Using Commodity Collateral for Survival: China's Banking during the 1930s

In this dissertation I investigate the impacts of the use of commodity collateral on the performance of China's banking industry during the 1930s. The traditional method of lending in China was relationship lending without collateral. A new lending method based on commodity collateral was introduced into China in late 1910s. This new method of lending emphasized securing loans with commodity collateral and lending loans only to those who could pledge the required collateral. China's banks established warehouses to store and manage the commodity collateral pledged by borrowers. This new lending method was very similar to today's asset backed lending, a form of transaction banking. However this new practice was very unpopular in the beginning because of the popular belief that pledging collateral was equivalent to loss of credibility and a social shame (losing face). This new practice saw a drastic change of its popularity during the Great Depression. It was believed to have protected banks from widespread defaults of borrowers and bank runs during a period of severe deflation and economic recession in the 1930s. As a result this new lending method was adopted by more and more banks and became a trend in the banking industry. In this dissertation I attempt to statistically evaluate the role played by the use of commodity collateral on the stability and performance of the banking industry.;In Chapter 1 I investigate the impact of using commodity collateral on the performance of China's modern banks during the severe deflation period and the following reflationary period, namely 1934--1936. Modern banks were relatively new banking institutions owned and operated by Chinese citizens. Their forms of organization and methods of banking drew inspirations from the banks in advanced economies and were different from the traditional Chinese native banks. I use whether owning warehouses as a proxy of emphasizing the use of commodity collateral in making loan contracts. Using balance sheets, income sheets, general characteristics, and dates of failure, if happened, of modern banks during 1934--1936, I find that the use of commodity collateral did reduce the probability of failure for modern banks. But it was also associated with sharper declines in deposits and loans during the period of severe deflation and a slower recovery during the ensuing reflationary period.;In Chapter 2 I investigate the impact of using commodity collateral on the performance of the traditional native banks in Shanghai during the 1930s. Native banks in Shanghai had dominated China's internal and international trade credit market from the mid-19th century. But they saw massive closure and sharp declines in profits during the 1930s. Their decline was partly attributed to their emphasis on unsecured relationship lending by students of China's financial history. However some native banks in Shanghai did own warehouses and secured loans with commodity collateral. I use the ownership of warehouses as a proxy of emphasizing the use of commodity collateral, same as in Chapter 1. I find that the emphasis in the use of commodity collateral is associated with lower probability of closure, higher profits during the deflationary period, and less increment in capitalization.;In Chapter 3 I use the internal balance sheet data of a China's major modern bank during the 1930s to further investigate whether the conclusions in Chapter 1 are robust in an inter-bank branch level comparison. The internal balance sheet data is collected from archives of the Shanghai Commercial and Savings Bank. I use the percentage of loans secured by commodity collateral in each branch before the start of the severe deflation as a measure of emphasizing the use of commodity collateral by each branch. Results show that high percentage of loans secured by commodity collateral was associated with sharper declines in secured loans and all loans and lower profits. I also find that the pre-deflation percentage of secured loans had different impacts on profitability and loan growth during the deflation period. It implies that the type of collateral matters in performance of banks during a period of financial distress.