Systemic risk in the Chinese banking sector


Figure 1(b) compares the systemic risk contribution of the four biggest banks (Bank of China, Agricultural Bank of China, Industrial and Commercial Bank of China, and China Construction Bank) with that of all other banks. From an 80%–20% split in 2011 in favor of the Big 4, the difference has receded to 60%–40% in 2018, which highlights the increased importance of smaller banks. The bank that influences the most other firms is China Merchants Bank, which affects 13 other firms, followed by China CITIC Bank (12), China Everbright Bank (11), and Agricultural Bank of China (11). China Everbright Bank (16), Bank of Nanjing (16), Ping An Bank (15), and Chongqing Bank (14) have the highest number of total connections.  This demonstrates that smaller firms have not only become more important individually, but also are able to exert significant sectoral influence. Although we do not disregard the capacity for intervention of Chinese regulators, our results point toward an increasing vulnerability of China’s banking system due to contagion effects.

An international investor should be concerned about the influence of smaller Chinese banks on financial stability and take their systemic and individual riskiness into account.  Their increased exposure and connectedness may trigger a systemic event with wider repercussions, significantly larger than their individual size. Although state ownership may prevent a bankruptcy similar to that of Lehman Brothers, our findings suggest that the overall cost of distress may be higher than commonly assumed. Our main policy suggestion is that further regulatory changes need to focus not just on the systemically important largest institutions but also on smaller banks.

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