Study on the Risk Transmission Mechanism of Rural Banks in China *

Transcription

1 06 nd International Conference on Modern Education and Social Science (MESS 06) ISBN: Study on the isk Transission Mechanis of ural Banks in China * Shan-Shan WANG,,a, Jian-Guo WEI,b, Juan CHENG 3,c, *, Shuang PAN,d Law School, Yunnan Minzu University, KunMing, Yunnan, China School of Econoics, Wuhan University of Technology, Wuhan, Hubei, China 3 Shenzhen Branch of Shanghai Pudong Developent Bank, Shenzhen, Guangdong, China a @qq.co, b weijg@whut.edu.cn, c @qq.co, d @qq.co *Corresponding author Keywords: ural banks, Credit risk, Transission echanis, isk anageent. Abstract. This paper studies the rural banks credit risk factors and risk transission path, sets up a nonlinear differential dynaical syste odel for the transission and analyzes its equilibriu by phase-plane ethod, then discusses how credit risk dynaically configures to reach equilibriu aong the nodes in the transission process. The paper s ain conclusions are as follows: the sources of rural banks credit risk are transitted inside the banks by virtue of the carriers of capital flow and inforation flow, and the recipients in the banks internal credit risk transission ay becoe new risk sources and lead to regional financial risks; the credit risk dynaic configuration ay reach equilibriu aong the nodes in the transission subsyste. Finally, this paper gives suggestions on credit risk anageent of rural banks in China. Credit isk Factors of ural Banks Credit risk transission of rural banks refers to the risk generated fro credit activities of rural banks being transitted to distinct nodes and their external associated parties. It possesses specific carriers and paths, and leads to deviation fro expected profits of rural banks and related parties. A coplete risk transission syste consists of five eleents: sources, transission carriers, transission nodes, risk recipients and risk threshold. isk transission path is interpreted as the process that risk flow based on transission carriers transfers aong nodes and finally exerts effects on soe recipients. Credit isk Sources of ural Banks To exactly define risk sources is the foundation of research on credit risk transission of rural banks. The uncertain factors, which affect the operation of rural banks both internally and externally, ay becoe the credit risk source. In this paper, credit risk sources of rural banks are categorized into external sources and internal sources. External risk sources include: Natural environent. Agricultural production is naturally weak, susceptible to ipacts of natural environent. Farers would suffer great daage when they encounter droughts, floods, epideic diseases, fires and insect outbreaks. Market environent. With long production cycle, farers who generally lack risk hedge instruents could only passively accept price fluctuation in agricultural product arket. Policy environent. Doestic agricultural production is backward and strongly subjected by national agricultural policies. Farers revenue is sensitive to the changes of the policies. * This paper is financially supported by National Social Science Fund in China: Study on the Innovation of Credit isk Managent for ural Bank under Fragile Credit Environent ( Grant No. 4BGL85). 99

2 Credit environent. ural credit syste in China is not perfect, and national credit syste is still under construction. Less educated farers are lack of credit consciousness and largely dependent on agricultural support policies. If the intended use of the loan is arbitrarily changed by borrowers to high risk projects, or if the repayents of the principal and interests are not on tie, it ay trigger the outbreak of credit risks. Internal risk source refers to lack of awareness and sound credit risk anageent syste, shortage of qualified risk anageent personnel, eployers lower operating capability, etc., which leads to iperfect execution of credit review, poor credit check anageent and consequently exposes rural banks to credit risk. Credit isk Transission Carriers Transission carriers are those tangible substances or intangible effects that transfer inforation and knowledge. In the process of risk transission, carriers bear risks created by sources and then deliver it out. Capital flow is an iportant carrier of risk transission since capital is rural banks operation object. When the lenders are stiulated by external risk sources or the borrowers fail to evade internal risk sources, capital chain will break, then credit risk will occur. Siilarly, huan resources flow and inforation flow could be credit risk carriers of rural banks. A well-perforing syste of inforation anageent contributes to coprehensive collection of borrowers inforation, which would be helpful to reduce adverse selection and oral hazards due to inforation asyetry. Highly qualified professionals could identify risk factors of a loan so that the credit risk could be prevented and controlled. Credit isk Transitting Nodes Transitting nodes are joints that internal and external risk overlaps and utually penetrates. Since risks are gathered and released at nodes, the control of nodes concerns risk transfer effects being weakened or enhanced. If a transitting node could actively absorb and resist credit risk transferred fro other nodes, it could weaken transfer effects of credit risk or even terinate risk transission of the syste. Conversely, if a transitting node is incapable of reducing or shifting risks, it would be significantly shocked by the risks. [] And the shock ay converse into a new risk source and transfer to other nodes, which would bring huge loss to the syste. Credit isk ecipients If the credit risks are not released at previous nodes in the transission, they will be accepted at soe nodes, which are called credit risk recipients. When risks on soe recipients accuulate to a certain degree (risk threshold), the previous recipients becoe new sources of risks and ipact other recipients. Cobing all factors entioned above, we will obtain a logic diagra of risk transission: Figure. Logic Process of isk Transission. 930

3 Credit isk Threshold isk threshold is the upper liit of risk that a transission node or a risk recipient could bear. isks will flow through invisible valves during the transission. If the physical energy of risk flow surpasses the threshold, it passes the valve and approaches the next node or recipient. If the physical energy does not reach the upper liit, the valve will terinate the process and eliinate influences on the recipients. One point needed to be addressed is that if a risk flow ceased at one node encounters another flow and fors a strong coupling effect, it will lead to a greater risk flow to affects the recipients. isk threshold is not fixed since external or internal environent of rural banks ay often cause soe changes to the threshold value. A decrease of risk threshold indicates a decline of defense ability against risk. While an increase of the threshold indicates strengthening of risk defense ability, which produces positive effects on risk transission control. Credit isk Transission Path of ural Banks The path of risk transission refers to the route fro risk sources through transission nodes to risk recipients. Credit risk of rural banks can be classified into pre-loan risk and post-loan risk. The forer is caused by adverse selection, and the latter is attributed to oral hazards. This paper ephases the analysis of post-loan risk. We divide the credit risk transission of rural banks into two aspects: internal credit risk transission and regional financial risk transission outside rural banks. We firstly hypothesize that: () There is only one rural bank and one borrower within the syste, and loan application of borrower has been approved; () The bank fails to identify the usage of credit loan; (3) The bank and the borrower are rational; (4) The borrower is willing to take corresponding risks for higher return; (5) No collateral is needed when applying for a loan. Under these assuptions, the transission path of credit risk in rural banks can be depicted as Figure : Figure. Internal Transission Path of Credit isk of ural Banks. A borrower would use the fund for other purpose to axiize his benefit after he got the loan. Then, speculative inforation becoes a risk source which creates stiulus to the borrower via inforation flow. If the borrower is aware of higher return project which is not copliant with lending contract, he potentially chooses to breach covenants. Under the circustances a deviation in loan usage fro the expectation of rural banks will occur, and consequently physical energy of risk in this node will exceed the threshold value and pose credit risk to rural banks. [] 93

4 Even if the borrower uses the fund according to covenants, credit risk would eerge. In such condition, the borrower is confronted with new risk sources, including natural environent deterioration, unfavorable change of arket prices of products, introduction of adverse policies. These sources together with inforation flows will stiulate the nodes. If physical energy of risk exceeds threshold value, the borrower faces losses and will choose a passive breach, which exposes rural banks to credit risk. If the threshold value is not reached, the borrower is capable of resisting risks and acquiring expected benefits. New risk sources would also arise after the borrower acquires the expected benefits. He would intend to refuse repayents with the belief that he will not be severely punished, which results fro the borrower s weak credit consciousness. Siilarly, the borrower will not repay the loans if the threshold value is exceeded, and vice versa. As above, there are three cases that would trigger the borrower to default the loan, which ay lead to credit risks for rural banks. [3] If the risks are not controlled proptly, they would be converted to new risk sources and react with external ones, then initiates another risk transission process. Transission Path of egional Financial isks Analysis above is based on the assuption that there is only one rural bank and one borrower within the syste while the actual credit risk transission is far ore sophisticated. Thus, we will relax the assuption to a nuber of rural banks, depositors and borrowers while keeping other assuptions the sae. When physical energy of risks reaches the threshold value at each node, path of credit risk transission can be depicted as Figure 3: Figure 3. Transission Path of egional Financial isks. ural banks are risk recipients in the internal credit risk transission. The afterath of risk transission is that credit risk occurs if borrowers default on loans is not punished. Meanwhile, recipients being exposed to credit risk ay becoe a new risk source and continue spreading. Borrowers not being punished for default initiates the effect of broken window that if bad phenoena are left unregulated, ore and ore people will be tepted to behave badly. Therefore, one borrower defaulting on his debt potentially leads to iitation of other borrowers, creating probles for capital chain and inducing liquidity risk [4]. 93

5 A network of relationships is fored aong farers due to blood and regional factors. Inforation inside the farer group is coplete so that any bad news of rural banks will be quickly spread, which will also accelerates the spread of risk inforation. Banks would face a risk of runs. On the other side, liquidity risk will undoubtedly result in other borrowers with good credit records incapable of acquiring loan. If there exist a large nuber of farers who are heavily dependent on bank loan in one area, the break of capital chain would directly result in frustration in regional production and deterioration of econoic environent. Liquidity risk induced by credit risk of rural banks and other financial institutions, together with deterioration of econoic environent, would lead to regional econoic crisis. Suarily, credit risk sources of rural banks, through the ediu of inforation flow and capital flow, transit in a particular route inside the bank. Those sources exert effects on individuals and related departents outside the banks through financial transactions, which will generate credit risk and ay even aplify the risk. ecipients of credit risk transission inside the bank ay becoe new risk sources, which would consequently lead to regional financial risks. Credit isk Transission Model and Equilibriu Analysis Model of Credit isk Transission The general odel of credit risk between two conductive nodes is constructed subsequently, and equilibriu process of risk dynaic configuration is explored. Model assuptions and sybols are given as follows: Firstly, transission of credit risk between two nodes has no friction. And () t, () t are the risk values of two transission nodes at tie t respectively. Secondly, and are risk thresholds of two transission nodes. Thirdly, each transission node has a certain ability of risk iunity owing to soe factors such as risk anageent level at the node, which contributes to a better withstanding of risk. Nonetheless, the ability of risk iunity is finite, which eans that the transission node is not fully iunized against credit risk., stands for coefficients of risk iunity for two nodes and 0 i ( i,) holds obviously. Lastly, risk transission is utual between two nodes within the subsyste. stands for coefficients of risk transission fro node A to node B, and stands for coefficients fro node B to node A. There are three effects in credit risk transission process, naely transission effect, retarding effect and iunity effect. Transission Effect In the transission syste, the risk accuulation rate at each node is proportional to the risk status of adjacent node. For instance, the higher the risk level at node, the faster the risk accuulation at node. This reflects the transission effect of the subsyste of risk transission. We denote credit risk accuulation rate at node and as () t and () t respectively, with () d t dt, t () d. () dt The correlation that represents the transission effect of credit risk is that () t and () t are positively correlated with and respectively. etarding Effect isk anageent easures are adopted in each node in risk transission subsyste. With the conduction and accuulation of credit risk, its spread speed attenuates gradually. The retarding factor at node and node can be defined as / and / respectively. 933

6 etarding effect of credit risk transission iplies that () t is negatively correlated with /, and () t is negatively correlated with /. Iunity effect Not only retarding effect works at each node, the node can also be iunized with liits against risk transitted fro other nodes, which eans that the risk-bearing capability at each node is expanded and the risk threshold is increased. To be ore specific, the increased risk threshold at node is, and that at node is. Based on analysis above, the rural banks of credit risk subsyste transission odel is constructed as follows: t t ( ) ( ) ( ) ( ). () Differential equation set () is a nonlinear differential dynaic syste odel, which is difficult to solve using regular differential equation ethods. Therefore we choose phase-plane ethod to analyze its trajectory characteristics in order to reveal the risk transission process between two nodes and the status of risk equilibriu configuration. [5] Equilibriu Analysis of Credit isk Transission The Equilibriu Point and its characteristics of Credit isk Transission Model According to the distinguishing theore, the equilibriu point of differential equation set () should satisfy following conditions: f g (, ) ( ) 0 (, ) ( ) 0. (3) Solving equation set (3) we obtain two equilibriu points,naely the origin point(0,0) and point * * Q(, ), with,. * * (4) Considering the external risk sources and risk transission, credit risk cannot be copletely * * eliinated. Hence the origin point(0,0) is not a rational solution, which indicates that point Q(, ) is the unique equilibriu point of the odel. Since the odel is a two-diensional nonlinear differential dynaic syste, the characteristic atrix Z is introduced to further explore the stability characteristics of equilibriu point Q. Z [ ] f f ( ) g g [ ] ( ). (5) 934

7 Substitute Q into corresponding characteristic root equations of atrix (5), discriinants are expressed as: ( ) ( ). (6) n ( ). (7) n 4 4 ( ). (8) Taking into account the above third assuption as 0 i ( i, ), then 0, therefore 4n 0 and 0, n 0. According to the distinguishing theore, the unique equilibriu point Q is the stable node of this differential dynaic syste. Trajectory Evolution and the Equilibriu of Credit isk Transission Model A two-diensional phase-plane is built on the plane set {(, 0, 0} and is divided into four regions by boundary lines L and L. L is deterined by and L deterined by ( ). (9). (0) * * The intersection of two boundary lines is the equilibriu point Q(, ). The distribution of trajectory gradient of four regions is shown as follows: S : 0, 0 S : 0, 0 S3 : 0, 0 S4 : 0, 0 The trajectory evolution of the phase-plane of credit risk transission is displayed in Figure 4. Q(, ) * * Figure 4. The Evolution of the Phase-plane Trajectory of Credit isk Transission. The evolutionary track of trajectory of credit risk transission odel can be concluded fro Figure 4. If the initial risk of credit risk subsyste is located within region S, the transission trajectory will either enter into S 4 through boundary line L or enter into S through boundary line L. If the 935

8 initial risk of the subsyste is located within region S 3, the transission trajectory will either enter into S through boundary line L or enter into S through boundary line 4 L. If the initial risk of the subsyste is located within region S or S 4, the transission trajectory will ove towards the equilibriu point Q. Since the gradient direction of point Q is 0 and 0, the trajectory would stop at equilibriu point once it reaches there. Consequently the trajectory evolution of risk transission reaches equilibriu. The following conclusions can be drawn accordingly. In the transission subsyste, credit risk dynaically configures and reaches equilibriu between two nodes, and its accuulation speed at each node is positively correlated with the transission effect and iunity effect but negatively correlated with the retarding effect. The accuulation speed of credit risk is the synthetic effect of risk transission, risk retarding and risk iunity. Policy Suggestions for Credit isk Manageent of ural Banks Based on the analysis of transission echanis of credit risk, policy suggestions about the credit risk anageent of rural banks can be ade in the following three aspects: iniizing influences of risk sources, controlling risk transission nodes and iproving risk thresholds. Miniizing Influences of isk Sources Establishing and Iproving Agricultural isk-sharing Mechanis The priary easure of agricultural risk-sharing taken by rural banks is the agricultural insurance. It can copensate the loss fro risks and curb the risk transission in a certain degree when farers econoic condition gets worsen. [6] Governent should iprove the policy to support agricultural insurance syste, in which the policy insurance doinates and coercial insurance suppleents. Moreover, governent should guide farers, sall and ediu rural enterprises to participate in agricultural insurance. Governent should subsidize the insured individuals and enterprises to increase their enthusias and induce the uninsured to purchase insurance. A sound agricultural insurance syste contributes to protecting farers interest and iniizing the occurrence of credit risk. Copleenting the ural Credit Syste The People s Bank of China should cooperate with local governent and related departents to jointly set up a working group to construct a sound credit syste in rural areas. ural bank should establish electric archives household by household, and share the credit database of the People s Bank of China and establish electronic credit records in accordance with its deand, which can help the rural bank to coprehensively grasp custoers credit inforation and accurately deterine their credit level. ural bank should cultivate farers credit awareness with the help of local governent. It needs to do soe work such as prooting credit knowledge, conducting credit knowledge contest and farers credit rating copetitions, etc. Controlling isk Transission Nodes Pre-loan investigation echanis should be strictly ipleented. When a rural bank receives a loan application, it should conduct a rigorous assessent to the borrower s credit status through a coprehensive survey. The assessent should include the legitiacy of borrowing, the safety of loan usage, the profitability of borrowing projects, etc. The details are illustrated as follows: legitiacy of the borrower, the existence of valid collateral, financial status, operating conditions and repayent ability. Post-loan supervision should be strengthened. After the loan distribution, staff ebers of the bank should regularly visit the borrower, pay special attention to changes of the borrower s operating conditions and financial status, and the changes in collateral price. The rural bank should 936

9 appropriately anages repayents of loan and roll over loans for qualified borrowers. Collections and punishents are necessary for overdue payents. The punishent echanis for dishonesty should be strengthened. Credit inforation database should be constructed and shared as soon as possible. Classify borrowers with good credit records into the red list and borrowers with poor records into the black list or grey list according to the seriousness of default. Interest of loan, credit line and transaction process should differ for custoers with different credit ratings so as to increase costs of dishonesty and encourage trustworthiness. Iproving isk Thresholds The rural bank s inner control syste should be iproved. With respect to the internal governance structure, rural bank should proote diversity of its ownership structure, iprove corporate governance echanis, perfect internal rules and regulations, and increase the intensity of internal audit [7]. The separation of review, credit lending and check followes. Three links in loan process, such as pre-loan survey, in-loan processing and post-loan supervision, ust be strictly separated, and each link s responsibility ust be ipleented on different persons to for utual restraint echanis for loan officers and transaction procedures.this can achieve ultiple effect to control credit risk. All these work would be helpful to iprove the risk thresholds. eferences [] Y. Zhang, M.X. Zhu, Financial risk transission under open econoy: conditions, path and echanis, Counication of Finance and Accounting (05) 3-5. [] W.J. Bai, N.N. Zhang, esearch on the transission echanis of interest rate risk in life insurance copany, Hainan Finance (03) 8-. [3] J. Grunert, L. Norden, M.Weber, The role of non-financial factors in internal credit ratings, Journal of Banking and Finance 9(005) [4] F. Allen, E. Carletti, Credit risk transfer and contagion, Journal of Monetary Econoics 53(006) 89-. [5] H. Gu, F. The conduction odel and echanis research of credit risk of coercial banks under the cooperation of bank and insurance - Based on the environent of risk liited iune syste, Journal of Finance and Econoics 6(04) [6] W.C. Wu, Analysis on the present situation of developent and risk control of rural banks, China Market 5(05) [7] J.. Huang, C.P. Lin, Discussion on iproving internal control of rural banks, Developent esearch (04)