What Drives Cost Efficiency of Banks in China?
Date | 01 March 2015 |
Published date | 01 March 2015 |
Author | Jingyi Jia,Hung‐Gay Fung,Ning Ding |
DOI | http://doi.org/10.1111/cwe.12107 |
61
China & World Economy / 61–83, Vol. 23, No. 2, 2015
©2015 Institute of World Economics and Politics, Chinese Academy of Social Sciences
What Drives Cost Efficiency of Banks in China?
Ning Ding, Hung-Gay Fung, Jingyi Jia*
Abstract
This study uses stochastic frontier analysis to examine the factors that influenced cost
efficiency of banks in China from 2005 to 2013. The results indicate that policy variables,
such as the reserve requirement ratio, the interest rate spread and open market operations
by the People’s Bank of China, are effective in improving the cost efficiency of banks, but
shadow banking variables may reduce cost efficiency. Among the various bank types, city
commercial banks appear to be the most efficient and foreign banks are the least efficient.
The present study suggests that policy-makers can have a positive influence on bank cost
efficiency by adjusting macro policy variables on different types of banks and by requiring
more information on the shadow banking activities to improve monitoring.
Key words: bank types, cost efficiency of banks, policy tools, shadow banking
JEL codes: D24, E52
I. Introduction
Banks play a critically important role in China’s economy and financial development because
they are the major source of credit to firms for investment and to consumers for consumption;
however, research on banks in China is limited. The present study attempts to fill this gap.
Of interest here are government policies that affect banks’ behavior as the Chinese
Government attempts to maintain tight control over banking activities. This study examines
banks’ cost efficiency behavior in China and the reasons for their behavior.
*Ning Ding, Associate Professor, School of Finance, Dongbei University of Finance and Economics,
Dalian, China. Email: dingning610@hotmail.com; Hung-Gay Fung, Curators’ Professor of Finance and Dr. Y. S.
Tsiang Professor of Chinese Studies, College of Business Administration, University of Missouri-St. Louis, St.
Louis, USA. Email: fungh@msx.umsl.edu; Jingyi Jia, Associate Professor, School of Business, Southern Illinois
University, Edwardsville, USA. Email: jjia@siue.edu. We thank the Editor for helpful comments. Ning Ding
acknowledges financial support for this paper from the China National Social Science Foundation; the project
topic is Research on Risk Management and Supervisions of Shadow Banking under the Interest Rate Liberalization
Reforms (Grant No. 14BJY173).
62 Ning Ding et al. / 61–83, Vol. 23, No. 2, 2015
©2015 Institute of World Economics and Politics, Chinese Academy of Social Sciences
Banks’ cost efficiency has been examined extensively in the literature. Berger and
Mester (1997) identify the differences in the efficiency concept used by banks and other
financial institutions and discuss variations in measurement methods applied to estimate
efficiency. Cebenoyan et al. (1993b) examine the cost efficiency of savings and loans
and their relationship to different ownership structures. Cebenoyan et al. (1993a) document
how the regulatory closure of thrifts (savings and loans associations) is related to their
cost inefficiency in China.
The present study uses a stochastic frontier analysis to arrive at cost efficiency scores
for banks in China between 2005 and 2013. We then examine factors affecting the cost
efficiency of all banks using data from Bankscope. Our study complements the profit
efficiency study by Wang and Feng (2014) on the Big Four Chinese banks and the bank
profitability study by Zhang and Daly (2014) that examines underlying macro and micro
factors affecting bank performance.1 Using a large sample, we examine the macro policy
and bank-specific variables that affect the cost efficiency of banks in China. Specifically,
we investigate three main factors that affect banks’ cost efficiency.
First, the Chinese Government has implemented various monetary policies to monitor
bank behavior as part of overall economic reforms, and we examine whether these policies
have achieved their intended goals. Monetary policies, such as reserve requirements,
changes in the interest rate spread and open market operations, which have been used
frequently in the past decade, are intended to dampen excessive lending, monitor banking
operational performance and regulate bank liquidity. We expect these policies to have a
positive effect on the cost efficiency of banks in China.
Second, we examine certain banking activities, including trust loans and interbank
loans (also examined in Barnett and Roache [2014] and Lu et al. [2014]), that may be
problematic and risky and can adversely affect cost efficiency. Shadow banking has become
an issue of increasing concern in China since the 2008 financial crisis. Although the
estimated size of the shadow banking industry differs across reports, Phillips et al. (2014)
and Spring (2014) estimate it to make up approximately 40 percent of China’s GDP and
50 percent of the assets in the banking system, comprising such a large proportion that it
creates tremendous systematic risk for the banking sector and the entire Chinese
economy. Our study provides useful information for policy-makers and bank managers
so that they can better develop policies on these loans.
Banks in China are classified as either domestic banks or foreign banks. Domestic
banks are subdivided into city commercial, rural commercial and state-owned banks, among
others, while foreign banks are divided into purely foreign banks and Chinese–foreign
1See http://finance.sina.com.cn/china/20120218/202011406489.shtml.
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