Empirical Analysis On The Relation Between Exchange Rate Of RMB And Banking Stock Price In China

On July 21st,2005, monetary authority of China described reform of exchange rate regime for RMB. Rather than merely a changed level of the exchange rate, the reform was said to involve a shift away from the fixed exchange rate, a gradual movement towards greater flexibility, and a peg to a basket of currencies. This reform gave a sign that Renminbi exchange rate would no longer only peg to dollar, but become a more flexible system. As to commercial banks in China, they take more and more part in international operation. Bank of China is well-known as the most foreign exchange business. Between 2004 and 2005, it cooperated with many foreign financial institutions, and accepted their investing capital which was denominated in foreign currency. It is a example that can illustrate performances of commercial banks in China are more and more affected by Renminbi exchange rate. From the experience around the world, there often exists obvious relation between exchange rate for the currency of a nation and the stock price in it. Now there are 14 listed commercial banks in China. And dose the relation between Renminbi exchange rate and their stock price? This paper will answer it by empirical study, based on the data from 14 listed banks and Renminbi exchange rate.Then, this paper analyzes exchange rate risk of commercial banks with general theory. It firstly gives the definition of exchange rate risk and its classification that is common used, including dealing risks, accounting risks and economic risks. A number of large commercial banks have been actively engaging in foreign exchange operations in order to offer a more competitive service to a growing customer base in foreign markets and to take advantage of the profit opportunities perceived in fluctuating foreign exchange rates. Yet, with the expansion of international financial relationships and the continued liberalization of cross-border cash flows, the banks have become more and more exposed to the risks associated with foreign exchange operations as well as funding costs both at home and abroad. Financial exposure of banks that engage in both domestic banking activity and foreign exchange operations can be separated into two primary categories:interest rate exposure and foreign exchange exposure. Such exposure can have a significant impact on a bank's financial performance. Besides, the business of commercial banks in financing for clients overseas is likely to be influenced by exchange rate. Especially, once the rate changes to a large extent, the exposure will be huge.Furthermore, this essay analyzes concretely the exchange rate risk in commercial banks of China. First, it shows how Renminbi exchange rate changed from July 2005 to the end of 2008. In a word, all the major curr(?) ncies against RMB declined during that time, with different extents. And exchange rate risk in the face of commercial banks of China can be separated into three primary categories: transaction risk, accounting risks and economic risks. Transaction risk is basically cash flow risk and deals with the effect of exchange rate moves on transactional account exposure related to receivables, payables or repatriation of dividends. An exchange rate change in the currency of denomination of any such contract will result in a direct transaction exchange rate risk to the commercial banks. Accounting risk is basically balance sheet exchange rate risk and relates exchange rate moves to the valuation of a foreign subsidiary and, in turn, to the consolidation of a foreign subsidiary to the balance sheet of parent banks. The risk for a foreign subsidiary is usually measured by the exposure of net assets to potential exchange rate moves. In consolidating financial statements, the translation could be done either at the end-of-the-period exchange rate or at the average exchange rate of the period, depending on the accounting regulations affecting the parent bank. Thus, while income statements are usually translated at the average exchange rate over the period, balance sheet exposures of foreign subsidiaries are often translated at the prevailing current exchange rate at the time of consolidation. Economic risk reflects basically the risk to the present value of future operating cash flows of a commercial bank from exchange rate movements. In essence, economic risk concerns the effect of exchange rate changes on revenues and operating expenses. The risk is usually applied to the present value of future cash flow operations of the parent bank and foreign subsidiaries. And these factors can affect the cash flow of commercial banks, which result in economic risk.The core section of this paper is the empirical research on the relation between Renminbi exchange rate and the stock price of commercial banks of China. And this paper uses error correction model (ECM) with four variables, which are separately stock price index of commercial banks as explained variable, and Renminbi exchange rate, interest rate and market index as the explanatory variable. All the data that is used is daily data, which is further examined through unit root test and co-integration tests. And the period is from 21 July,2005 to 31 December, 2008. And the study concludes as follows. In a long period, the connection between Renminbi exchange rate and stock price of commercial banks is negative, that is appreciation of RMB exchange rate leads to increase of the stock price, which can be explained by both global capital flow and anticipation of commercial banks. In a short term, the influence is opposite to the former way. That is, appreciation of RMB exchange rate results in the decrease of the stock price, which can be interpreted by both increasing foreign exchange rate risk and the reaction of investors to the exchange rate moves.The major contribution of this paper is that. Firstly, this paper used a new way to construct the stock price index, which is the weighted average of stock prices of 14 listed commercial banks with weight of the sum of foreign exchange assets and liabilities in these banks. Secondly, this paper adds market index in the model, so as to construct error correction model with four variables, based on the ECM with three variables.The shortage of this paper is the selection of exchange rate variable in the section of empirical analysis. This variable should have been denoted with efficient exchange rate. However, the daily data of efficient exchange rate is unavailable, so we use the exchange rate of dollar against RMB to replace it. And this point is to be worthy of being improved.