Real estate investments and financial stability : evidence from regional commercial banks in China

The 2008 United States subprime mortgage crisis demonstrated how developments inreal estate markets can cause instability in the banking sector and raised concerns inmany emerging economies with significant real estate development and a rapidlygrowing commercial banking sector, particularly in China. There is clear evidencethat commercial banks in China, especially regional commercial banks, have lentsignificantly to the real estate sector. The recent slowdown in the housing market inChina and the increase in nonperforming loans (NPLs) in China's commercial bankingsector motivated us to investigate the connection between real estate markets andbanking stability. This paper proposes three testable hypotheses linking the growth ofinvestment in real estate and the stability of regional commercial banks in China,measured by NPLs. Our empirical results reveal a close connection between thegrowth of investment in real estate and the NPLs among regional commercial banks,and its sensitivity to real estate market cycles. When real estate market activitydeclines, our results suggest, regional commercial banks can find themselves introuble if they have significant exposure to one type of (real estate) asset. In addition,we find that regional bank competition plays a critical role in defining the relationshipbetween bank stability and real estate investment activity