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BANKING SYSTEM EFFICIENCY AND CHINESE REGIONAL ECONOMIC GROWTH: AN EMPIRICAL ANALYSIS BASED ON BANK’S MICRO-EFFICIENCY

CHAPTER ONE

1.0          INTRODUCTION

1.1    BACKGROUND OF THE STUDY

A well-functioning financial sector fosters economic growth via capital accumulation and increased capital productivity (Levine, 1997). Banks in China dominate in the financial sector whereas the equity and bond market is relatively small compared to the banking sector (Allen and Qian, 2014; Liu et al., 2018). Over the last two decades, China has witnessed successively soaring economic growth as well as fast expansion in the banking sector, which has drawn significant attention to banking sector development and economic growth in China.

A flourishing body of literature has emerged to help researchers understand the relationship between financial development and economic growth in China. The empirical findings are, however, mixed at best. Some studies provide evidence supporting a positive relationship between finance and economic growth (e.g. Laurenceson and Chai, 2001; Chen, 2006; Ma and Jalil, 2008; Yao, 2010; He, 2012), while others find that the level of financial development in China has an insignificant or even negative impact on provincial economic growth (e.g. Aziz and Duenwald, 2002; BoyreauDebray, 2003; Chang et al., 2010). Allen et al. (2005) argue that China is a counterexample to the finance-lead-growth literature because of its high economic growth rates and an under-developed financial system.

The above-mentioned studies on China use the ratio of liquid liabilities to GDP or the ratio of loans to GDP to measure financial development. Both variables reflect the quantity of the financial system in the economy. However, the use of quantity measures of financial development in the finance-growth studies are subject to two problems. First, the increases in liquid liabilities or loans in the financial sector as a result of excessive credit creation has a weak relationship with economic growth, suggested by Rousseau and Wachtel (2011). Second, the quantity measures essentially focus on the role of the financial sector in stimulating capital accumulation, while overlooking the efficiency role of the financial sector in improving capital productivity by channeling funds to the most productive projects (Koetter and Wedow, 2010). A fast expansion in the financial system does not necessarily indicate an improvement in the quality of financial intermediations to effectively allocate funds to productive investments. Therefore, a quality measure of the financial system is important for researchers to better understand the impact of financial development on economic growth in China

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