The Study of Intrinsic Mechanism that State-Owned

Cheng-Liwei

School of Management

Harbin Institute of Technology University

Harbin, China

Meng Xue

School of Management

Harbin Institute of Technology University

Harbin, China

Abstract—The capital allocation inefficiency has become an important factor that restricted China’s sustained economic growth, long-term macroeconomic stability and low financial system risk. Along with the further reform and opening policy, the commercial bank credit rationing phenomenon is more obvious, it is easily viewed that, on the one hand there is overinvestment even malignancy capital increase in the state-owned major industry, on the other hand it is extremely difficult for the small and medium enterprise to get loan. This paper firstly establishes a two-stage state-owned commercial bank credit rationing model which is based on the bank manager and loan officer’s utility maximization, then analyzes the intrinsic mechanism of capital allocation inefficiency, finally on the base of the theoretical analysis, this paper proposes the related conclusion and suggestions of improving the capital allocation efficiency in China.

Keywords-credit rationing; capital allocation efficiency; intrinsic mechanism; state-owned commercial bank

I.I NTRODUCTION

In China, the question that investment efficiency of the

macro disobeys to that of the micro [1], the cost efficiency of commercial bank enhances steadily while the level of profit

efficiency declines accelerated [2], ultimately it is attributable to the capital allocation inefficiency, the capital allocation inefficiency has become an important factor which restrict China’s sustained economic growth, long-term macroeconomic stability and low financial system risk. In China under the indirect financing system which is led by bank, the allocation efficiency of bank credit determines the allocation efficiency of all the social capital in a large extent.

Foreign researchers investigated the allocation function of bank credit mainly involve in three areas. Firstly, several researchers have indicated that financial vulnerability and other factors will cause the bank to bankrupt repeatedly; in order to improve the capital allocation efficiency, the financial authority should exert more financial regulation, however, the authority may not be able to achieve its objectives, on the contrary, it maybe reduce the efficiency [3-6]. Secondly, compared to the regulations, system environment is more natural, the financial restraint, financial constraints and financial liberalization all play a more significant implication to the bank capital allocation function [7], several researchers pointed out that

according to the government’s political economical need it may

uses the credit quota and different interest rate to provide the exclusive protection to the special department in order to

enhance the macroscopic capital allocation efficiency [8]. Finally, the system environment of the credit domain can affect and even decide the system arrangement, through the empirical analysis, a few writers have found that state-owned banks will cause the credit capital allocation political, and reduce its use efficiency [9-10], or the state-owned bank monopoly is not conducive to the improvement of economic efficiency and long-term growth [11]. As for the research of state-owned commercial bank credit allocation efficiency, domestic researchers concentrates in two aspects. A number of authors have examined the degree that the credit fund investment reflects to the industry value-added change, through the econometric analysis of the corresponding industry data, they found that the capital allocation efficiency in China is at a low level [12-14]. On the other hand, credit rationing theory is widely introduced, under the framework of Stigliz-Weiss’s credit rationing model, the credit phenomena and the causes behind it acted by the state-owned commercial banks have been discussed by several investigators [15-16]; the discussion on the relationship between the bank credit rationing and the small and medium enterprise (SME) loan has shown that asset size of the enterprise may become a critical standards when it enters into the credit market [17-18].

In these literature above, although while much research has

been devoted on the empirical analysis of China’s capital allocation inefficiency, little research has been done on the intrinsic mechanism of this phenomenon. Next, many researchers have investigated the credit rationing question in the credit market from the side of bank costs and benefits, while few researchers have studied on the behaviors that bank manager and the loan officer both are influenced by the residual government politics during the restructuring economic.

In this paper, inspired by the credit rationing and rural

economic efficiency model which is produced by Ma Hong, Zhang Li and Tian Gang, we establish a simple two-stage state-owned commercial bank credit rationing model which is based on the bank manager and loan officer’s utility maximization: firstly, we develop their study field from the rural economic tothe entire economic entities, furthermore the loan objects are

divided into two heterogeneous production departments, state-owned and non-state-owned sector; secondly, instead of the

loan officer, it is the bank president and the loan officer who both decide how to allocate the credit fund, and the president’s management idea is emphasized in the bank credit decision, which is more in line with the actual reality of the branch bank; thirdly, we expand the president’s single objective of profit maximization to the profit and the political income dual goals maximization; finally, we definite it as a short-term behavior, which is decided mainly by the current evaluation mechanism which determines the present’s promotion.

II.THE C REDIT R ATIONING M ODEL D ETERMINED B Y THE

B ANK P RESIDENT AND THE L OAD O FFICER T OGETHER

A.the Basic Assumptions of the Model

•The production departments are not heterogeneous, there are inefficient sectors (assumed to be state-owned

economy enterprise or duplicate construction projects

under the background of government) and high-

efficiency sectors (assumed to be non-state-owned

economy enterprise or projects without government

background).

•The enterprise production only uses the credit fund, and its demand is infinite, besides, the interest rate is

implemented and cannot fluctuate.

•The discrimination to the non-state-owned enterprises is just the performance of the state-owned commercial

bank credit rationing behavior, that is to say, after the

loan failure those who loan to non-state-owned

enterprise will take greater risk cost than those who

loan to state-owned one.

•The production technology is facing the uncertainties.

•The president’s utility function both includes the profit and certain political gains, and the loan officer’s utility

function is caused by the wages earned from the bank

profit and the responsibility risk cost when the

corporation bankrupts.

B.the Hypothesis of the Model environment

We assume that the production function of the two departments are: inefficient sector A: y A=(a+u)K A; high-efficiency sector B: y B=(b+u)K B. Hereinto y refers to output, K refers to capital storage quantity, a+u and b+u is the capital productivities R i of the two different departments, a and b express the definite part of the capital productivity, further more a1+r, the enterprise pays the bank 1+r; when 02

()(1/2)

i i i i

C D c D

θ

=,{}12,

,,

i A B c c

=<,()0

i

C D

′>,

()0

i

C D

′′> (1)

D i refers to the quality of loan fund to apartment i, c i refers to the risk cost coefficient when the loan fails. In the situation of R i<0, as apartment B does not have the government protection background, the probability that it goes out of business is 1, instead, the probability of apartment A is ș,(0<ș<1) in the same situation because of its state-owned property rights. It is just because of the different sectors. When the loan fails the risk cost for the loan officer to undertake is smaller, that is to say, c1C.Bank Manager's Decision-making Behavior

Under the specific economic conditions in China, not only the market allocation mechanism in the loan credit market, but also the non-market-oriented one plays an important role. Using the administrative method, the government affects the commercial bank to loan the credit fund with additional preferential benefit conditions to the state-owned enterprise or to the private enterprise which has relationship with the government. These causes the banks of credit supply side, enterprises of credit demand side and the market credit volume have some different characteristics from the bank, enterprise and interest rate phenomenon under the market economy. Introducing all of the above, we construct the bank manager’s credit ration model:

()(1)

U D p

λπφαλ

=−+− (2) Hereinto, Ȝ refers to the evaluation weight of the profit in the bank’s effectiveness, the more Ȝ is, the more important bank’s profit effectiveness is regarded, ʌ refers to the profit function of the bank. We suppose that the proportion of the political loans in the bank total loans D is Į , and the political loans bring the bad account loss are ijĮD , besides, ij is the bad debts loss rate of the political loan, p means political gains brought from the political loans, including various credit aid to the bank and bank manager’s promotion income, (1-Ȝ) refers to the evaluation weight of the political gains in the bank manager’s effectiveness, so

22

/()0,/()0

p D p D

αα

∂∂∂∂=

; (3) D.Loan Officer’s Decision-making Behavior

Under the conditions that bank manager has decided the credit loan sum which is less than the optimal loans D, the loan officer will take charge of reviewing loan applications, contracts and statements, investigating the enterprise condition, since the opinion of the credit department person in charge is established in the loan officer’s investigation, in short, the views of the loan officer is extremely essential. This is the loan officer’s utility function including the wages earned and the risk costs when the corporate failures:

(,)(,)(,)

A B A B A B

U D D W D D C D D

βπ

=+− (4) Hereinto, D A,D B refers to the credit funds that loaned to the department, W0 means the fixed part in wages bonus income, and ʌ refers to the profit function, ȕ refers to the weight of the bank gain sharing, meaning the uniformity of the loan teller’s and bank’s profit goals, we suppose W0=0 since it doesn’t influence the analyses results. We got the loan officer’s effectiveness function of department A,B:

1121()()()[(1)()()()]1

()2

A A A A A A m r a

A A r a

a

a A m

EU D E D EC D D r g u du D a u g u du c D g u du

βπβθ+−+−−−−=−=+++−³

³

³ (5)

1122()()()

[(1)()()()]1()2

B B B B B B m

r b

B B r b

b

b b m EU D E D EC D D r g u du D b u g u du

c D g u du

βπβ+−+−−−−=−=+++−³

³

³ (6)

And the maximized question faced by the loan officer is :

max{(,)()()}

.A B A A B B A B EU D D EU D EU D st D D D

=++= (7) III.THE I MPACT ON THE C APITAL A LLOCATION E FFICIENCY O F THE C REDIT R ATIONING A.Term 1 The maximization condition of the bank manager effectiveness is

()(1)0p U D D D πλφαλ∂∂∂=−+−=∂∂∂ (8) In other words, it equals to 1p D D

πλφαλ∂−∂=−∂∂ (9) Supposing that the bank manger pursues the profit maximization, the optimal size of the credit should conform to this condition:

22/0,/0D D ππ∂∂=∂∂E (10)

Considering after the 90s of the 20th century, as the bank commercialization reforms gradually thorough, bank operating mechanism changes a lot, risk and income consciousness is enhanced, market-oriented financing constraints come into play, the weight of the profit target in the evaluation of the effectiveness is stepping up gradually, administrative intervention and political income reduces, so (9) increases, seen from (10) , we get that at this moment, the credit supply D declines at a large scale, in the market, the credit rationing deepens. In the market dual rations exist, one is the political instructional credit ration left by the economic transformation, the other one is the formal credit rationing in the financial market with asymmetric information, so when the bank facing

the large amount stat-owned enterprises operated with

difficulty and huge bad loans, the bank loan behavior tends to be cautious, which caused a certain extent less loan to the SME and too much loan to the state-owned enterprise. Thus, the capital allocation efficiency is reduced at the first level.

The reasons that caused the bank manager’s subjective evaluation weight of the political gains (1-Ȝ) keep high, and the projects of two different nature does not follow unification credit standard are: firstly, the state-owned commercial bank lacks president's market selection mechanism, and the bank manager is a political banker rather than a professional banker with objective function of two goals; secondly, the state-owned commercial banks undertake excessive intervention from the government, which is related to the evaluation mechanism of the local government’s G DP; thirdly, during the bank manager’s achievement inspection, the short-term effect is remarkable when talked about the position difference and the political incentive to achieve it, which disobeys the long-term profit of the bank; finally, the market-oriented interest rate mechanism has not been completely established, neither have the multi-level bank system and capital market system.

B.Term 2

Under the principle of loan scale determined by the bank

manager, the loan officer chooses loan options according to his own risk cost and subjective income appraisal goal, through the Lagrange Law we obtain the credit allocation scheme under the loan total amount D decided by the bank manager:

2

121

12()(1)()()()

()(1)()()()

A B c q b D r b a D c q a c q b c q a D r b a D c q a c q b βθθβθ−−+−=−+−−++−=−+− (11)

In this formula, q-b, q-a, b-a are all positive numbers, to enable the discussion to be significant, we can adjust the

parameter to make D A ,D B bigger than 0. From the results we can obtain that: firstly, the lower loan officer’s subjective appraisal weight of earning corresponding achievement and bonus from the bank obtains (ȕ decreases), the bigger extent that the credit funds flow into the inefficient

state-owned enterprises, credit rationing expands, and the all capital allocation efficiency drops; secondly, when credit loan for state-owned enterprise’s loan fails, the loan officer will

undertake less responsibility or the government will promise much less favorable condition, all these make the credit fund

flows to the efficient private enterprises(D A decreases, D B

increases), it means the capital allocation efficiency is proved; thirdly, the government shows more protection to the state-owned enterprises which is going out of business (șdecreases), namely it is not easier for the state-owned enterprise to close down, then the more credit fund flows to the inefficient sector, meaning credit fund capital allocation efficiency is lower; finally, if the two departments are in the equal competitive environment, including the loan officer loans to them will bear the risk of failure by the same responsibility, and the government doesn’t intervene the bank loan plan(c 1=c 2

,

ș=1), the efficient enterprises will receive more credit fund, so the capital efficiency increases. The reasons that caused the loan officer’s subjective evaluation weight of the bank profit gains ȕ keep low, and the projects of two different nature does not follow unification credit standard are: firstly, in the reality bank management,

loan officer not only measures his own wages but also considers the complex interpersonal network relations, just like

they should approves and carries out bank manager's management idea on the credit total amount; secondly, the loan officer is lack of professional knowledge and ability, in the absence of effective incentive mechanism, it is difficult for him to balance the credit work risk and the repayment, thus it causes the loan officer to disobey with the bank management goal; thirdly, the loan officer is both the first responsibility person of the credit investigation and the specific post-lending management commitment member, and also the natural

it is easily understood that the loan officer pays more attention

to the risk cost; finally, the bank management responsibility system was introduced successfully to clear about the responsibility and to strengthen the profit goal, but it also causes the loan officers to pass the buck, focusing only on the achieving profits in the tenure, neglecting the long-term development of the bank.

It is the bank manger and the loan officer’s different levels

of maximum utility that results in the state-owned economy (government background and duplicate construction projects) and the non-state-owned economy (general projects) are not in the equal competition, making more funds flow to the low effect department, and leading to inefficient allocation of capital.

IV.C ONCLUSION AND P OLICY P ROPOSITIONS The state-owned banking system, as a government-led market economy associated arrangements, its property right restraint enable the vulnerability of the system to have self-fixed ‘path dependence’ character, so it needs: firstly, a market mechanisms for selecting executives should be established, that the manager appointed by the government should be changed

to the mechanism that the bank manager is decided by the board of directors according to the request of the market operation; secondly, state-owned commercial bank achievements inspection mechanism needs to be improved, in the salary structure of state-owned commercial bank manager and executives, the fixed income part should be reduced, while the risk income part linked to company achievement should be increased, besides, the bank long-term management benefit inspection should be strengthened to promote the cross-time capital allocation efficiency ; thirdly, we should push forward the market interest rate reform process to reduce the constrains

of the SME, build new multi-level relations of banks and enterprises, improve the multi-level capital market, in order to reduce the credit rationing behavior of the commercial bank. In more details, the fund price should be determined by he market supply and demand relationship, the property mortgage ability

of the SMEs should be reduced to relax the degree of credit rationing, this question is faced by the China’s private enterprises especially the SMEs. The relations between the banks and the enterprises should be promoted, namely both the independent economic subject status and the right to make their own decisions of the two contract sides should be considered. According to the more transparent information, the lower financing costs, a large-scale bank and the big enterprises can build the loosely relations between them; while, according to the opaque information, the higher financing costs, the small and medium-sized financial institutions and SMEs should construct the close relations on management mechanisms, property right and so on.

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