Banking Structure, Marketization and Small Business Development: Regional Evidence from China

Abstract

This paper provides an empirical examination of the regional banking structures in China and their effects on entrepreneurial activity. Using a panel of 27 provinces and four directly controlled municipalities from 1997 through 2008, we find that the presence of large banking institutions negatively correlates with small business development in local markets and that this negative relation is driven mainly by participation of large banks in the short-term loan market. Rural banking institutions, in contrast, are found to promote regional entrepreneurial activity. Moreover, large state banks facilitate small business development in concentrated markets. When we interact measures of banking financing by state banks and rural banking institutions with a set of provincial level marketization indexes, we find that extensive marketization, factor market development, and sophistication of legal frameworks mitigate the negative effect of large state banks on small business development. In provinces with advanced market development, efficient factor markets, and favorable institutional settings, the positive effect of rural banking institutions on small business growth is even stronger. Finally, we present evidence that banks do a better job of promoting regional entrepreneurship when it occurs in conjunction with policies to foster innovation activity and assure protection of intellectual property rights.