Non-Performing Loans, Moral Hazard and Regulation of the Chinese Commercial Banking System

Abstract

This paper studies the role of non-performing loans in the regulatory measures of the Chinese commercial banking system. A threshold panel regression model has been applied to the data of 87 commercial banks in China from 2006 to 2012. The empirical results suggest that a higher non-performing loan ratio (over 4.8%) can trigger a moral hazard problem, which will then cause further deterioration of the loan quality and potential instability. The standard regulatory measure, namely, capital adequacy ratio (CAR), only partially covers this problem. It is therefore important for the regulators to monitor the level of non-performing loan ratios as an additional regulatory measure.

Keywords: Moral hazard, Non-performing loans, Capital adequacy ratio, Bank regulation, Threshold panel regression

JEL Classification: G21, G30