Non‐interest Income, Profit, and Risk Efficiencies: Evidence from Commercial Banks in China

• DOI: http://doi.org/10.1111/ajfs.12112
• Published date: 01 October 2015
• Date: 01 October 2015

Non-interest Income, Profit, and Risk

Efficiencies: Evidence from Commercial

Banks in China*

Wen-Long Bian**

National School of Development, Peking University

Xiang-Nan Wang

Institute of Finance and Banking, Chinese Academy of Social Sciences

Qi-Xiang Sun

School of Economics, Peking University

Received 6 December 2014; Accepted 27 August 2015

Abstract

Chinese commercial banks are transforming their activities into more non-interest income

businesses under a highly regulated financial system. This paper investigates the effects of this

transformation on profit and risk efficiencies. We find that commission and fee income sig-

nificantly reduce risk efficiency due to the circumvention of the regulation on deposit interest

rate and the assumption of risk that should have been borne by customers. In terms of trad-

ing income, it significantly reduces profit efficiency due to the upper limit of the loan-deposit

ratio, the lack of investment channels and low returns of bond markets. The regulatory

authorities are supposed to further liberalize the banking industry and grant banks more

rights.

Keywords Non-interest income; Profit efficiency; Risk efficiency; Stochastic frontier analysis

JEL Classification: C23, D22, G21

1. Introduction

Traditionally, banks have been perceived as financial institutions that accept depos-

its and make loans. However, non-interest income, which primarily consists of

commission, fee, and trading income, is playing an increasingly important role for

*We would like to thank the Editor, Professor Hee-Joon Ahn, and two anonymous referees

for their highly constructive and helpful comments.

**Corresponding author: Wen-Long Bian, National School of Development, Peking Univer-

sity, No. 5, Yiheyuan Road, Beijing, China. Tel: +86-18810334272, Fax: 01059868206, email:

1101111179@pku.edu.cn.

Asia-Pacific Journal of Financial Studies (2015) 44, 762–782 doi:10.1111/ajfs.12112

762 ©2015 Korean Securities Association

banks in both developed and developing countries.

1

Figure 1 presents the patterns

of non-interest income over total operating income and total assets for commercial

banks in China, respectively. In 2002, non-interest income accounted for only 6.7%

of total operating income and 0.15% of total assets. In 2012, that percentage

reached 20.3% and 0.60%, respectively, suggesting that commercial banks in China

are adjusting their income structure and diversifying their income sources.

Commercial banks in China are confronted by ever-increasing challenges such

as interest rate liberalization, the expansion of non-bank institutions, the implemen-

tation of the Basel New Capital Accord, the trend of transition to financial holding

companies, and so on. First, in 2013, the People’s Bank of China (PBoC)

announced that the loan interest-rate floor was eliminated and liberalization of

deposit interest rates was also in process. We can anticipate that interest rate

spreads between deposits and loans will further decline, which means that the

contributions of traditional businesses to commercial banks’ profits will be lower.

Figure 1 Ratio of non-interest income to total operating income (total assets), 2002–2012

Data source: Bankscope database.

1

The ratio of non-interest income to total operating income (net interest income plus non-

interest income) increased from 25% to 43% for commercial banks in the United States dur-

ing the period 1984–2001 (Stiroh, 2004); this ratio increased from 26% to 41% for commer-

cial banks in Europe during the period 1989–1998 (Lepetit et al., 2008); For Indian banks,

the ratio increased from 10.7% in 1992 to 21.62% in 2007 (Kumar and Gulati, 2014).

Non-interest Income, Profit, and Risk Efficiencies

©2015 Korean Securities Association 763