Integration of Chinas Banking System with the World - Essay Example

Integration of china’s banking system with the world Table of Contents Introduction 3 Literature review 3 Theoretical preview 4 China’s banking system 5 Methodology 6 Presentation of results 7 Discussion of results 10 Conclusion and recommendations 12 Reference list 14 Introduction China’s economy is seen to grow at a fast pace. The banking sector also plays a vital part in such a growth. China’s foreign exchange reserves are a whopping $1.8 trillion (Masson, Dobson and Lafrance, 2008). Still the nation lacks integration with the global financial. Banks of China, which are considered to be some of the largest in the world on the basis of financial strength and market capitalization, have very little presence in the international banking structure. Renminbi, the Chinese currency which is also known as the Yuan, is not used much outside of the Chinese market. The capital markets of china are also not accessed much by international investors for gaining profits. The lack integration of the Chinese economy with the world needs to be understood from the view point of the commercial and domestic interests of the nation individually. The priority of the Chinese economy in the past years has not been to be a part of the global economy, instead the focus has remained upon achieving growth and stability, while radically restructuring the overall economy and its sectors. The nation has directed its economic efforts towards developing adequate job opportunities and to be able to absorb layoffs. China’s labour market is quite large in size. The target of the economy has always been to provide adequate level of employment opportunities and maintain the stability of the economy. China has been successful in meeting these challenges adequately. The nation has been able to achieve economic growth of 10% annually. Market forces have been made free and to be able to promote efficiency. Privatization also had facilitated in the rapid restructuring of the economy. Integrating the Chinese economy with the world economy has therefore not been a high priority as China was able to maintain its stability. However, the maturity of the Chinese economy has however made it essential for it to participate in the global economy and sustain its growth. Moreover the Chinese economy possess as an important economic opportunity (Turner, Tan and Sadeghian, 2012). Literature review China plays a vital role in the global financial regulatory framework. The nation is a member of the G-20 Financial Services Board and the Basel committee. The Chinese banks and financial institutions have decided to implement the Basel III standards in respect of international bank capital standards from the year 2013 onwards (Lieberthal and Lieberthal, 2003). The implementation has already begun depicting efficient management of financial resources. The banking system of China owing to its well established control and greater dependency upon the indigenous sectors was less affected by the global financial crisis. The Chinese banking sector serves as a suitable example of the fact that greater dependency upon the domestic market acts as a protective shield from the influence of the global financial sector (Sachs, et al., 1995). Also since the interaction with foreign funds was low, induction of risk laden financial instruments was less. When most of the nations across the world were seen to experience a downfall of the economic markets, the Chinese economy was amongst the very few which was seen to experience growth. The Chinese economy is seen to rapidly expand its bank credit provided to government projects. The increase in credit provide for such projects has slowed down growth in the recent times. Financial experts such as Morck, Yeung and Zhao (2008) have stated that such credit enhancements are likely to induce risk. However it is expected that the government sector is less likely to default on debts unless there is any major financial crisis. However in the long run, the banking institutions of China have determined to expand their activities by diversifying their credit policies. Although public banks have less liberty in the matter, the commercial privatized banks are expected to play a greater role in providing greater credit facilities to the private sector and also to foreign institutions and take advantages of the liberalized policies. In general, it is observed that foreign banks play a minor role in the banking sector of the country. Only 2% of the entire banking system comprises of foreign banks (Summers, 2000). Such foreign banks find it extremely difficult to compete with the domestic banks of China. Also the regulatory restrictions imposed upon the activities of foreign banks restricted their growth. As a consequence the growth and expansion of foreign banks was low. However since 2001, the increased level of integration of the Chinese banking system with the global economy has provided some impetus to the foreign banks operating in China. The liberalization process has been slow but it is expected in the coming times that as that as the role of China becomes more and more important on the global front, importance of foreign banks are likely to enhance. Theoretical preview China is expected to play an important role on the global economic front due to the large number of opportunities available at its disposal. In the recent times the government have been exercised to provide greater freedom to capital controls. Authorities are seen to take suitable measures for enhancing exchange rate flexibility so that the nation’s economy can be easily adapted with others, globally. It cannot be stated that the Chinese economy is fully independent of the world economy. Integration does exist, but at a minor form. However as the economy matures, it is essential that more global participation is exercised. Modern day economic conditions are extremely complex. Those economies which refrain from participating on the international front experience slow growth and high risks. Moreover the advantages which the global markets provide attract many nations. International market participation not only facilitates exchange of financial resource and making use of the financial strengths of other developed nations, it also facilitates reducing and sharing risks which an economy faces due to market conditions. Considering the wide opportunities available, it is expected that China is likely to emerge an important player in the world economy. Many privatized organizations of china have already begun moving towards overseas investments. In the theoretical preview section analysis is done in respect of the conditions existing in the Chinese banking systems (Prasad, 2004). China’s banking system China’s capital market is awash with ample financial resources. Prodigious savings have been provided to financial and banking sector by the government and the commercial firms. There also exists a strong incentive amongst the household sector to provide savings. Almost 70% of the savings of the nation are held by the banking sector of China, making the segment financially very strong. Most of the banks in China are owned by the government. The composition of the entire banking system of the nation has been shown in the figure below. (Source: Masson, Dobson and Lafrance, 2008) The banking system of the nation includes five large size public commercial banks, a dozen different joint stock commercial banks and more than a hundred different commercial banks which are owned by the nation’s municipal authorities. There are also more than 30,000 rural and urban cooperative banks. The public banks dominate the entire baking system of the nation holding more than half of the sectors assets, employing lacks of people across its thousands of branches in the nation. However considering the growth rate, the government banks are seen to grow at a rate of 15% while the commercial banks and the joint stock banks are seen to grow at 29% and 33% respectively. Privatization is gradual and it is seen that an increasing number of foreign investors are approaching the financial markets of China by investigating bank equities. The banking sector of China is not very big as it consists of mainly indigenous players. The Government of China has been working strategically to restructure the banking system. As part of the 2001 WTO (World Trade Organization) agreement, the nation of China agreed to open up their banking sectors to foreign investors by the year 2007. In order to make the banking sector more competitive the government of the nation had taken three essential steps. The first step is to restructure and to recapitalize the banking sector. Secondly steps were taken to enhance the participation of foreign investors. Foreign investments were encouraged not for enhancing capital but for mainly procuring greater expertise. By the end of the year 2007, around $20 billion of foreign investments had been procured. The third step was to permit many banks to enlist their holdings in the stock market of Shanghai and Hong Kong (Sbracia and Zaghini, 2003). Methodology Setting a suitable methodology for conducting a study is crucial so that analysis can be conducted in a proper manner. The current study aims to understand whether the Chinese Banking system should be integrated with the global financial markets and would the same be beneficial for the nation. The study is largely qualitative in nature and is based on secondary sources of information. Secondary sources refer to the information collected from different books, journals and website publications. The Chinese economy is seen to be slightly integrated with the international markets. Information regarding the effects of such integration have been collected and analysed. Such a research strategy facilitates to understand whether the Chinese economy should consider integrating its banking system more widely with other nations or refrain from the same. The philosophy followed in the current paper is interpretivism. The interpretivism theory allows the researcher to understand that the subject of study based upon their level of knowledge and exposure to different information. While the positivism approach is based on strict structures and hypothesis, the interpretivism approach provides sufficient independence to adapt any method which the researcher considers suitable. Considering the nature of the study, the interpretivism approach is considered to me most suitable as it facilitates the research to construct ideas based on information obtained. Presentation of results Figure 1: Foreign investments in Chinese banks from 2002 onwards Year Chinese bank Foreign Investor Equity share (%) US $ (millions) 2002 Shanghai Pudong Dev Bank Citigroup 15 73 2002 Bank of Shanghai IFC/HSBC 15 145 2002 China Everbright Bank IFC 5 19 2002–05 Bank of Nanjing IFC/BNP Paribas 25 114 2004 Industrial Bank Hang Seng/ IFC/GIC 25 326 2004 China Minsheng Banking Corp. IFC/Temasek 6 125 2004 Shenzhen Development Bank Newbridge 18 150 2004 Xi’an City Commercial Bank IFC/Scotiabank 25 40 2005 Jinan City Commercial Bank Commonwealth Bank 11 17 2005 Bank of Beijing IFC/ING 25 270 2005 Hangzhou City Commercial Bank Commonwealth Bank/ADB 25 110 2005 Huaxia Bank Deutsche/ Sal Oppenheim 13 325 2005 Bohai Bank Standard Chartered 20 125 2005 Bank of Communications HSBC 20 1,750 2005 China Construction Bank Bank of America 14 4,000 2005 Bank of China RBS/UBS/ Temasek/ADB 17 5,175 2005 Tianjin City Commercial Bank ANZ 20 110 2005 Industrial and Commercial Bank of China Goldman/ Allianz 10 3,700 2006 Ningbo Commercial Bank OCBC 12 70 2006 Shanghai Rural Commercial Bank ANZ 20 252 2006 United Rural Cooperative Bank of Hangzhou Rabobank/IFC 15 30 2006 Chongquing Commercial Bank City Dah Sing/ Carlyle 25 130 2006 Guangdong Development Bank Citigroup/IBM 25 760 2007 CITIC Industrial Bank BBVA 5 650 2007 Dalian City Commercial Bank Scotiabank/IFC 25 320 (Source: Masson, Dobson and Lafrance, 2008) On the basis of the above flow of foreign investments received between the years 2002 to 2007, the following graph has been prepared: Figure 2: Foreign investment growth in Chinese banks Figure 3: Chinese banks profitability (Source: Turner, Tan and Sadeghian, 2012) Discussion of results When banks participate in international markets, a greater level of transparency is encouraged. This facilitates open and fair dissemination of information. Also since the banks fall under the review of many regulatory authorities they perform more diligently. Transparency is a vital factor which firms must follow so as to be able to participate in the international markets. Listings in foreign markets lead to attracting greater foreign investments and expertise. The banking sector of China was seen to reach its saturation point of advancement on the basis of indigenous sources of expertise. For further growth and development much help is required from the foreign institutions. Alongside of the flow of financial investments, the acquisition of expertise also gets facilitated (Khanna, Palepu and Sinha, 2005). The measures taken have had a drastic impact on the net assets and liabilities of the Banking sector of China. The flow of fund has impacted other industries as well as greater investments could be made in their growth and development. The increase in the flow of foreign investments also improved some of the weakly developed sectors of the financial markets. Many non performing loans began to perform better. The financial reforms had impacted many non performing loans. China’s monetary growth is dependent upon interest and exchange rates. Such institutional features of the financial system are seen to impact the manner in which assets are procured and managed. The investment led export oriented growth of the nation is seen to get adequately influenced by the changes in key prices such as interest and exchange rates. A significant advantage of the low presence of China in the international markets is that the nation’s exchange rates have fluctuated at a lower rate than others. However the increasing level of exposure of the Chinese financial system with the global economy is seen to induce greater risks than before. In order to minimize the impacts of external risks upon the overall economy the central bank of China has considered maintaining a certain level of control over the economy. Instead of allowing banks to provide market determined rates, the government regulates the existing rates from time to time. Monitoring is done in a manner such that lending rates remain high and comparatively low rates are provided on savings. The control exhibited by the financial regulators of the nation ensures that growth of the financial sectors is not hampered due to integration of the banking systems with the international economy (Claessens, Demirgüç-Kunt and Huizinga, 2001). In order to integrate the Chinese banking system with the world, the economy of china had imposed strict regulations, reducing the independence of the monetary policy of the nation. Market determined rates are considered to be risky and might hamper healthy spread and lead to speculative cash inflows. Such a situation might lead towards an upward rise in the exchange rates causing much economic losses. However, the implementation of such administrated interest rates had prohibited growth. After 2007, the tight regulations in the banking system were seen to become slightly more liberalised in order to facilitate growth. A successful outcome of the implementation of the administered rates of interests was that commercial banks independence to provide risky credit was strictly monitored. Credit policies if not monitored effectively in an economy that participates in the global markets, might cause liquidity crisis. To prevent such situations adequate balance must be maintained in between lending and procuring rates (Mishkin, 2007). From the above figures showing the inflow of investments into the economy of China, it can be seen that post opening up of the banking sector of China towards foreign investments, the overall inflow of foreign exchange into the financial sector have enhanced adequately. Chinese banks are slowly seen to increasingly participate in the global financial markets, thereby mitigating a number of risks which arise in the indigenous economy. In the recent times a number of Chinese banks have begun investing in international firms and provide finance to firms outside of Chinese economy. The participation of the banks outside of the Chinese economy has encouraged many global institutions to participate in the economy of China. The low fluctuation of interest and exchange rates and stable economic structures provides adequate scope for international banking institutions to invest in and reap profits. Chinese banks due to their abundant financial resources are counted amongst some of the most efficient worldwide. The continued government ownership and prudential standards of regulations have contributed heavily towards this success. Although the continued control of the government has reaped many profits for the banking sector of China, there are still many short comings. Majority of the Chinese banks and especially the public banks, rely upon traditional methods for acquiring financial resources. The banks rely upon the savings procured from state commercial firms (Claessens and Laeven, 2004). These firms depict very less growth as global economy advances. It is feared that the overdependence of the banking sector upon government sector enterprises may stagnate their growth in the long run. For such reason the banking systems was decided to be made more liberalised. The increased participation of private and international commercial organizations in this sector is expected to provide higher benefits to the overall economy. The profits in the Chinese banking sector are seen to grow remarkable post the economy adopted liberalization (Ikenberry, 2008). Conclusion and recommendations The Chinese banking sector can be stated to be partly integrated with the global economy. Many weak performing loans and financial instruments have begun performing better post integration with global financial systems. The highly regularized environment of the Chinese banking system facilitates avoiding risks and grows at a steady pace without compromising on the needs of the indigenous market. The rapid economic development of the Chinese markets is considered to play an important role in encouraging the banking to integrate itself more with the global economy. The stable currency of China has facilitated in managing the rate growth of the industrial sector, but the same has however developed much constrains in the monetary policy. Greater exchange rate flexibility facilitates quicker appreciation of currency values. The Chinese banking sector follows the policy of integrating its system with the global financial system as internal domestic market problems area get solved one after the other. As the control over the Chinese economy becomes more and more liberalized, it is essential to seen to what extend in the Chinese currency used for international transactions. It is important that the foreign holdings of underlying assets in Chinese currency are enhanced. However until and unless the central bank of China develops opens philosophy and establishes flexible rates of exchanges, the capital market of the nation will not obtain much acceptance in the global markets. Considering the current situation existing in the Chinese economy, an increased integration with the global banking system would act as strong stimulus of economic growth and enhanced investments. Reference list Claessens, S. and Laeven, L., 2004. What drives bank competition? Some international evidence. Journal of Money, Credit and Banking, 1(1), pp. 563-583. Claessens, S., Demirgüç-Kunt, A. and Huizinga, H., 2001. How does foreign entry affect domestic banking markets? Journal of Banking & Finance, 25(5), pp. 891-911. Ikenberry, G. J., 2008. The rise of China and the future of the west: can the liberal system survive? Foreign affairs, 1(1), pp. 23-37. Khanna, T., Palepu, K. G. and Sinha, J., 2005. Strategies that fit emerging markets. Rivals from developing countries are invading your turf. How will you fight back?, 1(1), pp. 4. Lieberthal, K. and Lieberthal, G., 2003. The great transition. Harvard Business Review, 81(10), pp. 70-81. Masson, P., Dobson, W. and Lafrance, R., 2008. 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