The Effectiveness of Capital Regulation on Bank Behavior in China

Abstract

This paper examines the impact that ownership and governance structures have on how Chinese banks react to regulatory pressure. We find that the current regulatory regime induces banks to increase their capital, but its effectiveness in doing so varies based on whether the bank is listed or not, and also who is the majority shareholder. We also find that the degree of central government ownership and the political ties the chief executive officer of the bank has play an important role in the risk‐taking behavior of banks. Overall, our results have a number of policy implications supporting the need to further reduce state ownership of banks in China to mitigate the prevailing moral hazard and dual‐agency problems that arise from the government being both the regulator and the majority shareholder.

Venture capital certification of small and medium‐sized enterprises towards banks: evidence from China

“…Developed economies, such as the US and the UK, have in practice constantly reduced the information asymmetry between firms and financial institutions, and subsequently improved market efficiency in allocating resources. In comparison, China's underdeveloped banking sector demonstrates noticeable differences in proficiencies across regions (Xu and Lin, ; Fu et al ., ). Therefore, there may be less information asymmetry between SMEs and banks in regions of better developed banking sectors.…”

“…Despite its continuous ownership reforms, the government still, directly and indirectly, holds most equity in the banks in China. The government often sends lending instructions for banks to follow (Xu and Lin, ; Fu et al ., ). As a result, SOEs in China have traditionally been advantaged in accessing bank loans under better terms (Allen et al ., ; Bailey et al ., ).…”

“…The noticeable difficulty in accessing bank loans and high borrowing costs deprive them of growth opportunities. Bank loans are the primary source of funding for most firms in the bank‐based economy (Fu et al ., ). In comparison, the bond and stock markets are supplementary to the banking sector in the country (Bryson et al ., ; Lin and Milhaupt, ) and consequently cannot satisfy the needs of SMEs.…”

A review of research on regulation changes in the Asia‐Pacific region

“…More recently, Avkiran et al (2015) examine the effects of the relaxation of regulatory requirements imposed on foreign banks in China on their ability to compete. In another Chinese study, Fu et al (2015) examine the impact of ownership and governance structures on Chinese banks' reaction to regulatory pressure. They find that the degree of central government ownership and the CEO's political ties play important roles in the risk-taking behaviour of banks.…”

International compliance with new Basel Accord principles for risk governance

“…When political structures confound the purpose of bank regulation, the implementation of risk governance reforms may be compromised, as Fu et al . () indicate in their study of the effectiveness of capital regulation on bank behaviour in China. Also, a comparison that includes both developed and underdeveloped capital markets will highlight the differences between them but may not be sufficient to identify the means of resolving their respective weaknesses.…”