Can China Meet the Banking Openness Challenge without Significant Harm?

Abstract

The particular features of the Chinese banking system have so far allowed the country to avoid a systemic banking crisis despite strong microeconomic imbalances and distortions. The fundamental determinants of banking crises as well as empirical research focusing on developing countries have allowed the identification of macro and microeconomic determinants of such crises. By focusing on the time-profile of such determinants and using the best binomial model for signaling such crises, this paper refines the analysis and allows using the model for China over the next decade. The set of significant macroeconomic and financial determinants of banking crises in developing economies includes high non-performing loans, excessive growth in investment and consumption, falling return on average assets in banks, low inflation and rising current account deficits, with a combination of these variables providing a good early warning signal of banking crises. Making a large range of plausible assumptions for China's economic framework to 2015, we show that accelerating reforms in the Chinese banking required by WTO requirements will not allow the country to avoid a large banking shock. This crisis will appear in the very short-term if China fully meet the planned total openness, but will also prove less costly than if authorities defer the adjustment and circumvent their international commitments.

Keywords: banking crises, early warning systems, developing countries, China

JEL Classification: C25, F30, G21