Corporate Governance，Government Regulation and Bank Stability

WANG Yu－m ing(王宇明)，QU Hong－jian(曲洪建)，GAO Chang－chun(高长春)

1 Glorious Sun School of Business＆Management，Donghua University，Shanghai200051，China

2 Fashion College，Shanghai University of Engineering Science，Shanghai201620，China

Corporate Governance，Government Regulation and Bank Stability

WANG Yu－m ing(王宇明)1，QU Hong－jian(曲洪建)2，GAO Chang－chun(高长春)1

1 Glorious Sun School of Business＆Management，Donghua University，Shanghai200051，China

2 Fashion College，Shanghai University of Engineering Science，Shanghai201620，China

By using the data collected from the years2006 to 2012 of 16 listed banks as samples，an empirical test was set up to analyze the impacts of corporate governance and government regulation towards bank stability．The results show that the nature and percentage of ownership of the largest shareholder，aswell as the top 10 shareholders，have no significant impact on bank stability．Supervision of board of directors increases bank stability，while independent directors could not p lay the role of supervision．Higher executive com pensation increases bank stability，while shareholding of executives does not show much incentive function．Franchise value has self-regulatory effects．Capital regulation also improves bank stability．Implicit insurance covers the entire banking system．Im proving corporate governance and government regulation to increase bank stability are put forward．

corporate governance;franchise value;capital regulation; recessive Insurance;bank soundness

Introduction

Within the whole financial institution system，commercial banks are special“enterprises”.The features of low equity capital and high debtoperation lead to the vulnerability of banks，which brings vulnerability to the whole financial system through contagion effect.In 2007，the global financial crisis caused by American subprimemortgage crisis brought great losses to banks of various countriesand economy.This financial crisis resulted to failures ofmany well－known banks.Up to now，a total number of 450 banks in U.S.have become bankrupt.Thousands of bankswere listed as“problem banks”.Affected by the global financial crisis，China's commercial banks also suffered from strikes in terms of stability.Although the government adopted variousmeasures to copewith the impactof financial crisis，there have been problems with bank stability since May 2013.The rising fund rate in financialmarkethasbroughtaboutbad impacts on China's economy.

Imperfect corporate governance of commercialbanks causes bank risks and reduces stability of banks.In order to improve the stability of banking system，China Banking Regulatory Commission(CBRC)promulgated Guidelines on Liquidity Risk Management of Commercial Bank in 2009.In November 2010，the Basel Committee set a new supervision standard for bank capital and its liquidity.The steady implementation of new standard not only is within the general trend of international financial regulatory reform，but also further enhances the resistance against risks of Chinese commercial banks and increases the stability of banking system.

To discuss the risk taking of commercial banks from the angle of ownership structure，there are two viewpoints:“the theory ofmoral hazard”and“company cybernetics”.Based on the study of Merton［1］，Amihud and Lev［2］first analyzed the impact of corporate governance mechanisms on risk taking of banks from the perspective of“moral hazard”.As research continued，the theory of“company cybernetics”was gradually accepted by scholars.As for research on Shareholders' characteristics and ownership concentration，the empirical study of Liu and Zhang［3］discovered the positive correlation between shareholding ratio of top ten shareholders and bank risks. However，there are also opposing views.Wang［4］found that the impact of ownership property on commercial banks was not significant，and the impact of the largest shareholder on bank performance was not significant.

As for the relationship between the size of the board of directors and bank risk and performance，Wang［4］discovered the size of the board of directors and the board of supervisors had significant impacts on bank performance.The empirical study result of Liu and Zhang［3］showed that the expansion of board of directors had significant influence on reducing banking risk.Xue and Wu［5］conducted regression analysis using the data collected from 16 banks from 2006 to 2011，and it showed that the size of board of directors could improve the performance of banking institutions.Although the size of the board of directors could be determined according to other successful experience，Jenson［6］pointed out that too large size of the board of the directorsmay cause failure in information transfer，impairing the supervision function of the board.As to the relationship between independent directors and bank risk and performance，the empirical study of Liu and Zhang［3］showed a higher proportion of independent directors had significant influence on reducing bank risk.Study of Xue and Wu［5］showed independent board of directors increased bank performance.Similarly，the opposing views still exist.Empirical research of Kong and Dong［7］discovered that there was positive correlation between the proportion of independent directors and risk taking of banks.

About the relationship among executive compensation，banking risk，and banking performance，John et al.［8］considered reasonable executive compensation system could reduce the operation risk.Fortin et al.［9］carried out empirical analysis on the data of 83 American banks，and they discovered that the higher the executive compensation，the lower risk they would like to take.There are also opposing views，Wang［4］found that higher executive compensation could not increase bank performance.About the relationship between managerial ownership and bank risk and performance，Li and Zhang［10］believed the improvement in of themanager governance reduced corporate governance risk.However，Gong et al.［11］thought proportion of executive shareholding had a cubic function to corporate performance.

Among existing literatures，there are many studies on the access regulation of banks.Most of the studieswere carried out from the perspective of franchise value.Shang et al.［12］found that the franchise value reduced bank risk;Fisher and Gueyie［13］discovered franchise value increased bank risk.Qu et al.［14］considered endogenous franchise value would increase bank stability.

Regulatory capital is the regulation of m inimum capital requirements for commercial banks.The viewpoint that regulatory capital increases the ability of commercial banks to withstand risks andmaintains the stability of banking system has been accepted bymany scholars.Itwas found that strengthening capital regulation reduced bank costs and improved bank performance［1519］.However，therewere also opposite views，it was found that regulation on capital adequacy ratio could not only reduce the efficiency but also increase bank risk，which was contrary to the original intention of the regulatory authorities［2023］.

About explicit deposit insurance system，since the system provides deposits protection，even if the protection is not complete，regulationmotivation of depositorswillbeweakened. This conclusion is supported by many studies.Thanson［24］and Kaufman［25］believed that government regulation and bank safety netweakened depositors'motivation of regulation towards banks.Through empirical studies，Nier and Baumann［26］found that uninsured savings could constrained bank risk.However，when the government provided protection for the bank，this constraint effect would be reduced.About implicit insurance system，it was discovered that through different studies on sample data，implicit insurance system reduced confinement effect on bank risk，reducing bank stability［2731］.

However，as can be seen from current status of domestic and foreign research，the studies on the impact of corporate governance mechanisms and government regulation on bank stability mainly focused on either bank risk or bank performance.There are few studies on the relationship of corporate governance mechanisms，government regulation and bank liquidity.This paper argues that bank stability includes three aspects:safety，profitability and liquidity.In order to fully grasp the status of bank stability，analyses on bank risk，bank performance and bank liquidity are very important. Therefore，based on the studies of bank risk and performance by predecessors，further research on bank liquidity has been carried out in this paper.In this case，it is necessary to determine key factors thataffectbank stability through the study on relationship among corporate governance，government regulation and bank stability.By adjusting those factors，core competitiveness of commercial banks could be improved，which could promote the sound operation of commercial banks and maintain the security of the entire financial system.

1 Research Design

1．1 Sam ple selection and data sources

In this paper，we collect 16 listed commercial banks'data from the years 2006 to 2012 and use unbalanced panelmodel to analyze.Stock prices are from the CSMAR database;regulatory capital is from annual reports from the years 2006 to 2012 of CBRC.Other data are from the websites of Shanghai Stock Exchange and Shenzhen Stock Exchange，as well as the semiannual and annual reports of listed commercial banks.

1．2 Selection of variables

1．2．1 Explained variables

Data Research Department of Investor Report selected four indicators:capital adequacy ratio，non－performing loan controlling，provision coverage level，and liquidity to measure bank stability.CBRC holds that the core indicators of banking supervision should be divided into three levels:the levelof risk，risk migration and risk compensation，a totalof seven categories of 16 indicators.In this paper，bank stability consists of three aspects:safety，profitability，and liquidity.Therefore，six indicators are selected to measure stability of monomer bank， such as non－perform ing loan ratio(N)，provision coverage ratio (PR)，returns on equity(R)，cost－to－income ratio(C)，liquidity ratios(L)and loan－deposit ratio(DR).In this paper，all indicators of bank stability are standardized using the mean value and standard deviation as the benchmark.Then the bank stability index(BSI)of bank stability could be established by arithmetic average.Because the N ratio，cost－to－income ratio and loan－deposit ratio make negative contribution to bank stability，reciprocals of the three indicators should be taken before normalization and equalization.

n;j=1，2，…，m;i means bank i，j means indicator j．

1．2．2 Explanatory variables

With reference to the viewpoint of Cao and Wang［31］，we use the shareholding ratio of the largest shareholder(O)，property of the largest shareholder(S)，shareholding proportion of the top ten shareholders(T)，executives shareholding(M)，executive compensation(C)，size of the board of directors (B1)，and independent directors proportion(I)as indicators to measure corporate governance mechanisms.In this paper，Q=is used to calculate franchise value(F)，P representsVstock price，N represents number of shares，BLrepresents book value of liabilities，and BArepresents book value of the bank's total assets.Because of the endogenous feature of franchise value，it may not be independent from bank stability，and the first order lag franchise value is used as explanatory variable.As for themeasure on capital regulation，dummy variables were set up［20，32-33］.Different from their studies，in this paper，number of regulations and normative documents selected by the CBRC，total number of employees，violation amount of investigation，number of illegal financial institutions that had been dealtwith，all kinds of on－site inspections that canceled senior management qualifications，on－site inspection coverage are used as indicators tomeasure capital regulation.Regulation index is built by bank stability index.Different from the studies of Zhang and He［27］，for themeasure of implicit insurance(D)，we assume there are more implicit protection to the four major state－owned banks. Therefore dummy variables are set up to control bank property. For the fourmajor state－owned banks，the variable would be 1. Otherwise the variable would be 0.

1．3 Establishment of regression model

Using bank stability as explained variables and FV，R，D，S，X，O，T，B1，I，M and Z as explanatory variables，multiple regressionmodels of the panel data of Chinese listed commercial banks are as follows: where BSIi，trefers to different measurement factors of the stability of bank i in the period of t.FVi，t－1is the franchise value of bank i in period t－1.β0i，tis the intercept.β1，β2，β3，β4，β5，β6，β7，β8，β9andβ10represent the regression coefficients of FVi，t－1，Ri，t，Di，t，Zi，t，Oi，t，Ti，t，B1i，t，Ii，t，Mi，t，and Si，tto bank stability，andηi，tis the error term.

2 Em pirical Analysis

2．1 Descriptive statistics

Table 1 lists the characteristics of the descriptive statistics of related variables.There is huge difference among the minimum values and maximum values of the shareholding proportions of the largest shareholder and top ten shareholders，which means there is a big difference between remuneration levels of different banks.The gap between shareholding proportions of the largest shareholder and the top ten shareholders indicates the big difference in equity situation among different banks.Difference among other variables is not so big;there would be no further discussion.

Table 1 Descriptive statistics of variables

2．2 Analysis on correlation

From the results of Table 2，it can be seen that there is certain correlation between explained variables and explanatory variables.According to significance test，the correlation is basically in line with the regression analysis.Most of the correlation coefficients between the explanatory variables are smaller than 0.5，indicating that the multicollinearity of variables may not exist.In order to further examine the multicollinearity between the variables，we conduct a VIF test. From the results of Table 3，the maximum is 6.430，and the minimum 1.111.Both of the maximum value and minimum value are smaller than 10，indicating that there is no significant collinearity between themajor variables.

Table 2 Correlation of variables

Table 3 VIF test table

2．3 Regression analysis

Many factors affect the stability.In addition to corporate governance and government regulation，there may be omitted variables，such as external macro－environment.The use of cross－sectional data or time seriesm ight cause heteroscedasticity and serial correlation，which lead to inaccurate regression results.Therefore panel regression analysis is adopted.Detailed results of regression analysis could be found in Table 4.

Table 4 The result of regression analysis

It could be seen from the regression results in Table 4.

(1)From the regression results of ownership structure: property and shareholding proportion of the largest shareholder and shareholding proportion of the top ten shareholders fail atthe significance test，whichmeanswhatever the property of the shareholder，even though they have the right to control the bank，they would not take measures to reduce bank risk and increase bank stability;binding effectof the top ten shareholders to the largest shareholders did not achieve good results. Therefore，changes in the shareholding structure can not affect bank stability in some banks.The point of view that participation of private shareholders reduced bank stability could not be supported.

(2)From the regression results of the board，it could be seen the impact of board size on bank stability passes the significance test;while the impactof independent directors does not.This indicates the board of directors of a listed bank fully plays the functions of supervision and management.The board is able to provide policy advice ofmultiple perspectives，helping the bank to obtain necessary resources.The checks and balances between members are good for the adoption of different suggestions and avoiding operational risks，achieving stable operation.Regulatory functions of the independent directors have not been reflected.Most of the independent directors of listed banks are employed and get paid by the bank.They are not independent in term of economy and controlled by controlling shareholders and management team.They cannot objectively supervise the operation of the bank and have little influence on bans stability.

(3)Shareholding of executives passes the significance test，and the regression coefficient is negative.Passing the significance test indicates that the shareholding of executives can resolve the failure of principalagent.Therefore，ithas relatively small influence on bank stability.Test on compensation incentives of executives in Chinese banks shows that compensation is a major factor for bank stability.Higher remuneration of bank executives increases their working enthusiasm，and thus improve bank soundness.

(4)Franchise value passes the significance test，and the regression coefficient is positive，which indicates the positive correlation between franchise value and bank stability.It is also showed the self－regulatory effects of the franchise value.The more franchise value of a bank，the bigger the cost of bankruptcy after itwas caught in a financial crisis，and themore motivated for the operators to regulate the operation and avoid bank risk.This is to the benefit of stable operation of the bank.

(5)Capital regulation passes the significance test，and the value is positive，which indicates the more regulation from government，the better the bank stability.Regulatory capital sets up theminimum capital requirements for commercialbanks. It improves the ability of resisting risksand w riting off the losses caused by uncertainties，increasing bank stability.

(6)Implicit insurance fails the significance test，and the government implicit insurance can protectboth fourmajor stateowned banks and other banks.Due to the pivotal role of a bank in a country'smacroeconomic system，the country has always been the solid backing of its credit.If there is debt crisis，central banks and localgovernmentswill bear the responsibilities for debt settlement and help banks to survive and maintain a stable economy.

3 Conclusions

This paper takes an empirical analysis on the impacts of corporate governance and government regulation towards bank stability.The results show that:the nature and percentage of ownership have no significant impact on bank stability. Supervision of board of directors increases bank stability，while independent directors can not increase bank stability.Higher executive compensation increases bank stability，while shareholding of executives does not show much incentive function.Franchise value has self－regulatory effects.Capital regulation also improves bank stability.Implicit insurance covers the entire banking system.

According to the conclusions of this paper，we put forward suggestions to improve corporate governance and government supervision on increasing bank stability.(1)A diversified ownership structure should be established by bringing in strategic investors and changing the situation of simple ownership structure.Improvement of corporate governance and management level could increase bank stability.(2) Responsible system of directors and supervisors should be established.Directors should bear corresponding legal responsibilities and perform faithfully their duties of trustees. Supervisors should strictly fulfill their supervisory duties，and conduct due diligence to directors，senior managers as well as other staff and supervise banking operations.Their regulation and supervision shall not be interrupted by shareholders.(3) The shareholding of executives and compensation incentive systems should be further improved to resolve the“principalagent failure”.(4)By changing banking business model，expanding the range of intermediate business and developing business innovation，franchise value should be increased.(5) CBRC could increase its efforts on violation investigation and non－compliance of financial institutions.It could also increase the coverage of on－site inspection.Strengthening bank capital supervision could increase bank stability.(6)To change the implicit insurance system into an explicit insurance system. Improvement of supporting policies should also be noticed.

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1672－5220(2015)04－0700－05

date:2014－01－17

s:M inistry of Education Humanities and Social Science Youth Fund Project，China(No.12YJC630157);ShanghaiUniversity of Engineering Science，China(No.2012pg33)

*Correspondence should be addressed to WANG Yu－ming，E－mail:309198080@qq.com