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| Bank Competition, Bank Profits, and Household Welfare |
| Shao Quanquan, Liu Yu
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| School of Finance, Nankai University, Tianjin 300350, China |
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Abstract China's financial sector has shifted from a phase of rapid expansion to high-quality development. In the 2023 Central Financial Work Conference, General Secretary Xi Jinping highlighted the imperative to advance five major initiatives to foster the high-quality development of finance, focusing particularly on deepening the structural reforms on the supply side of the financial sector. This paper constructs a Stackelberg difference game model of banking competition, adapting to China's unique conditions. Through numerical simulations and actual data, it examines the impact of banking competition on the profitability of banks with different ownership structures and its impact on household welfare, as well as the broader implications of the profitability in the banking sector on household welfare. This study is significant both theoretically and practically. It presents a framework to analyze competition in China's banking sector and its impact on bank profitability and household welfare, and how banking profits affect household welfare. The findings aim to help policymakers improve financial development and deepen financial reforms by offering guidance for designing policies in the banking sector.
The study begins by formulating a Stackelberg difference game model based on the empirical context of competition between state-owned and private banks in China, anchored in the Monti-Klein framework. Through numerical simulations, it probes the influence of banking competition on industry-wide profits and household welfare. The analysis reveals that increasing deposit and loan interest rates contribute to higher total profits within the banking industry and enhance household welfare. Market competition intensity and loan-to-deposit ratio have a nonlinear relationship to bank profitability and household welfare, which manifests distinct characteristics at various stages of the evolution of the banking industry. The competitiveness in the deposit and loan market has direct influence on the profits of state-owned and private banks, and indirect influence on household welfare through interest rates of deposit and loan. Moreover, the paper delves into the theoretical nexus between bank profits and household welfare. Subsequently, employing an unbalanced panel dataset from 446 Chinese banks between 2007 and 2021, drawn from the CSMAR database, and panel data from 31 Chinese provinces between 2011 and 2018, the empirical section corroborates these insights. The findings demonstrate that increases in deposit and loan rates, alongside intensified market competition and an elevated loan-to-deposit ratio, bolster bank profitability, wherein the intensity of market competition and the loan-to-deposit ratio exert nonlinear influences on profitability. Furthermore, enhancements in deposit and loan rates, market competition, and the loan-to-deposit ratio augment household welfare. Panel threshold regression unveils significant threshold effects between key independent and dependent variables. There is a positive correlation between bank profitability and resident welfare. The empirical analysis also includes mediating effect examinations, offering a nuanced exploration of the relationships between independent and dependent variables, thereby empirically validating the theoretical simulations posited in the earlier sections.
Based on the main findings, the paper has the following policy implications: First, carefully adjust deposit and loan interest rates, and expand the banking sector's role in inclusive finance. Second, promote balanced competition to prevent market failures due to under-competition and minimize systemic risks from over-competition. Additionally, understand disparities among regions and development stages of the banking industry, and advocate for more comprehensive structural reforms from the supply side.
This paper contributes to existing literature by integrating the Stackelberg difference game into the analysis of competition within China's banking sector, considering the leader-follower dynamics amongst banks of diverse ownership forms, thus capturing the competitive behaviors between state-owned and private banks in China more precisely. It also introduces the deposit and loan markets in the banking industry, linking these markets through appropriate assumptions to reflect market prices and quantities. Drawing on the Monti-Klein framework and adopting Ljungqvist and Sargent's (2018) recursive contracts analytical framework, the study crafts a theoretical model that simulates time series of profits for market leaders and followers, consumer surplus, and welfare for a comparative static analysis. In contrast to existing studies that predominantly focus on the impact of banking competition on operational outcomes like performance and profitability, this research broadens the analytical lens to encompass the effects of banking competition on bank profitability and household welfare, thus offering a more holistic analysis within a comprehensive market-theoretical system. Future studies may extend to general equilibrium analysis.
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Received: 25 September 2023
Published: 02 May 2024
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