Inside the Black Box: Bank Credit Allocation in China’s Private Sector

Abstract

Allen, Qian and Qian (2005, Journal of Financial Economics) explores the role of alternative financing channels (e.g., trade credits and private credit agencies) and governance mechanisms, such as those based on reputation and relationship, in explaining the growth of the private sector in China. We complement their study by examining how the Chinese state-owned banks allocate loans to private firms. We find that the banks extend loans to financially healthier and better-governed firms, which implies that the banks use commercial judgments in this segment of the market and are behaving more like their western counterparts. On top of this, however, we find that having a state minority ownership helps firms obtain bank loans, which suggest that political connections still play a role in gaining access to bank finance. In addition, we find that commercial judgments are important determinants of the lending decisions for manufacturing firms, large firms, and firms located in regions with a more developed banking sector; political connections are important for firms in service industries, large firms, and firms located in areas with a less developed banking sector.