Foreign Ownership And Bank Performance: Evidence From China's Banking Sector

During the past three decades, China's economy not only expands fast, but also transforms into a relatively free market. Nowadays, more and more foreign capital pursues profit there. Banking sector is no exception.With the globalization of financial markets and financial services, the reform and opening-up of the financial system to foreign participation has become a key decision for most of the transition nations. In China, there used to be numbers of regulations and restrictions on the operations of foreign banks and foreign participations in banking sector, but after joining the World Trade Organization (WTO) in December 2001, the Chinese government has made commitment to speed up the process of financial liberalization by opening up its banking sector, and foreign investors were also allowed to acquire minority ownership stakes in China's domestic banks. Since then, huge foreign capital flowed in and brought about substantial changes to the ownership structure of China's domestic banks. In particular, there arise some important questions. How do these ownership changes affect bank performance? Do Chinese banks benefit from such changes? To address these questions, this paper intends to examine the performance effects of foreign ownership using a panel dataset of Chinese domestic banks over the time period of 2002-2008.Based on the methodology proposed by Berger et al. (2005), this paper uses econometric models to examine the effects of foreign ownership on the performance of China's domestic commercial banks. In particular, variables that capture dynamic, selection and static effects will be examined. Referring to Berger et al. (2005), Dynamic effects indicates the performance changes caused by changes in corporate ownership (i.e., foreign, domestic, and state ownership) over the sample period; Selection effects refer to the performance differences among banks that have observed some changes in corporate ownership structure; Static effects represents performance differences among banks that have not experienced any corporate ownership change in the long term. The empirical analysis implies that compared with joint-equity banks and city-level banks, the "Big Four"stated-owned banks tend to have worse performance. Also, it indicates that foreign investors tend to select banks with better performance prior to acquisition. Although the dynamic effects suggest that the expected performance effects of foreign ownership are not significant, the marginal effects of foreign ownership can still be observed.With respect to the empirical results of both models, this paper argues that in China's banking sector, foreign ownership is associated with better performance. However, it is possible that the institutional environment in China to some extent hinders the positive effects of foreign ownership. For one thing, the foreign investment in China's banking sector is still under regulation; as a result, foreign investors in most domestic banks may be able to play a constructive role in the corporate governance. What's more, since foreign investors have been restricted to only minority ownership stakes, the incentive of transferring technology may not be sufficient enough. Furthermore, it may take a long time before the payoff of foreign acquisitions to be realized. As a consequence, the positive performance effect of foreign ownership is not very significant in China; further opening and liberalization of banking industry should be highlighted in future reform.