Sector only, China's ratio drops sharply to 0. 24, suggesting that most of the bank credit is issued to companies in the State and Listed Sectors. Moreover, Chinas banking system is not efficient: its overhead cost to total assets(0. 12)is much higher than the average of French-origin countries (0.05 ), the next highest group of countries The second panel of Table 1-A compares the relative importance of financial markets vs banks("Structure indices"). China has the lowest scores for both"Structure Activity"(Log of the ratio of Value Traded/Total Bank Credit)and""Structure size"(Log of the ratio of Market Capitalization/Total Bank Credit), suggesting that its banking sector is much larger than its financial markets, and this dominance by the banks over markets is stronger than the average of all LLSV sample countries. In terms of" Structure efficiency"(Log of product(Market capitalization/GDP)X (bank overhead cost/bank total assets), which denotes the relative efficiency of markets vs banks China has the highest score, suggesting that its stock markets are actually relatively more efficient than banks compared to other countries. This result is mainly driven by the extremely high costs of Chinas banking system We also compare the development of the entire financial system("Financial Development), including both banks and markets in the last panel of Table 1-A. Given that all other countries measures were based on private bank credit only, if we only include China's bank credit made to the Hybrid Sector, we find that Chinas overall financial market size, in terms of both"Finance Activity"(Log of product of (Total value traded/GDP)X(Private credit/GDP)and"Finance Size"( Log of product of (Market capitalization/GDP)X(Private credit/GDP)), is smaller than the LLSV sample average level, and is only higher than the French-origin countries'average. In terms of Finance Efficiency"(Log of (Total value traded/GDP)Overhead cost), China's measure is below all sub-samples of LLSV countries. Based on the above evidence, we can conclude that Chinas financial system is dominated by a large but inefficient banking sector 11.3 Firms'financing channels: Aggregate evidence The four most important financing sources for all firms in China, in terms of firms'fixed asset investments, are:(domestic) bank loans, firms' self-fundraising, the state budget, and foreign direct investment(FDI). By far the two most important sources of financing channels are self- fundraising and bank loans. Consistent with previous evidence on Chinas banking sector, bank loans, including loans from the non-state banks, provide a large amount of funds to firms, and
11 Sector only, China’s ratio drops sharply to 0.24, suggesting that most of the bank credit is issued to companies in the State and Listed Sectors. Moreover, China’s banking system is not efficient: its overhead cost to total assets (0.12) is much higher than the average of French-origin countries (0.05), the next highest group of countries. The second panel of Table 1-A compares the relative importance of financial markets vs. banks (“Structure indices”). China has the lowest scores for both “Structure Activity” (Log of the ratio of Value Traded/Total Bank Credit) and “Structure size” (Log of the ratio of Market Capitalization/Total Bank Credit), suggesting that its banking sector is much larger than its financial markets, and this dominance by the banks over markets is stronger than the average of all LLSV sample countries. In terms of “Structure efficiency” (Log of product (Market capitalization/GDP) × (bank overhead cost/bank total assets)), which denotes the relative efficiency of markets vs. banks, China has the highest score, suggesting that its stock markets are actually relatively more efficient than banks compared to other countries. This result is mainly driven by the extremely high costs of China’s banking system. We also compare the development of the entire financial system (“Financial Development”), including both banks and markets in the last panel of Table 1-A. Given that all other countries’ measures were based on private bank credit only, if we only include China’s bank credit made to the Hybrid Sector, we find that China’s overall financial market size, in terms of both “Finance Activity” (Log of product of (Total value traded/GDP) × (Private credit/GDP)) and “Finance Size”( Log of product of (Market capitalization/GDP) × (Private credit/GDP)), is smaller than the LLSV sample average level, and is only higher than the French-origin countries’ average. In terms of “Finance Efficiency” (Log of (Total value traded/GDP)/Overhead cost), China’s measure is below all sub-samples of LLSV countries. Based on the above evidence, we can conclude that China’s financial system is dominated by a large but inefficient banking sector. II.3 Firms’ financing channels: Aggregate evidence The four most important financing sources for all firms in China, in terms of firms’ fixed asset investments, are: (domestic) bank loans, firms’ self-fundraising, the state budget, and foreign direct investment (FDI). By far the two most important sources of financing channels are selffundraising and bank loans. Consistent with previous evidence on China’s banking sector, bank loans, including loans from the non-state banks, provide a large amount of funds to firms, and
constitute a large fraction of firms' total financing need Self-fundraising includes proceeds from capital raised from local governments(beyond the state budget), communities and other investors, internal financing channels such as retained earnings, and all other funds raised domestically by the firms. Since our current data source, the China Statistical Yearbook(2000-02), does not provide the breakdowns of"self-fundraising, we can only present the total figures. The size of total self-fundraising of all firms has been growing at an average annual rate of 14% over the period of 1994-2002. Total self-fundraising(for fixed asset investment)reached US$275.5 billion at the end of 2002, compared to a total of US$ 106. 6 billion for domestic bank loans for the same year. It is important to point out that equity and bond issuance, which are included in self-fundraising, apply only to the listed Sector, and account for a small fraction of this category. Moreover, self-fundraising is the most important source of financing for many types of firms. For example, individually owned companies(of the hybrid Sector),not surprisingly, rely mostly on self-fundraising(about 90% of total financing). Interestingly, even for state-or quasi-state-owned companies, self-fundraising is also important in that it captures somewhere between 45%and 65% of total financing The state budget and FDi are the other two important financing sources. As was the case for ll socialist countries, China used to rely on a central planning system to allocate the state budget to most of the companies in the country But the state budget now only contributes 10% of state owned companies'total funding On the other hand, FDI is comparable to the state budget, both terms of aggregate size and in terms of the relative importance in firms' financing. This evidence confirms that China has evolved from a centrally planned, closed economy toward an open market economy. For example, in terms of the ratio of FDI over GDP, China attracted more FDI than both South Korea and Taiwan during the 1990s With the knowledge of the four financing channels at the aggregate level, we now focus on different types of firms' financing decisions. The results are presented in Figures 2-A, 2-B, and 2-C In all of these figures, each of the four connected lines represents the importance of a particular financing channel over the time period of 1994-2002, measured by the percentage of firms'total financing coming from this channel Insert Figures 2-A, 2-B, and 2-C here For example, firms in the State Sector rely on bank loans to raise more than 25% of their total financing needs. A similar pattern holds for jointly-and collectively-owned companies, both of which belong to the Hybrid Sector. Our Ivey evidence also indicates that bank loans are important financing sources for the Hybrid Sector
12 constitute a large fraction of firms’ total financing needs.5 Self-fundraising includes proceeds from capital raised from local governments (beyond the state budget), communities and other investors, internal financing channels such as retained earnings, and all other funds raised domestically by the firms. Since our current data source, the China Statistical Yearbook (2000-02), does not provide the breakdowns of “self-fundraising,” we can only present the total figures. The size of total self-fundraising of all firms has been growing at an average annual rate of 14% over the period of 1994-2002. Total self-fundraising (for fixed asset investment) reached US$275.5 billion at the end of 2002, compared to a total of US$106.6 billion for domestic bank loans for the same year. It is important to point out that equity and bond issuance, which are included in self-fundraising, apply only to the Listed Sector, and account for a small fraction of this category. Moreover, self-fundraising is the most important source of financing for many types of firms. For example, individually owned companies (of the Hybrid Sector), not surprisingly, rely mostly on self-fundraising (about 90% of total financing). Interestingly, even for state- or quasi-state-owned companies, self-fundraising is also important in that it captures somewhere between 45% and 65% of total financing. The state budget and FDI are the other two important financing sources. As was the case for all socialist countries, China used to rely on a central planning system to allocate the state budget to most of the companies in the country. But the state budget now only contributes 10% of stateowned companies’ total funding. On the other hand, FDI is comparable to the state budget, both in terms of aggregate size and in terms of the relative importance in firms’ financing. This evidence confirms that China has evolved from a centrally planned, closed economy toward an open market economy. For example, in terms of the ratio of FDI over GDP, China attracted more FDI than both South Korea and Taiwan during the 1990s. With the knowledge of the four financing channels at the aggregate level, we now focus on different types of firms’ financing decisions. The results are presented in Figures 2-A, 2-B, and 2-C. In all of these figures, each of the four connected lines represents the importance of a particular financing channel over the time period of 1994-2002, measured by the percentage of firms’ total financing coming from this channel. Insert Figures 2-A, 2-B, and 2-C here. 5 For example, firms in the State Sector rely on bank loans to raise more than 25% of their total financing needs. A similar pattern holds for jointly- and collectively-owned companies, both of which belong to the Hybrid Sector. Our survey evidence also indicates that bank loans are important financing sources for the Hybrid Sector
First, Figure 2-A(2-B)illustrates how firms in the Listed Sector(State Sector) finance their investment for fixed assets. While the Listed Sector has been growing fast, SOEs are on a downward trend, as privatization of these firms is still in progress. around 30% of publicly traded companies' funding comes from bank loans, and this ratio has been very stable, despite the fast growth of the stock markets(Figure 2-A). Around 45% of the Listed Sector's total funding comes from self-fundraising, including internal financing and proceeds from equity and bond issuance fraction of total funds raised in comparison to internal financing and other forms of fundraising e Moreover, equity and bond sales, which rely on the use of external markets, only constitute a s Combined with the fact that self-fundraising is also the most important source of financing for the State Sector(Figure 2-B), we can conclude that alternative channels of financing are important even for the State and Listed Sectors Next, we consider how firms in the Hybrid Sector raise funds(Figure 2-C). Self-fundraising here includes all forms of internal finance, capital raised from family and friends of the founders and managers, and funds raised in the form of private equity and loans. Clearly, this category is by far the most important source of financing, accounting for close to 60% of total funds raised Moreover, since firms in this sector operate in an environment with legal and financial mechanisms and regulations poorer than those available for firms in the State and Listed Sectors, financing sources may work differently from how they work in the State and Listed Sectors, and those in developed countries [L 4 China's "foreign" financial sector As the largest emerging economy, China has attracted a large amount of foreign investment in terms of FDI, joint ventures, holdings of B share stocks, and so on. It will not be surprising that this trend continues in the foreseeable future. Here we provide a brief overview of China's foreign " financial sector, through which capital flows out of China and to other countries. this sector is in its infancy, but will probably grow rapidly in the near future as China becomes more integrated with the rest of the worlds economy and financial system Insert Tables 1-B and 1-C here Table 1-B compares both the flows(Panel a)and stocks( Panel b)of the inflow and outflow of fDI in China and other countries and regions The scale of Chinas fDi outflows(both in flows and stocks)is diminutive(about one tenth) relative to the inflows, and unlike the inflows they have not exhibited a steady growth trend. While China's scale of total FDI inflows dominates that of Singapore, the scale of outflows is much smaller than Singapore, whose financial system is highly
13 First, Figure 2-A (2-B) illustrates how firms in the Listed Sector (State Sector) finance their investment for fixed assets. While the Listed Sector has been growing fast, SOEs are on a downward trend, as privatization of these firms is still in progress. Around 30% of publicly traded companies’ funding comes from bank loans, and this ratio has been very stable, despite the fast growth of the stock markets (Figure 2-A). Around 45% of the Listed Sector’s total funding comes from self-fundraising, including internal financing and proceeds from equity and bond issuance. Moreover, equity and bond sales, which rely on the use of external markets, only constitute a small fraction of total funds raised in comparison to internal financing and other forms of fundraising. Combined with the fact that self-fundraising is also the most important source of financing for the State Sector (Figure 2-B), we can conclude that alternative channels of financing are important even for the State and Listed Sectors. Next, we consider how firms in the Hybrid Sector raise funds (Figure 2-C). Self-fundraising here includes all forms of internal finance, capital raised from family and friends of the founders and managers, and funds raised in the form of private equity and loans. Clearly, this category is by far the most important source of financing, accounting for close to 60% of total funds raised. Moreover, since firms in this sector operate in an environment with legal and financial mechanisms and regulations poorer than those available for firms in the State and Listed Sectors, financing sources may work differently from how they work in the State and Listed Sectors, and those in developed countries. II.4 China’s “foreign” financial sector As the largest emerging economy, China has attracted a large amount of foreign investment, in terms of FDI, joint ventures, holdings of B share stocks, and so on. It will not be surprising that this trend continues in the foreseeable future. Here we provide a brief overview of China’s “foreign” financial sector, through which capital flows out of China and to other countries. This sector is in its infancy, but will probably grow rapidly in the near future as China becomes more integrated with the rest of the world’s economy and financial system. Insert Tables 1-B and 1-C here. Table 1-B compares both the flows (Panel a) and stocks (Panel b) of the inflow and outflow of FDI in China and other countries and regions. The scale of China’s FDI outflows (both in flows and stocks) is diminutive (about one tenth) relative to the inflows, and unlike the inflows they have not exhibited a steady growth trend. While China’s scale of total FDI inflows dominates that of Singapore, the scale of outflows is much smaller than Singapore, whose financial system is highly
integrated into the international system. In terms of the fraction of gross fixed capital formation(or investment for fixed assets ), China's FDi inflows are again higher than the averages for other Asian ountries, developing countries and the entire world, but the outflows are lower than the averages of Table l-C provides an overview of cross-border mergers and acquisitions(M&As). Once again, in terms of total deal value, foreign firms and investors have acquired more Chinese firms ("sales")than Chinese firms/investors have acquired foreign firms("purchases"); while the sale of Chinese firms to foreign firms and investors is higher than that of Singapore firms and investors from Singapore have purchased more foreign firms than their Chinese counterparts. An example of the cross-border M&A is the Lenovo Group's US $1.25 billion purchase of IBMs personal computing division and subsequent formation of the Lenovo U.S. in 2005(e. g, Financial Times 12/08/2004,andhttp://www.lenovo.com).FoundedunderthenameLegendCo.byelevenChinese computer engineers( who worked for the Computation Center in the Chinese Academy of Science) in 1984, this Hybrid Sector firm enjoyed a fast growth track and was listed and traded on the Hong Kong Stock Exchange(HKSE)in 1994. Total sales of Lenovo U.S. in 2005 are expected to top US$13 billion. Despite the small scale of Chinese firms acquisitions of foreign firms to date, the number of the type of acquisitions accomplished by lenovo are expected to rise exponentially over the next few years China's banking sector also has a limited amount of investment overseas. According to the Almanac of China's Banking and Finance(1996-2003), at the end of 2002, all of Chinas commercial banks(state-owned and non-state owned) have around 670 foreign branches, holding a total amount of us$160 billion assets and $156 billion liabilities: more than 90% of these branches and their assets and liabilities belong to the Big Four'state-owned banks. The entire banking system(including all non-bank financial intermediaries )has net assets(total assets minus liabilities) overseas in the amount of US$380 billion. Finally there are currently 1 1 1 Chinese firms listed on exchanges overseas: 108 in the HKSE, 13 in the U.S. (NYSE and NaSdaQ), 3 in the U. K,, and 2 I. The banking and intermediation Sector In this section we examine the status of Chinas banking and intermediation sector. After reviewing aggregate evidence on bank deposits and loans, we analyze the problem of NPls in the
14 integrated into the international system. In terms of the fraction of gross fixed capital formation (or investment for fixed assets), China’s FDI inflows are again higher than the averages for other Asian countries, developing countries and the entire world, but the outflows are lower than the averages of these regions. Table 1-C provides an overview of cross-border mergers and acquisitions (M&As). Once again, in terms of total deal value, foreign firms and investors have acquired more Chinese firms (“sales”) than Chinese firms/investors have acquired foreign firms (“purchases”); while the sale of Chinese firms to foreign firms and investors is higher than that of Singapore, firms and investors from Singapore have purchased more foreign firms than their Chinese counterparts. An example of the cross-border M&A is the Lenovo Group’s US $1.25 billion purchase of IBM’s personal computing division and subsequent formation of the Lenovo U.S. in 2005 (e.g., Financial Times, 12/08/2004, and http://www.lenovo.com). Founded under the name Legend Co. by eleven Chinese computer engineers (who worked for the Computation Center in the Chinese Academy of Science) in 1984, this Hybrid Sector firm enjoyed a fast growth track and was listed and traded on the Hong Kong Stock Exchange (HKSE) in 1994. Total sales of Lenovo U.S. in 2005 are expected to top US$13 billion. Despite the small scale of Chinese firms’ acquisitions of foreign firms to date, the number of the type of acquisitions accomplished by Lenovo are expected to rise exponentially over the next few years. China’s banking sector also has a limited amount of investment overseas. According to the Almanac of China’s Banking and Finance (1996-2003), at the end of 2002, all of China’s commercial banks (state-owned and non-state owned) have around 670 foreign branches, holding a total amount of US$160 billion assets and $156 billion liabilities; more than 90% of these branches and their assets and liabilities belong to the ‘Big Four’ state-owned banks. The entire banking system (including all non-bank financial intermediaries) has net assets (total assets minus liabilities) overseas in the amount of US$380 billion. Finally, there are currently 111 Chinese firms listed on exchanges overseas: 108 in the HKSE, 13 in the U.S. (NYSE and NASDAQ), 3 in the U.K., and 2 in Singapore. III. The Banking and Intermediation Sector In this section we examine the status of China’s banking and intermediation sector. After reviewing aggregate evidence on bank deposits and loans, we analyze the problem of NPLs in the
banking sector as well as assess solutions to this problem. Finally we review evidence on the growth of non-state banks and financial intermediaries IIl.I Aggregate Evidence on Bank Deposits and loans Similarly to other Asian countries, household savings rates have al ways been high in China Given the growth of the economy, the sharp increase in personal income and limited investment opportunities, it is not surprising that total bank deposits from individuals have been growing very fast since the mid-1980s, with the 2001 figure approaching RMB 7000 billion(or US$800 billion) From Figure 3-A, residents in metropolitan areas contribute the most to total deposits beginning in the late 1980s(roughly 50%), while deposits from enterprises(including firms from all three sectors) provide the second most important source. The role of deposits from government agencies and organizations(including non-profit and for-profit organizations) has steadily decreased over time, while the increasing gap between urban and rural deposits indicates the increasing imbalance of wealth and living standards in these areas. Moreover, ownership of bank deposits is highly concentrated, in that 60% of all bank deposits are held by less than 10% of the population( china Daily, and Washington Post Foreign Service, Nov 2001) Insert Tables 2-A, 2-B, and Figures 3-A and 3-b here. Table 2-A compares total savings and bank deposits across China, Japan, South Korea, and India during the period from 1997-2002. In terms of the ratio of Gross Domestic Savings/GDP(the term"Gross Domestic Savings"comes from national accounts and includes more categories than bank deposits), China maintains the highest level(around 40%), while Japan leads the group in terms of total amount. Looking at the breakdown of bank deposits, interest-bearing"savings deposits"are by far the most important form of deposits in China, providing a good source for bank loans and assets. Figure 3-B compares total bank credit extended to Hybrid Sector firms in China, and privately owned firms(including those publicly listed and traded)in Taiwan and South Korea during their respective high economic growth periods: China in the 1990s and Taiwan and South Korea in the 1970s(each year appearing on the horizontal axis indicates the time period for China while a particular year minus 20 indicates the time period for Taiwan and South Korea). We can see that the growth of China's(bank)'hybrid credit has been faster than the growth of private credit that Taiwan and South Korea experienced in the 1970s: with less than 5% of GNP in 1995, the ratio of total outstanding bank credit to the Hybrid Sector of China reached 25% of gnP at the end of 6 However, depositors in cities include the large population of workers who are rural residents by birth and registration Chukou) but are currently working in cities
15 banking sector as well as assess solutions to this problem. Finally we review evidence on the growth of non-state banks and financial intermediaries. III.1 Aggregate Evidence on Bank Deposits and Loans Similarly to other Asian countries, household savings rates have always been high in China. Given the growth of the economy, the sharp increase in personal income and limited investment opportunities, it is not surprising that total bank deposits from individuals have been growing very fast since the mid-1980s, with the 2001 figure approaching RMB 7000 billion (or US$800 billion). From Figure 3-A, residents in metropolitan areas contribute the most to total deposits beginning in the late 1980s (roughly 50%), while deposits from enterprises (including firms from all three sectors) provide the second most important source. The role of deposits from government agencies and organizations (including non-profit and for-profit organizations) has steadily decreased over time, while the increasing gap between urban and rural deposits indicates the increasing imbalance of wealth and living standards in these areas.6 Moreover, ownership of bank deposits is highly concentrated, in that 60% of all bank deposits are held by less than 10% of the population (China Daily, and Washington Post Foreign Service, Nov. 2001) Insert Tables 2-A, 2-B, and Figures 3-A and 3-B here. Table 2-A compares total savings and bank deposits across China, Japan, South Korea, and India during the period from 1997-2002. In terms of the ratio of Gross Domestic Savings/GDP (the term “Gross Domestic Savings” comes from national accounts and includes more categories than bank deposits), China maintains the highest level (around 40%), while Japan leads the group in terms of total amount. Looking at the breakdown of bank deposits, interest-bearing “savings deposits” are by far the most important form of deposits in China, providing a good source for bank loans and assets. Figure 3-B compares total bank credit extended to Hybrid Sector firms in China, and privately owned firms (including those publicly listed and traded) in Taiwan and South Korea during their respective high economic growth periods: China in the 1990s and Taiwan and South Korea in the 1970s (each year appearing on the horizontal axis indicates the time period for China, while a particular year minus 20 indicates the time period for Taiwan and South Korea). We can see that the growth of China’s (bank) ‘hybrid’ credit has been faster than the growth of private credit that Taiwan and South Korea experienced in the 1970s: with less than 5% of GNP in 1995, the ratio of total outstanding bank credit to the Hybrid Sector of China reached 25% of GNP at the end of 6 However, depositors in cities include the large population of workers who are rural residents by birth and registration (hukou) but are currently working in cities