Foreign Penetration and Its Impact on the Chinese Banking Sector

Abstract

This study proposes a Foreign Banks’ Branch Networks Index (FBBNI) to capture bank-level exposure to competition from foreign banks in terms of geographical proximity. The index takes account the rapidly expanded branch networks of both foreign and domestic banks in China and therefore serves as a better proxy to study the impact of foreign bank penetration on the performance of domestic banks. Based on a sample of three types of Chinese commercial banks from 2002 to 2011, we find that the expanded branch networks of foreign banks help to stimulate the improved profitability of domestic banks, as a result of higher achieved efficiency, and the increased non-interest income of domestic banks, as a result of knowledge transformation from foreign banks. These positive relationships are more pronounced among joint-stock banks (JCBs). Finally, foreign bank penetration has been found to play a significant role in stimulating the risk- management improvement of domestic banks, especially these with foreign strategic investors.