State Aid and Competition in Banking: The Case of China in the Late Nineties

LICOS Centre for Institutions and Economic Performance Discussion Paper No. 250/2009

22 Pages Posted: 15 Jan 2010

See all articles by Xiaoqiang Cheng

Xiaoqiang Cheng

Hong Kong Monetary Authority

Patrick J. G. Van Cayseele

KU Leuven - Department of Economics

Date Written: November 1, 2009

Abstract

Many contributions to the literature on competition in banking use the Panzar and Rosse test (1987). This test encompasses a variety of market outcomes assuming firms maximize profits. However, when applied to the banking industry, this assumption may not be always valid as banks sometimes may carry social objectives or aim to be systemic players so as to be “too big to fail.” This then motivates different objective functions, departing from profit maximization. We present a reduced form model where banks can pursue other goals than profit maximization. This allows us to test for behavioral changes of banks over time. Our model provides a framework to evaluate whether moral hazard issues may plague banks receiving state aid, which concerns greatly the recent debate on government intervention in financial markets during the global financial crisis in 2008. To test the impact of state aid, we examine a natural experiment in the banking sector in China in the 1990s. We cannot reject that the possibility of receiving state aid triggers moral hazard prone conduct.

Suggested Citation

Cheng, Xiaoqiang and Van Cayseele, Patrick G. J., State Aid and Competition in Banking: The Case of China in the Late Nineties (November 1, 2009). LICOS Centre for Institutions and Economic Performance Discussion Paper No. 250/2009. Available at SSRN: https://ssrn.com/abstract=1536484 or http://dx.doi.org/10.2139/ssrn.1536484

Xiaoqiang Cheng (Contact Author)

Hong Kong Monetary Authority ( email )

3 Garden Road, 30th Floor
Hong Kong
Hong Kong

Patrick G. J. Van Cayseele

KU Leuven - Department of Economics ( email )

Leuven, B-3000
Belgium
+32-16-326830 (Phone)
+32-16-326796 (Fax)

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