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Chinese commercial banks are transforming their activities into more non-interest income businesses under a highly regulated financial system. This paper investigates the effects of this transformation on profit and risk efficiencies. We find that commission and fee income significantly reduce risk efficiency due to the circumvention of the regulation on deposit interest rate and the assumption of risk that should have been borne by customers. In terms of trading income, it significantly reduces profit efficiency due to the upper limit of the loan-deposit ratio, the lack of investment channels and low returns of bond markets. The regulatory authorities are supposed to further liberalize the banking industry and grant banks more rights.

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This paper estimates the cost and profit efficiency of the Chinese domestic banking sector to evaluate the effectiveness of China's financial reforms since 1978. We use the performance of foreign banks as the benchmark because foreign banks, subject to intensive worldwide competition, are perceived as possessing superior governing structure and organization, more advanced technologies and better trained labor force. On the other hand, competition in China's banking sector is mainly in the form of nonprice measures, thus putting foreign banks at a disadvantage. We find domestic banks have gradually caught up the cost advantage of foreign banks in a manner consistent with the increased competitive pressure. On the other hand, the profit advantage of domestic banks over foreign banks is widening because of institutional arrangements, cultural and social networks as well as the profit scope and revenue scale economy.

This paper estimates the cost and pro…t e¢ ciency of Chinese domestic banking sector to evaluate the e¤ectiveness of China's …nancial reforms since 1978. We use the performance of foreign banks as the benchmark because foreign banks, subject to intensive worldwide competition, are perceived as possessing superior governing structure and organization, more advanced technologies and better trained labor force. On the other hand, competition in China's banking sector is mainly in the form of nonprice measures, thus putting foreign banks at a disadvantage. We …nd domestic banks have gradually caught up the cost advantage of foreign banks in a manner consistent with the increased competitive pressure. On the other hand, the pro…t advantage of domestic banks over foreign banks is widening because of institutional arrangements, cultural and social networks as well as the pro…t scope and revenue scale economy.We would like to thank a referee and a co-editor, G.