durham theses, Durham University. Available at Durham E-Theses Online: http://etheses.dur.ac.uk/12164/ Use policy The full-text may be used and/or reproduced, and given to third parties in any format or medium, without prior permission or charge, for personal research or study, educational, or not-for-prot purposes provided that: • a full bibliographic reference is made to the original source • a link is made to the metadata record in Durham E-Theses • the full-text is not changed in any way The full-text must not be sold in any format or medium without the formal permission of the copyright holders. Please consult the full Durham E-Theses policy for further details. Academic Support Oce, Durham University, University Oce, Old Elvet, Durham DH1 3HP e-mail: [email protected] Tel: +44 0191 334 6107 http://etheses.dur.ac.uk Income Diversification of Chinese Banks: Performance, Risk and Efficiency Zhixian Qu A thesis submitted in partial fulfilment of the requirements for the degree of Doctor of Philosophy in Economics Department of Economics and Finance Durham University Business School University of Durham June 2018 To My Parents ACKNOWLEDGEMENTS In writing this acknowledgement as the final task to complete my dissertation, my thoughts turn to the many days I have spent with respected supervisors and teachers, and beloved family and friends. This thesis could not have been written without the instruction, inspiration, guidance and encouragement these people offered me. First I would like to present my special thanks to my supervisor, Dr Zhichao Zhang, who spent countless hours in guiding me. He taught me how to become an academic researcher, and on the occasions when I felt lost, he set me once again on the right path. I am truly fortunate to have had such a first-class and inspirational scholar as my supervisor and role model. I also wish to thank my co-supervisor, Dr Xiaogang Che, who provided generous help and suggestions for my research. Working with these creative academicians has shown me how to become a serious, independent, and responsible scholar, and built a solid foundation for my future career. Without them, I would have been unable to accomplish this project. I am deeply grateful to them, and to the University of Durham. Over the last few years I have travelled a long way, both in geographical space, and in I my development as a scholar. Without the love and encouragement of my parents, I could never have come so far. For years they have supported me, both financially and emotionally, offering unconditional love and blessings. Thousands of miles away from them, I channelled my nostalgia and homesickness into a determination to complete this project. Whenever I met obstacles in any aspect of my life, I remembered that my beloved parents were waiting for me, and this thought sustained me through all difficulties. Finally, I want to express my gratitude to my friends and colleagues. Their invaluable help sustained me and pushed me towards success. There must be special thanks for my close friend, Yao Zhang. Having known each other for over a decade, we have witnessed many significant moments in each other’s lives. As she, too, will finish her graduate study this year, I send her my sincere good wishes for the bright future she deserves. Z. Qu II Income Diversification of Chinese Banks: Performance, Risk and Efficiency Zhixian Qu PhD (Economics) St Aidan’s College June 2018 Abstract This research contributes to the debate on the effects of diversification in the banking industry, and provides a comprehensive analysis of how the diversification- performance, diversification-risk and diversification-efficiency nexus are affected when banks move into non-traditional businesses. The research first examines to what extent income diversification can affect performance in the Chinese banking industry in terms of profitability. Results showing that in the Chinese banking sector as a whole there exists a diversification discount, suggesting that a shift from traditional banking business to mixed business lines negatively affects bank performance. Following the discussion of profitability, we move the focus to the issue of stability. By adopting the first-differenced GMM estimator for the dynamic threshold panel data model, we get results showing that there exists an inverse U-shaped relation between diversification level and risk in the Chinese banking industry. Income diversification will reduce bank risk only after the bank has passed a certain threshold of income diversification. This pattern of relationship seems to be driven mainly by the learn-by- doing effect and the mitigation of agency problems, which result from the expansion of non-interest activities. Finally, this thesis analyses the efficiency implications of the trend towards greater income diversification. We use a two-step approach by adopting within maximum likelihood estimation (WMLE) and dynamic Tobit model to estimate banks’ efficiency scores and regresses those scores with banks’ diversification indicators. We find that for the overall Chinese banking sector, income diversification has an efficiency- destroying effect. This thesis provides a good reference for bank managers and policy makers to better understand and treat non-interest income in China’s banking market. Our results also have fundamental and useful implications for bank managers and policy authorities seeking to enhance the performance and efficiency of Chinese banks under the condition of maintaining financial stability in Chinese financial system. III Declaration The content of this doctoral dissertation is based on the research work completed at Durham University Business School, UK. No material contained in the thesis has previously been submitted for a degree in this or any other university. Copyright © 2018 by Zhixian Qu, All Rights Reserved. The copyright of this dissertation rests with the author. No quotation from it should be published in any format without the author’s prior written consent and information derived from it should be acknowledged appropriately. IV Table of Contents ACKNOWLEDGEMENTS ........................................................................................ I Abstract .................................................................................................................... III Declaration ................................................................................................................ IV Table of Contents ...................................................................................................... V List of Tables ......................................................................................................... VIII List of Figures ............................................................................................................ X 1 Introduction........................................................................................................... 2 1.1 Motivation and Research Questions ................................................................ 3 1.2 Main Findings and Contributions of the Thesis .............................................. 7 1.3 Income Diversification in the Chinese Banking Industry: An overview ..... 18 1.3.1 Classification of Diversification ............................................................ 18 1.3.2 Channels of Income Diversification ...................................................... 19 1.3.3 Income Diversification Activities.......................................................... 21 1.4 Theories on Income Diversification: An overview ....................................... 22 1.5 Endogeneity Problem .................................................................................... 38 1.6 Hypothesis Development .............................................................................. 40 1.7 Categorization of the Chinese Banking Market ............................................ 44 1.8 Organization of the Thesis ............................................................................ 49 2 The Rise and Development of Non-traditional Banking Business in China.. 53 2.1 Introduction ................................................................................................... 54 2.2 Banking System Reforms in China ............................................................... 56 2.2.1 First Stage of Reform: Establishment of a “two-tier” banking system . 57 2.2.2 Second Stage of Reform: Instituting the regulatory framework of “one bank and two commissions” ............................................................................. 58 2.2.3 Third Stage of Reform: Towards a market-oriented economy .............. 61 2.3 Changes in the Income Structure of China's Banks ...................................... 65 V 2.3.1 Structural Changes in the Mature Banking Market ............................... 65 2.3.2 Income Diversification in the Chinese Banking Market ....................... 67 2.4 Motivations for Chinese Banks’ Diversification ........................................... 76 2.4.1 Constraint-induced Diversification ....................................................... 76 2.4.2 Internal-bank Motivations ..................................................................... 87 2.5 Conclusion ....................................................................................................