Market response to bank loan announcements in a government-controlled banking system: evidence from China’s banks

Abstract

Under an enriched notion of “inside debt”, the unique benefits of bank financing from screening and monitoring processes have been well documented in a large number of studies investigating the information content of bank loan announcements. Thus, bank loan announcements convey positive signals to the market, and the market response should be positive. However, previous studies were conducted extensively in the non-government-controlled banking systems, such as the U.S., the U.K., Canada and Australia. It is unclear whether the traditional predictions on the functions of banks for non-government-controlled banking systems also hold for government-controlled banking systems. This study examines the market reaction to bank loan announcements in the Chinese financial market, where the banking system is highly controlled by the Chinese government. The study also investigates the possible characteristics of lending banks, borrowers and loans that may influence share price reaction to bank loan announcements in the Chinese financial market. Standard event study methodology is employed to test the share price returns of the borrowing firms in response to the bank loan announcements. The event window comprises of 21 trading days from the period beginning 10 days before the event date (day 0) and ending 10 days before the event date (day −10 to day 10). Data used in this study are collected from the China Stock Market and Accounting Research Database and China Financial Newspaper Database. This study samples all bank loan announcements from companies listed on the Shanghai Stock Exchange (SHSE) and the Shenzhen Stock Exchange (SZSE) between 1996 and 2009. The share-split reform started in 2005 which affected the stock price of listed Chinese companies considerably. In order to avoid the influence of the share-split reform, this study divides the sample period into two sub-samples, namely, 1996 to 2004 and 2005-2009. A total of 501 bank loan announcements are collected in the final sample for period 1996 to 2004 and 106 bank loan announcements for the period 2005 to 2009. Contrary to what previous studies have found for bank loan announcements in non-government-controlled banking systems, this study finds significant declines in stock values of Chinese borrowing firms during bank loan announcements for the sample period 1996 to 2004. The result implies that both positive and negative bank loan announcement effects are possible, depending on whether the banking system is run on purely commercial goals in non-government-controlled banking systems or is subject to political intervention in government-controlled banking systems. Banks controlled by the government may have to lend to bail out poorly performing firms for political reasons. If these weak borrowing firms are prevalent, the direction of the market response to bank loan announcement should be negative, and vice versa. The results show that the negative effect is particularly significant for loans from Big Four state banks, state owned or controlled banks, banks with lower ranking and banks in provinces with lower marketization in credit allocation. The negative effect is also particularly significant for problematic borrowing firms including firms that are opaque, have a higher possibility of expropriation or tunnelling, have ineffective expropriation-reduction mechanisms, and are controlled by the state. The results also show that the negative effect is particularly significant for loans with greater amount, shorter term, with covenants/collateral, and less syndication. There is a significant difference in the market response to bank loan announcements among different bank loan purposes and among different industries. This study finds no significant market response to bank loan announcements in the Chinese financial market for the sample period 2005 to 2009. However, the result shows that there is a significantly negative market response to bank loan announcements in the Chinese financial market for the sample period 1996 to 2004. This implies that the Chinese stock market does not view bank loan announcements unfavourably any longer after a series of reforms in the Chinese banking system.