China’s consumer goods. The agricultural boom consequently expanded

  China’s Economic system before 1979 primarily focused on an inefficient “township” method of agriculture.

The agricultural sector controlled the majority of Chinese people’s livelihood and was not a conducive mechanism to enable desirable GDP growth. Therefore, party leaders acknowledged the failure of the Maoist version of the central planned economy and set it sights on new economic reform. After 1979, Deng Xiaopeng’s open door policy fundamentally transformed the Chinese economy. Deng Xiaopeng’s economic reform began with an “adjustment process” from 1979-1981; primarily focused on increasing incomes, availability of food, housing, and other consumer goods. The agricultural boom consequently expanded the role of free markets for farm produce and increased the market possibilities by opening to foreign trade.

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The role of foreign trade and investments started a new-era in the Chinese economy.    The transition from a closed-market economy to a socialized “open” market economy has facilitated the necessary changes to the Chinese financial market. The open-door policy reform has enabled more competition and has gradually developed foreign trade. Consequently, the finance industry has gradually made steady developments. The new Chinese financial system was formed under regulations and supervision of the central bank, who in turn focused on establishing state-owned banks. This resulted in four specialized state-owned banks respectively named:  The People’s Bank of China, Agriculture Bank of China, China Construction Bank, and Industrial and Commercial Bank of China, commonly known as the “Big Four”. Their primary objective is to serve as policy lending conduits for the three specialized policy banks created in 1994;  “Agricultural Development Bank of China, China Development Bank and the Export –Import Bank of China.” The policy banks primary job is to finance economic trade including investments projects from the state.

   Overall China’s financial system is characterized as bank-based, controlling about 90% of the total financial assets. Followed up by highly concentrated banks which are predominantly state-owned banks. Even though the state-owned banks are profit oriented, they have maintained good financial stability despite a high-level of non-performing loans. The author respectively compares China and Germany because of the similarities in banking structures. Both countries, China and Germany, are not strictly profit-oriented but have managed to continually sustain a stable financial market with very poor bank performance.This paper aims to highlight the relationship between banking structure and financial stability as portrayed by the author.

Cai Conglu asserts two things in his paper: The trade-off between competition and concentration in banking industry are vital factors to maintain financial stability, and concentration doesn’t always have a negative correlation to financial stability, especially in banking systems with discontent bank performance.Ownership status       The Chinese and German banking structures both have commonalities and differences that characterizes each country’s financial market. By amalgamating differences in countries ownership status and concentration, we can attempt to distinguish the causal link between banking structures and financial stability.  Since China’s entry into the World Trade Organization in 2001, significant economic reform in the banking industry has caused shocks in the financial market. Ownership status determines the corporate governance mechanisms and behavior choices, which effects bank performance and its correlation to financial stability. Thus, begins to accentuate the idiosyncrasies between China and Germany’s banking structures. Conglu asserts that the pillars of the Chinese and German banking systems have similarities in terms of banking structure and ownership status.

Therefore, he breaks down the Chinese banking system into 3 categories: State-owned commercial banks, other commercial banks and credit cooperatives. In  Germanys case, the banking system contains 4 categories and are named as follows: Commercial banks, savings bank group, co-operative banking group and special banks. Then we can categorize types of ownership status with significant differences as follows: State-owned, private, domestic, or foreign. The ownership structure predominantly consists of state-owned banks which are largely in government control. Three of the “Big Four” state-owned banks have organized Initial Public Offerings to quantify the degrees of ownership by the public, but the Chinese government maintains majority control. The banking reform enables foreign banks as well as investors to open up branches, but can only make minority investments in state-owned commercial banks.   Furthermore, understanding the levels of profitability in “Big Four” banks, Non-Big Four state-owned banks, private domestic banks, and foreign banks shows variations in efficiency.

The author initially asserts that increased state-ownership tends to have a positive correlation with profitability and cost efficiency. Then contradictory data has suggested that reduced government ownership in state-owned banks has led to a decrease in profits. The data analysis on this subject had been outdated and changed respectively. The exponential increase in foreign investments has had a robust effect in the Chinese banking market. These reforms diminished state ownership of banks which in turn has increased the role of foreign ownership. The causal link between reduced state-ownership and increased foreign ownership correlates positively with efficiency.   Chinese ownership structure reform has provided significant economic reform to the banking industry. The market structure between China and Germany draws out distinctions where the Chinese market is severely uneven versus a balanced German market.

The microstructure of ownership status is where China and Germany differentiate. Private banks in Germany consist of big banks, regional banks, as well as specialized banks. In contrast, the author mentions the Minsheng Commercial banks as the sole privatized bank in China. Due to the article being published over 12 years ago, I have made necessary adjustments to supplement with present-day knowledge.  The Peoples Republic of China’s delayed actions has caused spikes in informal banks and financial institutions. This led to the creation of “illegal banks” who offer better market rates for the foreign exchange conversions than the state-owned banks and were charged with funding offshore gambling visits for investors (

pdf). Furthermore, the implication regarding legal framework can scare domestic and foreign investors. In particular, the law and regulatory framework for private financial institutes were lacking, serious financial frauds and risks arose from the operation of these institutions.(http://www. The inception of the Chinese Banking Regulatory Commission strengthened banks supervision and increased consumer confidence. Thus, leading to the steady increase in privatized banks after 2004.

Germany’s private banks have maintained 30% of the total banking industry, while China lags behind in privatization. Although, recent transformations have progressed in the Chinese banking industry, foreign investors only own up to 3 percent of the total financial market (up to 25% ownership of private banks). Therefore, the bank market powers of state-owned (public) and private ownership are even on the whole. Both countries differences in foreign ownership accentuates the idea that varying degrees of banking structures must pertain to specific economic ecosystems (Conglu,2006). ConcentrationThe trade-off between market competition and concentration have direct implications for policy makers. By determining the proper balance of both competition and concentration can either achieve or maintain financial stability.  The countries that are generally associated with the highest concentration in the banking industry are the United States, the United Kingdom, Switzerland and Japan.

The principal benefits from concentration is required to gain a better understanding of it policy implications. The highly concentrated markets typically consist of higher prices, lower outputs and a smaller consumer surplus even in the absence of collusion. These attributes are primarily reflective of a market economy and doesn’t reflect the banking industry in any case. (

pdf). A study done by the National Bureau of Economic Research found that high concentration leads to high stability in the banking industry(   Furthermore, the benefits from market concentration varies in its pros and cons.

The pros of market concentration can be depicted by three things. First, conventional assertions for “highly concentrated” banks usually pertain to higher profits, and the possible increase of interest rates. This subsequently leads to increases in the interest rate and provides insulation from shocks in the economic market. Second, large banks have diverse portfolios that would mitigate shocks in one sector with investments in another. Small banks are more prone to the fluctuations of the market without necessary risk management. Third, big banks tend to be easier to audit versus their counterpart.

Also, its plays a role in alleviating the regulatory commissions time in regulating big banks. Although market concentration has many benefits, it can be seen that there often is an equal trade-off. The trade-off for highly concentrated banking industries cause a decrease in competition but a hike in prices. Large banks aren’t incentivized to address all consumers and market concentration is the causal link. The large banks will focus on the most profitable niches and may neglect those that are less profitable(

pdf). Although the negative implications say otherwise, the National Bureau of Economic Research has attributed stability with concentration. The trade-off between higher interest rates and investment risk may or may not be worth the stability it brings. This question is still left completely answered and needs several more researches done.

         In this case, concentrated markets are often leaning towards a stable macroeconomic policy then improving their efficiency. A by-product of this policy has lead to a significant percentage increase in non-performing loans. This phenomenon was induced due to state banks continually writing loans to state-owned banks.

The state-owned banks in turn have poor financial stability which led to an increase of non-performing loans from 30-40% ( further mitigate issues similar to non-performing loans, the Chinese government implemented tighter regulations on the loan-evaluation process. This regulatory process consists of a 5-layer classification system: pass, special mention, substandard, doubtful, and loss (

pdf). Through the implementation of this process, asset management companies bought large shares of non-performing loans and were protected by the Chinese government. Management incentives differentiate in the varying ownership sectors but has connections to the increase of non-performing loans.

For instance, in the case of state-owned banks in China, many banks are aware their non-performing loans will be paid by the People’s Republic of China. Until the recent change in the regulatory process on non-performing loans, the process was exceedingly inefficient and attributed to de-stabilizing the banking industry.     Market competitiveness is measured by these three indices: Concentration ratios (CRn), Herfindahl index (H), and the Lerner Index (L)6 (Conglu,2006). Concentration market quantifies the competitiveness by deriving the market share of the largest firms. They are usually divided into a four-firm or eight-firm ratios which indicates where on the oligopolistic spectrum the competition falls under.

Then the Herfindahl index is used to provide similar results and have asserted that the closer the banking industry is to a monopoly, the higher the concentration. Thus, coincides with the fact that both China and Germany are highly concentrated because of the state-owned banks dominance. The inclusion of the Lerner index finds the inverse correlation by comparing output pricing and marginal cost. The amalgamation of these three market indices provides an accurate and holistic view of  how market share impacts concentration and competition.



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