Free trade with China has changed the way America does business since the country joined the World Trade Organization (WTO) in 2002.
Industries across the U.S. economy have seen significant upheaval as a result of competition with Chinese business and industry. The effects of reduced manufacturing, employment, wages, and labor force participation are well documented.
But what about banks? A new study from a Tippie College of Business researcher finds the financial services sector has been hit hard in those regions, too, especially small community banks that rely on local businesses and borrowers.
The study finds the banks haven’t been directly affected by competition from Chinese banks, which are not allowed in the United States. But community banks are indirectly affected as their local economy begins to wither in the face direct competition.
Researchers led by Jiajie Xu, assistant professor of finance, looked at banks in 3,133 US counties to see how they were affected by China joining the WTO between 2001 and 2017. Using data from regulatory filings, researchers found that local banks in counties that were less affected by Chinese competition—mostly in large metro areas or coastal regions— showed little impact when measured by bank profitability, loan quality, deposit and loan pricing, and loan growth.
However, banks in counties that were more heavily affected—located mostly in Rust Belt areas in the Midwest, South, and Northeast—saw significant declines in business measurements across the board as a result of second-level impacts.
Xu said those banks’ loan activity shows just how hard they’ve been hit.
--Loan quality deteriorated, as local borrowers lost their jobs or otherwise saw their income cut and could no longer pay back their loans.
--Banks saw 11.1% drop in return on equity in their loan portfolios from the year 2001, before China’s WTO entry.
--Nonperforming loans increased 87%.
--Net charge-offs to total loans jumped to 90 percent and loan loss provisions to total loans skyrocketed 243%, suggesting banks that are in crisis.
Those banks also showed slower loan growth and higher loan interest rates, as they attempted to make up for the lower performing loans. This was true in all categories of loans, including mortgages, consumer loans, and even credit cards.
Aside from loans, bank profitability also declined and mergers and takeovers led to increased concentration that reduced small bank market share by 13%.
While banks took measures in an effort to reduce the damage, such as increasing interest rates or tightening lending standards, the negative impact persisted through 2017. This suggests those changes were not effective enough to reverse the long-term impact of the shock and likely made the situation worse, Xu said.
“This long-lasting negative impact on local U.S. banks is consistent with the negative impact of China’s WTO entry on other social, economic, and political aspects of the U.S.,” she said, adding that the change is likely permanent and continues today, and is not a one-time event.
The study found large regional or national banks were less affected by the competition, largely because they had resources in prosperous counties they could transfer to struggling branches.
But in small markets that don’t interest the big banks, community banks are often the lifeblood of the economy. Most lending is to local firms, so the performance of their loan portfolio is a good indicator not only of the bank but the local economy. In fact, Xu said prior research shows that gauges of bank loan portfolios reflect and predict the current and future performance of regional economies.
She said that in trade agreements, financial institutions are too often treated as a sidelight, with the expectation that they’ll always be there. The study suggests they need to be as primary a consideration as other economic impacts.
Xu’s paper, “China’s WTO Entry and Local Banks,” will be published in the Journal of Money, Credit, and Banking.
Media contact: Tom Snee, 319-384-0010 (o); 319-541-8434 (c); tom-snee@uiowa.edu