Real estate investments and financial stability: evidence from regional commercial banks in China

The 2008 US subprime mortgage crisis demonstrated how developments in real estate markets can cause instability in the banking sector and raised concerns in many emerging economies with significant real estate development and a rapidly growing commercial banking sector, particularly in China. There is clear evidence that commercial banks in China, especially regional commercial banks, have lent significantly to the real estate sector. The recent slowdown in the housing market in China and the increase in nonperforming loans (NPLs) in China's commercial banking sector motivated us to investigate the connection between real estate markets and banking stability. This paper proposes three testable hypotheses linking the growth of investment in real estate and the stability of regional commercial banks in China, measured by NPLs. Our empirical results reveal a close connection between the growth of investment in real estate and the NPLs among regional commercial banks, and its sensitivity to real estate market cycles. When real estate market activity declines, our results suggest, regional commercial banks can find themselves in trouble if they have significant exposure to one type of (real estate) asset. In addition, we find that regional bank competition plays a critical role in defining the relationship between bank stability and real estate investment activity.