Corruption and Bank Lending: The Case of China

by

Abstract

The role of the financial system in an economy is very important. Financial institutions by acting as intermediaries between agents with a surplus and agents with a deficit make possible that savings are invested. In theory efficient banks will select the best projects and will allocate scarce resources efficiently. However, corruption in bank lending can distort the allocation of credit and even produce a financial crisis. If banks continuously lend money to agents that will not pay the loans back they risk going bankrupt. In a bank goes bankrupt the contagion effect can be so severe that can provoke a generalized bank run and the collapse of the financial system. In an economy in which a large fraction of the banks are state owned the issue of corruption in bank lending may have be more harmful and more difficult to tackle. The objective of this dissertation was to explore the literature on corruption in bank lending and then study in more depth the case of China. The research approach was qualitative and primary in nature in order to understand corruption in bank lending in China. Some interviews with individuals in the banking industry will be conducted. The results found that corruption exist in China and anti-corruption measures should be taken to counter this problem.

Table of Contents

ABSTRACTII

1. INTRODUCTION1

Background of the Study1

Problem Statement2

Research Aim and Objectives3

Significance of the Study3

Research Questions3

Research Methodology4

Research Design and Process4

Sampling Method5

Participants5

Research Instrument6

Ethical Concerns6

2. LITERATURE REVIEW8

A. The Importance of the Financial System in the Economy8

B. Impact of Corruption in Bank Lending in the Economy8

Corruption8

Corruption and Bank Lending11

Corruption and Economics14

Impact of Corruption on Economy20

C. Causes and Consequences of Corruption in Bank Lending21

3. CASE STUDY: CHINA24

A. The Chinese Financial Sector24

B. Regulation in China - Factors Responsible for Corruption in China25

Issues and Problems in China's Banking Reform25

Law and NPLs in China: Soft Legal Constraint26

Soft Legal Constraint in Banking and Financial Market27

Domestic Law as a Legal Barrier to Efficient Banking30

The Conflicting Supervisory Roles31

Participation of Local Government as a Barrier to Efficient Banking32

Law of Bankruptcy as a Barrier to Efficient Banking35

Law of Banking as a Barrier to Efficient Banking36

The Anticorruption Organisations in China37

C. Notorious Cases of Corruption in Bank Lending In China38

Case 1 - Corporate Financing Activities in China: Case of Chinese Banks38

Case 2 - Postal Savings Bank of China (PSBC)40

Case 3 - Bank of China (BoC)43

Case 4 - China's Economic Development Rely on a Large Number of Bank Loans45

Case 5 - Local Government Borrowing Resulting in Bad Loans45

Case 6 - NPLs limit Chinese Banking Industry and Economic Development47

Impact of Corruption on Bank Lending on China's Economy48

Fundamental Change in the Current Chinese Banking System to reduce NPLs49

4. CONTROLLING CORRUPTION IN BANK LENDING52

REFERENCES56

1. Introduction

Background of the Study

China has a state-dominated banking sector with the four largest state-owned banks accounting for about 47 percent of total banking assets at the end of 2010.This sector has witnessed gradual reform during the past three decades but still displays low efficiency. The state-owned banks are inefficient in extending credit to the private sector ...