Chinese Financial System: Past, Present and Future

Queries
China's biggest state-run banks 623.61 billion yuan ($99 billion) in annual profits, Chinese financial system is better than the U.S ? Whether external shock will influence Chinas financial reform process against background of international crisis ?

Figure 1 Annual Net Profit for Big 4 State run banks

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Contents
A. The role of finance in economy B. The process of Chinese financial system transformation since late 1970s C. The problems of current Chinese financial system D. Financial System Reform and Economic Imbalance Conclusions

A. Role Of Finance In Economy

A1: definition of Finance: brain of modern economy A2: Concepts of money and finance" in a planned economy in China A3. Concepts of money and finance in a market economy

A2: Concepts Of Money And Finance" In A Planned Economy In China

1. Money is the only financial asset 2. Money is passive , only used as a tool for pricing and accounting. 3. Bank is cashier for the state fiscal system; assumes roles of both central bank and commercial banks, monobank system. 4. Banks financing to enterprises is limited only credit financing for non-budgeted working capital (i.e. ,the part of working capital that is not employed perennially) 5. Households and individuals are not allowed to participate in any financial activities other than opening deposit accounts in the bank.

Financial Repression In Planned Economy

Fund scarcity Prioritizing heavy industry development Distorted productive factor price Lowered the interest rate under the market level State directly controlled the banks, no financial market
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A3. Concepts Of Money And Finance In A Market Economy

A tool of resource allocation Financial system= various financial institutions + financial markets

Financial Deepening And Financial Broadening In Market Economy

Financial deepening: Increase in the ratio of financial assets to national income , or GDP Financial broadening: an increase in the variety of financial institutions and instruments. ----Source: Barry Naughton,The Chinese
Economy: Transition and Growth, pp450
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How Did China Reconstruct the Financial System to Adapt to A Market Economy?

Contents
A. Role of finance in economy B. The process of Chinese financial system transformation since late 1970s C. The problems of current Chinese financial system D. Financial System Reform and Economic Imbalance Conclusions
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B. The Process Of Chinese Financial System Transformation Since Late 1970s

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B1 Changes In Chinas Financial System In The 1980s: Drives

Two Drives: 1. The financial deepening challenged the financial repression policy 2. great changes in Chinese economy:
Peoples communes were replaced by households as units of agricultural production, which greatly expanded the scope of monetary activities Non-state industrial and commercial enterprises, which operated independently and were somewhat market-oriented, began to emerge SOEs were given more decision-making power in financing.
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B1 Changes In Chinas Financial System In The 1980s: Enterprise Financing

*SOEs

Major source: fiscal appropriations Perennially employed fixed asset investment and working capital (budgeted working capital) came from state budget short-term loans from the PBoC Temporary funds for daily operations (non- budgeted working capital) depended on short-term loans from the PBoC. replacing fiscal appropriation with banks loans for investment in capital construction (since 1985), encourage paid use. some enterprises began to raise funds through the securities market *Non-state sectors had to support their operations through self-financing

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B1 Changes In Chinas Financial System In The 1980s: Introduction Of New Financial Instruments And The Start Of Capital Markets Pre-reform: Cash and bank deposits in planned economy After reform
Offer Commercial paper discount service Offer Rediscount service Restore bond issues Establish corporate bonds and treasury bonds secondary markets Establish Shanghai Stock Exchange and Shenzhen Exchange(1991,1992)
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B1: Changes In Chinas Financial System In The 1980s: Organizational Structure Of Financial Institutions
Central Bank (PBoC) State-owned commercial banks
Industrial and commercial bank of China Agricultural Bank of China Bank of China Peoples Construction Banks of China

Commercial banks
Joint stock commercial banks

China Huaxia Bank Bank of Communications CITIC Industrail Bank China Everbright Bank Guangdong Development Bank Shenzhen Development Bank Shanghai Pudong Development Bank China Merchants Bank Fujian Induatrial Bank

Non-bank Financial Institutions

Trust Investment Companies Finance Companies Financial Leasing Companies Rural Credit Cooperatives Urban Credit Cooperatives 15

B1: Changes In Chinas Financial System In The 1980s: Central Banks Approaches To Macroeconomic Control
Pre-1979: Unified control over deposits and loans 1979: centralized planning, managing at different levels, linking Deposits with loans, and controlling the balance
1981: centralized planning, managing at different levels, linking Deposits with loans, and balance responsibility 1985: centralized planning, partition of funds, actual loans linked to actual deposits, and mutual financing

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B2:The Banking Reform in 1990s and Its Future Direction

1. Major Problems in Chinas banking system before 1994 reform 2. The Progress of the banking reform since 1994

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1. Major Problems In Chinas Banking

System Before 1994 Reform
a) PBoC: could not effectively perform its fundamental role in maintaining the stability of currency. b) Commercial business were not separated from policy related businesses in specialized banks. c) The market was in disorder and developed in a distorted way.
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2. The Progress Of The Banking

Reform Since 1994
1) Establishment of a separate central bank system 2) Establishment of Commercial Banks independent from the mono bank 3) Reform of Foreign Exchange Control System 4) Establishment and improvement of the financial supervision system
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1) The Establishment Of The Central Bank System

Switching the monetary policy from multi-level adjustment to single-level adjustment.
Replaced its 31 main branches in the provinces by 9 regional offices to further eliminate interference of local governments in the central bank s monetary policy and financial supervisions

Making indirect adjustment the core of the macro adjustment system.

Objectives of the PBC( Law of the Peoples Bank of China,1995): maintain the stability of currency and thereby promote economic growth; Intermediate objective: change from regulating credit quotas to regulating money supply

Policy tools: rediscount business, open market operation and reform of credit control system, improvement on interest rate mechanism
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2) Establishment Of Commercial Banks

Independent From The Mono bank

The four preexisting specialized state banks( the big four) were transformed to wholly state-owned commercial banks. separation operation established. non-wholly state-owned, joint-stock banks were established to foster competition within banking sector. Three policy banks were simultaneously created to fiance the infrastructure development to support Chinas agricultural sector and export industries
- China Development Bank, Agricultural Development Bank (ADB) Export-import Bank of China.

This decision freed the Big Four to become more focused on commercial Business
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3) Reform Of Foreign Exchange

Control System In 1994
Pre-reform and opening up:
Unified control over revenues and expenditures in FX Dual-track of foreign exchange rate FX retention

Reform in 1994
Sale and purchase of FX under current account Establishment of inter-bank FX market Merger of dual rate Formally accepted Article 8 of the International Monetary Fund Agreement, undertaking obligations of IMF members.
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Financial Institution
Bank System Commercial Bank

State-owned banks Joint-stock banks

Non-bank Financial System

Security Companies
Credit Housing & Cooperatives

Urban and Rural United Commercial bank Foreign banks

Policy-related Bank
The Central Bank (The Peoples Bank of China)

The State Development Bank The Agricultural Development Bank The Import and Export Bank

Trust & investment companies Insurance Companies Leasing Companies Funds Companies
Asset Management Company
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Financial Market

Monetary Market
Interbank Offer Market Repurchase Agreement Market

Capital Market

Foreign Exchange Market

A share

Stock market

B share H share and N share

Commercial Exchanges Market

Treasury Bills market

Bond Market

Treasury bonds Corporate bonds

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Establishment And Improvement Of The Financial Supervision System

The Peoples Bank of China

The China Banks Regulatory Commission

The China Securities Regulatory Commission The China Insurance Regulatory Commission
The State Administration of Foreign Exchange
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Contents
A. Role of finance in economy B. The process of Chinese financial system transformation since late 1970s C. The problems of current Chinese financial system D. Financial System Reform and Economic Imbalance Conclusions
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C. The Problems Of Current Chinese Financial System

C1. the financial system is unbalanced and underdeveloped. C2. the financial system in undersupported C3. the banking system is inefficient C4. the Banking system is potentially fragile.
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C1. The Financial System Is Unbalanced And Underdeveloped

Banking system dominates the financial system, Nonbank financial institutions still have a smaller impact; In banking system, The 4 state-owned banks monopolizes banking operations, Non-state commercial banks were restricted.

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The Stock Market Dominates Capital Market

Chinese Corporate Bond Issuance

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The Treasury Bonds Market Is Dominates The Bonds Market

Treasury Bond Issuance Corporate Bond Issuance

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Financial Service Still Lags Far Behind Financial Institutions In Developed Countries
Banking system The big four bank system is still managed as state banks in an inefficient way Capital market The right to list was rationed through local governments and central ministries. Existing company and securities laws lacked effective civil remedies for investors The bifurcated share structure negatively impacted the markets The price control The government sets all interest rates . The government controlled the pace and price of new share listings

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C2. The Financial System In Under-supported

Rating agencies, accounting and audit bodies, credit ad collateral registries, in formation systems and associated information technology, and the legal system are in their infancy.

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C3. The Banking System Is Inefficient

High operating costs: overstaffed, overly extensive branch networks Their portfolio owe little to market-based assessment of the credit-worthiness of their borrowers, policybased lending is very highlevels of nonperforming loans (NPLs)

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C4. The Banking System Is Potentially Fragile

As a legacy of central planning, the state-owned commercial banks (SCBs) are burdened with massive NPLs,
SCBs are technically bankrupt? though that concept might have little meaning in a system in which the banks and most of their clients are state owned.

How to improve SCBs performance and competitive position, especially after Chinas WTO entry?
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Asian Financial Crisis of 1997-98, a wake-up call

Most bank did not report NPLs systematically until the Bank of China applied for listing of its consolidated Hong Kong subsidiaries on Hong Kong Stock Exchange(early 2001), which started a new chapter in Banking reform. The pace of financial sector reform quickened markedly. In 1999, four newly created stateowned asset management companies (AMCs) absorbed renminbi 1.4 trillion worth of nominal NPLs from 5 SCBs.
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Chinas Commitment To Open The Banking Sector Upon Entry Into The WTO

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What Efforts Have Been Made ?

From 2001 to now: Opening of financial system speeds up formation of competitive financial market

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Reform SCBs into Share-holding System

1. Attract strategic investors both domestically and internationally 2. Financial restructuring--corporate governance reform--go public in stock market 3. Move risk based on lending. Introduced international risk standard introducing AMCs to transfer NPLs Injected capital into the Big Four Banks

4. Making innovative financial products that will better meet households saving goals.
Loans of autos and houses(privatization of urban housing in 1998) Individual financing business Credit Card Business E-banking services
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Making Further Perfect On The Capital Market System

1. Gradually relax segregated business regulation
-Changed from quotas to the approval system in share listing

-Set high auditing standards for the disclosure of information for financial institutions
applying for listing rights -Expand the number and size of investment management firms and let them play an important role in corporate governance.

2. Transfers of Non-tradable Shares of Listed Companies Rules 3. Gradually relax capital flow control to foreign investor FDI, QFII and QDII 4. Revisions were made to the Company Law and Securities Law focused on protecting investors -Non-tradable shares in SOEs listed were required to be converted into tradable shares
-Issued new accounting practices that will bring Chinese accounting practices in line with International Financial Reporting Standards - new Enterprise Bankruptcy Law was approved
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Close Cooperation with International Agencies

China became a member of the BIS in 1996.took full advantage of training and other development opportunities offered by this and other international financial institutions, such as IMF, The World Bank, IFC, and ADB. In parallel PBC developed close cooperation with the monetary authorities of Hong Kong, Singapore, and several other countries for staff training and system development.
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Establishment of an independent banking regulatory /supervisor

China Banking Regulatory Commission (CBRC) established in March 2003 was a watershed institutional development. It separated critical banking supervisory and regulatory functions from central bank and allowed PBC to concentrate on increasingly complex monetary policy changes.
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Removal of Cap on lending rates and floor deposit rates

The partial liberalization of interest rates, combined with the development of new financial instruments and long term contractual savings(insurance and mortgage) also contributed to development and commercialization of capital markets.

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Remained Problems
1. Heavy dependence on the banking system is a significant weaknessfinancial risks are concentrated in the banks The amount of NPLs has declined but not in proportion to the increase in total loans lack credit culture The segregated management control and supervision institutions facing new challenge. The entry approval issues ---firms primarily sponsored by private investors are either not approved or approved with crippling business restrictions The Banking system is relatively closed.

2.
3. 4. 5.

6.

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D. How does Financial System Reform influence Economic Imbalance?

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Domestic Dimensions
Chinas economic and social imbalances
Over-reliance for GDP growth on investment and net-exports Growing social inequality Environmental degradation

One of the reasons for over-investment, particularly in manufacturing, is low ceiling on deposit rates that renders them negative with respect current CPI inflation Low deposit rates have tended to increase excess liquidity in the corporate sector and depress the entire interest rate structure. Negative rates drive financial intermediation from regulated into unregulated----sometimes underground ----financial markets.
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International Dimensions: Chinas Dilemma

Hot money inflows in response to higher domestic deposit rate. To reduce that risk, domestic interest rate liberalization should be combined withflexiblization of exchange rate management and greater capital account opening Dilemma: join the international system fully and play by its rule, or maintain at least some capital controls and influence over the exchange rate.
The first choice risks importing instability; the second risks contributing to instability.
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The Result of Unfinished Financial Reform

National credit crunch Businesspeople borrowed money from private credit circles or invested in real estate collectively Crushing lack of liquidity private lending crisis entrepreneurs fled the city. The fleeing business owners were unable to repay loans they had contracted in the citys underground banking system, according to police. State Council decided to make the city of Wenzhou a pilot region for comprehensive financial reform in 2012

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Pilot Financial Reform Zone in Wenzhou 12 tasks

1. 2. The orderly development of fundraising for private enterprises. Accelerating the development of new types of financial organizations, including joint-stock village and township banks, loan companies and rural financial co-operatives. Qualified micro-credit companies can be developed into village and township banks. The development of special assets management to guide private capital into venture capital and private capital funds. Allowing private direct investments to be made overseas. Deepening reforms of regional financial institutions; encouraging Stateowned banks and joint-stock banks to set up special micro-credit programs for small and medium-sized enterprises; encouraging nonbanking financial institutions to expand their businesses; and encouraging rural joint-stock financial institutions. Developing financial services designed for small enterprises and companies involved in farm production.
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3. 4. 5.

6.

Pilot financial reform zone in Wenzhou 12 tasks

7. Developing local capital markets and encouraging exchanges of property rights - of technologies and copyrights, among other things - among privately held companies. 8. Opening the local bond market to small enterprises. 9. Broadening the insurance sector. 10. Strengthening the credit system to include small enterprises and rural entities and strengthening credit market regulation. 11. Building up a comprehensive local financial regulatory system. 12. Developing a risk management system for financial reforms and duly defining and dividing the local government's responsibilities for maintaining financial stability.

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Summary of 12 tasks
1. Financial access: allow private fund to access to financial system Development of fundraising for private enterprises Capital account liberalization, Allowing private direct investments to be made overseas. Financial system reform, to establish local financial management system

2.
3.

4.

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Whether Wenzhou Approach Will Work?

Roots of fund misalignment
High saving rate lead to fund surplus Monopoly in real economy, and Financial system is heavily dependent on banking

Wenzhou approach is difficult to change the fund misalignment

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Sequence of Reform
As China seeks to further refine its economic model, there will be greater challenges ahead, particularly in terms of balancing environmental and social development with the need for continued economic growth. Priorities in reform
Destroy monopoly in real economy Finance should serve real economy Better overall governance More effective regulation and supervision More reliance on market forces A more supportive legal system
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Conclusion
1. The beginning of transformation of Chinas banking system largely coincides with the reform process instigated by Deng Xiaoping. 2. Chinas state banks----after they had been created----were long used as quasi-fiscal agents to facilitate reform and development of the real economy in according with plan priorities. 3. The Chinese financial system is heavily dependent on banking system, it is a legacy of unfinished economic reform, especially the state-owned enterprise reform. 4. There exists monopoly in banking system, it is determined by the monopoly in real economy. The most active private sectors cannot get fund from official banking system, but the SOEs are eligible to get cheap loans, even they are making loss.
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Cont
5.

6.
7. 8.

9.

Wen Zhou pilot program may not work as expected, if the monopoly in real economy cannot be destroyed. The financial system contributed to Chinas economic and social imbalance Overall, Chinese financial system is inefficient ,weak and closed. The current international financial crisis did not influence the Chinese financial market directly, but Chinese financial system has more flaws. In post-crisis period, China will take a forced reform in real economy, and financial system. Because the international division to be changes, China is losing its comparative advantage. To maintain long stability, reform is needed.
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Questions?

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Glossary of Abbreviations
ABC ADB ADBC Agricultural Bank of China Asian Development Bank Agricultural Development Bank of China

AMCs BOC BoCom CBRC CCB CDB CDC

Asset management companies Bank of China Bank of Communications China Banking Regulatory Commission China Construction Bank China Development Bank China Government Securities Depository Trust and Clearing Co.Ltd.

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CSDCC

China Securities Depository and Clearing Company

CSRC HSBC ICBC IPO JSCBs MBNA

MOF NPLs

NSSF

China Securities Regulatory Commission Honkong and Shanghai Banking Corporation Industrial and Commercial Bank of China Initial Public Offering Joint-stock commercial Banks MBNA Corporation or its main part, MBNA American Bank Ministry of Finance Non-performing loans National Social Security Fund
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PBC RCCs RMB SAEC SAFE SASAC SCBs

Peoples Bank of China Rural Credit Cooperatives Renminbi State Administration of Exchange Control State Administration of Foreign Exchange Control State-owned Asset Supervision and Administration State-Owned Commercial Banks

SDB
SEZ UCCs

Shenzhen Development Bank

Special economic Zone Urban credit cooperatives
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Reference
1. 2010 2. China Financial System2010(Bilingual) 3. Zhu Min, Chinas Emerging Financial Markets: Challenges and Global Impact, John Wiley &Sons(Asia),2009 4. Wu Jinglian, Understanding and Interpreting Chinese Economic Reform 5. (Thomson/South-Western, 2005). 6. Barry Naughton, The Chinese Economy: transitions and growth, (MIT Press, 2007).
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