China Commercial Banks’ Franchise Value And Risk-Taking Behavior

Franchise value is the present value of a bank’s upcoming excess return obtained from its advantage to continually operate in this specific market. This kind of advantage comes from the bank’s dominant power in the market, but the bank can also further magnify its franchise value through efficiency creating. According to the traditional theory, franchise value can help restrict a bank’s risk behavior. When a bank declares bankruptcy, its franchise value would disappear. Therefore, a bank would spontaneously avoid risks in fear of losing its franchise value. Many scholars have proved that banks of higher franchise value tend to operate more prudently compared with those of lower franchise value. As a result, banks are encouraged to build their franchise value and the regulatory agencies can take advantage of its self-inhibition effect. However, the U.S. financial crisis exposed the vulnerability of traditional franchise value theory. Banks with super-high franchise value in the U.S. market didn’t choose a more robust management style. In fact, these banks excessively involved in risky businesses and ended up pushing the collapse of the entire banking system in the U.S.Experience from America taught us Chinese banks a lesson. This paper aims to explore a reasonable way to quantify franchise value through systematically combing theories related, modify econometric model to measure bank risks through finding risk-determining factors in the new era, and then get the relationship between China commercial banks’ franchise value and their risk-taking behaviors. Next, this paper quantifies franchise value by using Tobin’s Q, considers factors including implicit insurance, market competition, product innovation and mixed operation, and builds econometric model using data of 16 listed banks from 2007Q4 to 2013Q3(a total of 24 quarters). The major conclusions of this article are as follows:Firstly, franchise value and risks were positively related in China, and franchise value’s self-constrain effect failed in our country, too; Secondly, implicit insurance and market competition inspired banks’risky behaviors, while product innovation helped making income diversified, thus reducing banks’risks; Finally, mixed operations influenced bank behavior differently. Bank-insurance cooperation and bank-fund cooperation were both proved to discourage risk-taking motivation, but bank-trust cooperation would bring considerable risks.Based on research findings, this paper puts forward four corresponding policy recommendations:Firstly, the regulatory agency should standardize joint-stock commercial banks’ operation; Secondly, it should prevent vicious competition in the banking industry; Thirdly, the government should encourage banks to more engage in financial innovation; Finally, it should pay more attention to new mixed operation modes.