Analyzing Systemic Risk In The Chinese Banking System

Qiubin Huang

University of Groningen

Jakob de Haan

University of Groningen – Faculty of Economics and Business; De Nederlandsche Bank; CESifo (Center for Economic Studies and Ifo Institute)

Bert Scholtens

University of Groningen – Department of Finance & Accounting

September 23, 2015

CESifo Working Paper Series No. 5513


We examine systemic risk in the Chinese banking system by estimating the conditional value at risk (CoVaR), the marginal expected shortfall (MES), the systemic impact index (SII) and the vulnerability index (VI) for 16 listed banks in China. Although these measures show different patterns, our results suggest that systemic risk in the Chinese banking system decreased after the financial crisis, but started rising in 2014. Compared to the banking systems of Korea and the US, we find that Chinese banks are at greater risk according to the CoVaR, the SII and the VI approaches, but have the lowest MES.

Analyzing Systemic Risk In The Chinese Banking System – Introduction

This paper analyzes systemic risk in the Chinese banking system. China has achieved remarkable progress in reforming its banking system. There are 117 Chinese banks in the 2015 Top 1000 of banks;1 three of them (the Bank of China, the Industrial and Commercial Bank of China, and the Agricultural Bank of China)2 are rated as global systemically important banks. Chinese banks made $292 billion in aggregate pretax profit in 2013, or 32% of total earnings of the world’s top 1,000 banks, outperforming US banks (with a share of 20%), according to The Banker magazine.3 However, the Chinese banking system faces numerous challenges. Economic growth in China has been slowing down since the global financial crisis; overcapacity in some sectors is becoming increasingly serious; the stock market recently has faced severe blows; and there seems to be a bubble in the real estate market, whose financing mainly depends on banking loans. No doubt, these challenges seriously affect the stability of the banking system.

Furthermore, the rapid expansion of China’s shadow-banking sector may pose a threat to banking stability (Li, 2014). This was illustrated at the start of 2014 with the default (or near-default) of several trusts exposed to the coalmining sector.5 Banks are not immune to the risks of the shadow-banking sector, as many of them distribute wealth management products or refinance trust companies.

A banking crisis in China would create enormous problems, not only in China but also in other countries given the size of the Chinese economy and its position within the global economy. It therefore seems wise to nip the risk in the bud but the first step would be to analyze systemic risk objectively and accurately. According to official reports, the ratio of non-performing loans is only about 1% for the vast majority of banks, suggesting that the banking system is stable. However, China’s official figures are often of questionable reliability, as argued by Krugman (2011). Therefore, our research resorts to market data, providing a less politicized and more objective analysis of the soundness of the Chinese banking system.

We investigate systemic risk with the help of several measures. More specifically, we apply the conditional value at risk (CoVaR) measure of Adrian and Brunnermeier (2011), the marginal expected shortfall (MES) measure of Acharya et al. (2010), the systemic impact index (SII) and the vulnerability index (VI) of Zhou (2010) to 16 listed banks in China for the 2007-2014 period. The former two are widely used to monitor financial institutions by central bankers and bank regulators and have a high impact in the academia (Benoit et al., 2013). The latter two, which based on different method of estimation (namely, Extreme Value Theory), can be used to make a cautious comparison with the former two. These measures, calculated using daily equity returns, are used to capture each bank’s contribution to systemic risk.

Our paper contributes to the academic literature on the Chinese banking system. In the past decade, several papers have been published, analyzing different aspects of the Chinese banking system. To name a few, Garcia-Herrero et al. (2006), Fu and Heffernan (2009), Jia (2009), Lin and Zhang (2009), and Dong et al. (2014) focus on the reform and/or performance of the Chinese banking system; Berger et al. (2009), Ariff and Luc (2008), and Asmild and Matthews (2012) investigate the efficiency of China’s banks; Bailey et al. (2012) and Fenech et al. (2014) investigate the quality of bank loans and some other characteristic of the Chinese banking system. However, only a few studies investigate systemic risk in the Chinese banking system. Chen et al. (2014) apply an indicator-based approach proposed by the Basel Committee to identify domestic systemically important banks (D-SIBs) and analyze their correlation with non-D-SIBs. Wang et al. (2015) employ a Merton model to estimate the default probability of banks to construct a systemic risk index of banks. To the best of our knowledge, this is the first study that constructs multiple measures of systemic risk for Chinese banks. Our paper not only examines systemic risk in the Chinese banking system from different perspectives, but also compares systemic risk of Chinese banks to that of banks in some other countries.

Chinese banking system

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