Caixin
Jun 03, 2014 06:22 PM

Do China's Big Banks Enjoy a Monopoly?

A monopoly on either the buyer's or seller's side often means one or several enterprises relying on their strengths keep squeezing out or forcing the merger of small and medium-sized enterprises to gain unfair pricing power.

It is often caused by a monopoly over resources or entry barriers that result from government intervention. In light of this, is it reasonable to say that China's banking industry is monopolized?

It ought to be made clear from the very start that the banking industry in any country must operate on the basis of permissions. To open and run a bank requires special qualifications and regulatory approval. The procedures for getting the approval in the United States are not any simpler than in China. So the fact that opening a bank requires the regulator's rigorous examination and approval is not evidence that the state has monopolized the banking sector.

Let's take a look at the capital structure of China's banking industry. Non-state equity investments in the Big Four state-owned banks plus the Bank of Communications – the Big Five – exceed 20 percent of the total. Private capital in the 12 joint-stock commercial banks accounts for about 41 percent of the total.

The ratio for the 145 city commercial banks is about 54 percent, and it is more than 90 percent for rural financial institutions, namely 337 rural commercial banks, 147 rural cooperative banks and 1,927 rural credit cooperatives. So the claim that the country's banking industry is monopolized by the state does not conform to reality.

So why did the third full meeting of the Communist Party's 18th Central Committee make a point of stating that private capital can be allowed to be an initiating founder of a bank? Because the law on this issue is unclear. With a few exceptions, including China Minsheng Bank, private capital enters the industry primarily through banks' share-ownership reform and buying their shares. Not much private capital was involved in the establishment of one.

To clear up the ambiguity, the meeting addressed the issue from the top level of policymaking and demonstrated government's determination to deepen market reform. The banking industry is not monopolized by state capital, but it can and should have a more open market entry system and provide more equal investment opportunities for all parties.

Critics have also cited the huge size of the Big Five banks as proof they are monopolizing the industry. Let's look closer at this claim.

The international practice for measuring how big the top banks have become usually examines the degree to which the industry is concentrated. A major indicator for this is the asset concentration ratio five (CR5), which represents the assets of a country's biggest five banks as a percentage of the national total.

A comparison of the CR5 across 10 developed countries and the BRICS over the past few years shows that – despite some variations resulting from different calculation rules – 13 of the countries saw their top five banks' assets make up more than 50 percent of their country's total. The exception was India.

The ratios of the 10 developed countries are particularly high, with Australia and the Netherlands taking the lead at more than 90 percent, followed by Germany and Canada, whose ratios exceeded 80 percent. Spain, France, Britain and Italy all exceeded 70 percent, and the United States and Japan were between 50 and 60 percent.

What is noteworthy is that almost all of these countries' concentration ratios picked up rapidly from the 1980s as financial liberalization gathered pace. Some people think that as long as the banking industry is opened up, small and medium-sized banks will spring up and weaken the competitive strength of big banks, whose market share will decline. It seems that these people have oversimplified the matter.

Moreover, it seems that the banking industry's concentration ratio was positively correlated with the stability of the financial markets in these countries. The banking systems of Australia, Canada and the Netherlands, for example, appeared more stable during the global financial crisis.

In the United States, the CR5 was lower than 15 percent before the crisis in the late 1980s involving deposit-taking credit institutions. Since then, the United States' CR5 has risen fast, especially during and after the 2008 financial crisis. The ratio was 44 percent in 2007, 48 percent in 2010, 61 percent in 2012 and 63.2 percent last year.

We have exchanged ideas with famous bankers and regulatory officials in the United States, and they all think that this will continue. There will be fewer and fewer banks in America and the concentration ratio will continue to rise.

What are the implications of a banking industry growing more and more concentrated after a crisis? How is it related with the oft-mentioned warning about preventing banks from becoming too big to fall? These are some of the questions we need to research.

In Brazil, South Africa and Russia, the banking industry's concentration ratio has also climbed. Brazil's CR5 has increased to 70 percent from 50 percent in 1990. South Africa has reached more than 90 percent from 1990's 77 percent, and Russia has exceeded 50 percent from the 39 percent seen in 1995. India, the exception, saw the ratio fall from 44 percent in 1990 to 40 percent, but the ratio of assets to the total for its biggest bank, the State Bank of India, beat that of the other countries.

China has moved in the opposite direction when compared with the developed and BRICS countries in terms of the concentration ratio of its banking industry. Its CR5 has fallen fast in recent years. From 1998 to the third quarter of 2013, the assets of the top five banks as a share of the total fell from 63 to 44 percent, and the momentum behind the decline is picking up.

Leaving aside whether moving against the global trend is right or wrong and whether its positive effect on the Chinese economy outweighs the negative, this alone leads to one conclusion: there is not much reason in the argument that China's banking industry is monopolized by big banks. Nor does the claim that a high ratio of big banks' assets harms the vitality of the financial market hold water.

As for whether state-owned shares make up too much of banks' capital, this is another issue. The Big Five banks are overseas-listed public companies. There is room and a channel for their equity structures to be improved. But the experience of foreign countries shows that there is not a strong connection between equity structure and industrial concentration. In fact, it is clear that those countries' banking industries are more concentrated than China's.

So answering whether the Big Five are too large or whether they have monopolized the market cannot be accomplished by discussing their equity structure can be improved. As financial reform in China deepens, not only the government and regulators but also private investors interested in setting up a bank must think about these issues.

Yang Kaisheng is former president of Industrial and Commercial Bank of China. This is a translated excerpt of a commentary published in China Reform and on Caixin's Chinese website

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