Tests of Financial Intermediation and Banking Reform in China

In this article the authors develop tests of financial intermediation by examining national banking systems that exploit regional financial and economic data. Derived from a model of bank profit maximization, the tests are based on the expectation that in efficient systems, financial intermediation should:

• Not be overly influenced by policy variables;
• Be greater where projects are more profitable and require greater financing; typically in faster growing, richer, industrial areas;
• Direct funds to the best projects regardless of where deposits originate.

The authors apply these tests to Chinese provincial data from 1991-97 for all state banks, the Agricultural Bank of China, rural credit cooperatives, and other financial institutions. In the mid-1990s, China implemented a series of widely publicized financial reforms designed to improve bank performance. However, the authors state that descriptive and estimation results suggest that the importance of state bank policy lending (to support SOEs and finance agricultural procurement) has increased, not fallen, during the recent period, and lending does not respond to economic fundamentals. The paper concludes that only the group of smaller, less-regulated financial institutions appear commercially oriented. Despite reforms, significant barriers to efficient inter-regional financial intermediation remain.