The Journey of a Thousand Miles : A Decade of Impact of Foreign Shareholders on the Performance of the Chinese Commercial Banks

We analyze the impact of foreign shareholdings on the performance of 28 Chinese commercial banks over a period of 2010-2019, capturing the period prior to and following the reforms of 2014. Using panel data GMM with instrumental variables, we consider bank performance from three perspectives: profitability, quality of assets and liquidity. The individual performance indicators are return on equity (ROE), non-performing loan (NPL) ratio, loan-to-deposit ratio, and loan loss coverage ratio. We find that foreign shareholdings have a significant negative impact on ROE. Increase in foreign investment is coincident with growth in the size of Chinese commercial banks in terms of assets that is faster than the increases in the banks’ return on capital. These findings are intuitively justified: if foreign investors increase banks’ appetite for growth, growth in assets under management will tend to outpace growth in returns on assets in the earlier stages of new investments. From the quality perspective, we show that banks’ NPL ratio is negatively correlated with foreign shareholdings and the correlation is significant both statistically and empirically. NPL ratios fall in the banks with more foreign participation. This result stands contrasted by the fact that some foreign investors (activist and hedge funds), seek to invest in Chinese listed banks with higher NPLs. In terms of liquidity performance, foreign share ownership has a significant negative influence on banks’ loan-to-deposit ratio. Loan loss coverage ratio significantly increases, along with the increasing foreign participation in Chinese commercial banks shareholdings. Combined, these effects suggest significant positive twin effect of foreign shareholdings on Chinese commercial banks risk profiles. As the result, Chinese banks with higher foreign shareholdings are better prepared to sustain losses from bad loans and state risks and have lower risk exposures to bad loans. The combined effects of our findings strongly suggest that Chinese banks’ ROE can be expected to pick up in the near future with further financial opening in the sector and the greater involvement of foreign investors that comes along with it