Financial stability of banking system in China

This thesis aims at investigating the financial stability of China's banking system. Since the banking system is one of the most important financial intermediaries in the financial systems, the financial soundness of banks could secure the stability of the whole financial system. Two of the factors that may significantly increase imbalance of the banking system, and hence affect financial stability of an economy is the accumulated non-performing loans of banks and the macro-economic turbulences. This fact raises the questions of how macroeconomic condition, as a determinant of systemic distress, can be assessed more comprehensively and consistently, and what the implications are for modelling it within an integrated credit risk framework. The aim of this thesis is addressing these issues. We develop a framework for macro stress-testing of China's banking system. Our estimates of the correlations between banks' stability indicators and macroeconomic factors establish significant relationships between the non-performing loan ratio and key macro-economic variables, such as GDP growth, the retail price index, the unemployment rate, total fixed investment, the money supply, interest rates and exchange rates. Further, results from the macro stress tests show that robustness, or otherwise, of the banking system is highly dependent on the source of the potential risk. Our value-at-risk tests suggest that (at a 99% confidence level) the Chinese banking system is robust with respect to interest rate shocks. However, GDP growth and exchange rate shocks exhibit a profound negative effect, indicating that significant losses become likely. We also examine the determinants of non-performing loan ratio for regional China‘s banking system, using data from 2002 to 2011 for 31 regions in China. Our estimations suggest that the non-performing loan ratio worsens with decreasing economic growth, shrinking export and property market depression. Further, with the help of a probit model, we identify the leading indicators of banking distress and estimate the banking distress probability for regional China. Moreover, this study provides an overview of banking system stability in the geographical distribution of these indicators. The findings show there are significant relationships between the regional banking distress indicator and key macroeconomic variables, such as GDP growth, the consumer price index, the unemployment rate, and house price. Based on the findings, we designed an early-warning system to monitor banking stability of regional China. These results should prove informative for policymakers and regulators alike, regarding awareness of loss-limitation in China‘s banking system, the banking distress signals and macro-prudential perspectives to monitor the potential risk exposure of the banking system in China's regions