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| Profit Level, Support for Agriculture,and Risk Control: Theoretical Analysis and Empirical Tests of the Size Adjustment of Rural Commercial Banks |
| GUO Yan, HAN Qingxiao
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School of Management, Shandong University;
Branch of Jinan, People's Bank of China |
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Abstract In recent years, the increasingly fierce competition in the rural financial markets has gradually eroded the monopoly position and competitive advantage of the rural credit cooperatives, leading to the emergence of frequent operational malpractices. In the process, many deep-seated problems, such as a chaotic property rights system, low financial service functions, and an excessive proportion of non-performing assets, have been exposed. To solve these problems,the rural credit cooperatives has begun to focus on banking reform. Nevertheless, there are still major differences between the different departments of the rural credit cooperatives. This issue mainly relates to the following three questions: If the rural commercial banks expand after the reform, will this affect the strategic positioning of the agricultural sector？ Can the management of rural commercial banks support a substantial expansion in size？ If the rural commercial banks maintain their current size, will they be able to meet the needs of service improvement？ Due to the lack of clear answers to the above questions, the issue of the size adjustment of rural commercial banks remains an open research question.
To address the problem of the size adjustment of rural commercial banks, we summarize the relevant local and international literature, and find that the literature is too narrowly focused and has generated controversial conclusions. The rural commercial banks have been burdened with the task of supporting agriculture since their inception. In recent years, with the introduction of market-oriented reforms, commercialization based targets have become equally important, such as improving profitability and reducing the operational risk. In this way, if the size adjustment is only analyzed in relation to one single target, it may be biased. Furthermore, the existing theoretical models examine commercial banks under the condition of a high level of marketization, which is not the case for a number of types of banks. Therefore, it is necessary to expand the model when discussing the size adjustment of rural commercial banks.
Drawing on the optimal size selection model for commercial banks developed by Krasa and Villamil (1992) and Lin and Sun (2007), combined with the particular characteristics of rural commercial banks, in this paper, we propose a new theoretical model of rural commercial banks, and explore the internal mechanisms of the size adjustment of rural commercial banks under different objectives, including the profit level, level of support for agriculture, and risk control. Then, using non-balanced panel data on 102 rural commercial banks from 2009 to 2016, we conduct an empirical analysis of a dynamic panel model to verify the conclusions of the theoretical model, and further analyze the most reasonable size interval for rural commercial banks. The following conclusions are drawn from the results of the model derivation and econometric tests. First, rural commercial banks can maximize their profit and minimize their operational risk through size adjustment. Specifically, maintaining a moderate size is more beneficial for improving profitability and reducing operational risk. Second, the expansion of the rural commercial banks inevitably shifts their focus away from agriculture so that they can offer high quality non-agricultural loans. Thus, the proportion of loans to support agriculture decreases, which weakens the support for agriculture. However, when the size of rural commercial banks exceeds a certain threshold, the proportion of agricultural loans begins to increase. Third, the results under the triple target constraint show that based on the current management levels, rural commercial banks are not suited to significant expansion and restricting the logarithm of their total assets within the optimal range can better balance the three goals.
Overall, this paper makes the following contributions to the literature. First, unlike the single goal perspective examined in the literature, we examine three goals, namely, the profit level, support for agriculture, and risk control to analyze the size adjustment of rural commercial banks. Second, this paper expands the original theoretical model of commercial banks, and establishes a new model for the size adjustment of rural commercial banks. Third, we test the conclusions of the theoretical model using a sample of 102 rural commercial banks, and explore the optimal size to better achieve the three goals using simulation graphs.
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Published: 29 April 2019
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