Abstract
ABSTRACTThe 2008 US subprime mortgage crisis demonstrated how developments in real estate markets can cause instability in the banking sector and raised concerns in many emerging economies with significant real estate development and a rapidly growing commercial banking sector, particularly in China. There is clear evidence that commercial banks in China, especially regional commercial banks, have lent significantly to the real estate sector. The recent slowdown in the housing market in China and the increase in nonperforming loans (NPLs) in China's commercial banking sector motivated us to investigate the connection between real estate markets and banking stability. This paper proposes three testable hypotheses linking the growth of investment in real estate and the stability of regional commercial banks in China, measured by NPLs. Our empirical results reveal a close connection between the growth of investment in real estate and the NPLs among regional commercial banks, and its sensitivity to real estate market cycles. When real estate market activity declines, our results suggest, regional commercial banks can find themselves in trouble if they have significant exposure to one type of (real estate) asset. In addition, we find that regional bank competition plays a critical role in defining the relationship between bank stability and real estate investment activity.
Highlights
The bursting of the US housing bubble and declining home prices combined with troubled subprime loans have been widely considered the direct causes of the 2008 US financial crisis. Diamond and Rajan (2009) argue that one of the main reasons for the US credit crisis was the misallocation of investment in real estate by the domestic financial sector
This paper focuses on China, because of the size and significance of its economy in the world and the special characteristics of both its real estate market and commercial banking system compared to those in the United States
NPLi,t = α + βDINVi,t + θ DINVi,t · HHIi,t + φHHIi,t + f (Xi,t) + εi,t where DINV refers to real estate market growth6, Xi,t is a vector of control variables, including bank-specific characteristics and includes a proxy for macroeconomic conditions
Summary
The bursting of the US housing bubble and declining home prices combined with troubled subprime loans have been widely considered the direct causes of the 2008 US financial crisis. Diamond and Rajan (2009) argue that one of the main reasons for the US credit crisis was the misallocation of investment in real estate by the domestic financial sector. When the construction sector is included, the share of real estate-related loans becomes even higher and comprises the largest proportion of loans in four of the five banks This situation is quite common at most regional commercial banks. To the best of our knowledge, this paper is the first to explicitly examine the relationship between the real estate market and the stability of China’s regional commercial banks using a bank-level micro dataset. Tests of Hypothesis 3 indicate that bank competition plays a critical role in defining the relationship between bank stability and real estate investments These results have implications for many emerging markets that have seen significant growth in real estate markets and potential price bubbles in recent years..
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