How does financial opening affect industrial efficiency? The case of foreign bank entry in the People’s Republic of China

Abstract

This paper analyzes the effects of foreign bank entry on industrial efficiency in the People’s Republic of China (PRC) as a case study of financial opening. The study reveals an overall positive impact on the industry. However, the effects vary across ownership groups: negative for state and collective sectors, positive for private enterprises, and insignificant for foreign-invested firms. These findings are incompatible with predictions based on the “cream-skimming effect” and information asymmetry. We investigate two transmission channels of the policy effects—via an easing of financing constraints and through increased competition. Foreign bank entry, like financial liberalization, reverses the effects of repressive financial policy, which protects the state sector but discriminates against private enterprises. While enhancing bank competition can be an effective way to support private sector development, the state sector deserves close attention in order to ensure a smooth transition. This case study should offer some useful lessons for future financial opening.