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Brookings中国金融综述
目录
The Chinese Financial System
I. Introduction
Summary
Key Questions list
II. Key Questions
The Concept of “Total Social Financing”
Who regulates the financial system?
Banking Sector
How profitable is the banking sector in China?
How are lending and deposit interest rates determined?
How did the government reduce NonPerforming Loans?
How did efficiency at the state-owned banks improve over the years?
How do foreign exchange interventions affect China’s banks?
Bond Market
What is the structure of local government debt?
What is the situation of rating agencies in China?
Stock Market
Other Financial Institutions
What is the situation of the trust industry in China?
What is the situation of the insurance industry in China?
What is the situation of the Venture Capital and Private Equity industry in China?
How open is China’s financial system to foreign participation?
The Informal Financial Sector
The Intersect ion of the Financial System and the Real Economy
Conclusions
The Chinese Financial System
The Chinese Financial System
An Introduction and Overview
Douglas J. Elliott and Kai Yan
July 2013
The John L. Thornton China Center at Brookings
About Brookings
The Brookings Institution is a private non-profit organization. Its mission is to conduct high-quality, independent research and,
based on that research, to provide innovative, practical recommendations for policymakers and the public. The conclusions and
recommendations of any Brookings publication are solely those of its author, and do not reflect the views of the Institution,
its management, or its other scholars.
Brookings recognizes that the value it provides to any supporter is in its absolute commitment to quality, independence
and impact. Activities supported by its donors reflect this commitment and the analysis and recommendations are not
determined by any donation.
Copyright 2013
Douglas Elliott is a Fellow in Economic Studies
at the Brookings Institution.
Kai Yan is a Ph.D. student in Finance at Yale University
and was an intern at the Brookings Institution.
美国如何打赢中国
打仗解决不了问题
新帝国论（美利坚）
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I. Introduction
全球化核心：Flat3.0
季风亚洲（Monsoon Asia）
The financial system plays a critical role in
fueling the expansion of China, which has
grown to be the second largest economy in
the world and is likely to eventually surpass the
US. Yet there is much less understanding of China’s
financial system than there is of America’s or
Europe’s. Many analysts believe that the financial
system represents a major vulnerability for
China’s economic development, whereas others,
equally respected, think that the financial system
is adapting effectively to China’s more developed
status and will continue to provide the necessary
fuel for the rest of the economy.
This paper provides an overview of China’s financial
system and details what we know and what we
do not know about its workings. We begin with an
overview and then structure the remainder of the
paper around a series of questions and answers.
Financial systems can be organized in multiple
ways that differ in terms of the role of the government,
the relative importance of banks and other
financial intermediaries compared to stock and
bond markets, the degree of financial leverage in
the economy, and other differences. The optimal
financial system for a given nation depends on its
stage of development, its particular social values,
its political system, and various idiosyncratic factors.
This paper will frequently compare China
to the US, not because China should necessarily
copy the US approaches, but principally to help
our American readers put China in context. Some of the differences between China and the US will
disappear over time as China’s economy becomes
bigger and more sophisticated, and as the financial
system adapts to a level of development more
similar to the US. Other differences will remain
because of policy or societal choices or inherent
differences between the two nations.
Despite the variations across countries, all financial
systems need to perform a few key functions
effectively. Ideally, they optimize the allocation of
scarce funds to the most worthy projects, allow
savers and investors to maximize their return for
a given level of risk, allow risks to be diversified
across a wide pool of families and businesses (to
reduce the danger from catastrophic losses), and
help transform shorter-term assets into funds that
can support longer-term projects.
China’s financial system has managed for several
decades to perform well enough to support the
very rapid economic growth of that nation. One
can argue about whether alternative approaches
would have worked better, but, at a minimum, it
represents a real accomplishment to have avoided
acting as an anchor preventing the impressive
growth that China has achieved.
However, China is once again entering a new
phase of its economic development, and doing so
at a time of major political change, with the coming
to power of a new leadership team at the helm
of the Chinese Communist Party and the central government. How the leaders of the party, government,
and business sector manage the transition
over the next few years will have important
ramifications not only for China’s future, but that
of the world. The financial system will play a major
role in the future successes and failures of that
economic transition.
China’s financial system is particularly hard to
analyze because it is highly opaque and evolving
rapidly. Every decade sees major changes in the
regulation, structure, and operation of finance in
China, consistent with the rapid changes in the
nation’s overall economic and political development.
Only a few decades ago the private financial
sector virtually did not exist and all banking was
done through branches of the state-owned People’s
Bank of China.
In consequence of this opacity and continuing
evolution, there are questions about the strength
of the financial system, its effectiveness at allocating
capital to maximize China’s growth, and the
impact of capital allocation on the shape of the
economy (including the relative size of the government
and private sectors). Moreover, the likely
overall effects of future economic reforms, such as
loosened capital controls and freer exchange rates,
remain unclear.
A factor encouraging opacity is that China’s national,
regional, and local governments play a
much bigger role in directing the activities of
banks and other financial intermediaries than in
America or Europe. To some extent, the banks
make loans as a substitute for fiscal actions that
would otherwise need to be taken, as was clearly
shown in the use of the banking system to provide
the bulk of the economic stimulus after the global
financial crisis struck in 2008. The use of the
banking system for government purposes increases
opacity in at least two ways. Government leaders
often wish to obscure their interventions into
the financial system, making that system harder to
understand. The interventions also lead non-government
participants to seek ways around governmental policy. For example, direct controls on the
total amount of lending by banks can be circumvented
to some extent by shifting loans onto the
books of trust companies and their asset management
customers, with an implicit guarantee by the
bank. This creates incentives for Chinese banks to
obscure the continuing financial risks associated
with those loans, comparable to the reliance in the
West on Structured Investment Vehicles (SIVs),
whose blow-up contributed to the financial crisis.
In addition, there are a wide variety of implicit
guarantees embedded in the financial system.
These represent assumed support by the central
government for the borrowings of state-owned
enterprises, support for state-owned banks, implicit
deposit guarantees (since there is currently
no formal protection of deposits), the assumption
by many investors that banks or trusts will cover
losses on wealth management products, etc. Implicit
support is more opaque, easier to misunderstand,
and riskier, than more formal arrangements.
The leading role of the Chinese Communist Party
is enshrined in the Constitution and is very
much evident across all sectors of the economy,
especially banking. Party leaders at the national,
provincial, and local levels have many channels
through which they exert influence on finance,
including the ability to determine the career paths
of leading executives at financial institutions. As a
result, one of the areas of major debate among analysts
is the extent to which the major banks make
“commercial” decisions, as opposed to responding
to political influence.
As in many developing countries, problems with
the structure of the formal financial sector have
encouraged many informal channels for lending.
There is a strong tendency of the formal
sector to lend to large state-owned corporations
and to others with political connections, leaving
smaller and less favored businesses struggling
to fund their growth. This situation results
in high demand for otherwise riskier and more expensive informal lending channels. The informal
sector is less regulated, and sometimes
illegal, so information on this important sector is
much less readily available.
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Summary
Banks dominate the Chinese financial system,
providing about three fifths of total credit to the
private sector.1 This is not too different from European
levels, but contrasts with the US system,
where financial markets and non-bank lenders
provide significantly more credit than banks. The
Chinese banking system is fairly concentrated,
with five banks splitting almost half the total loan
market,2 which is somewhat less concentrated
than many national markets in Europe but more
concentrated than in the US.
A major difference with more developed financial
systems, however, is the high level of state ownership
and control. The five largest Chinese banks
are majority-owned by the central government
and there are significant government stakes in
many of the other banks. Further, the government
intervenes far more actively in banking decisions
than in the West. Most important, the central bank
explicitly sets maximum interest rates for deposits
and minimum interest rates for loans, and often
sets target levels for loan volumes.
Government and party leaders can exert considerable
influence behind the scenes, often pushing
loans to particular firms, sectors, or regions to
further their political agendas. The close linkages
between the government and banking, as well
as the pervasive power of the Communist Party,
make this possible. Unlike in the West, the careers
of the most important bankers are determined by
the Party and many of them move in and out of
the banking sector along the course of their careers.
The big banks lend principally to large, stateowned
enterprises (SOE’s), although the proportion
has declined substantially in recent years.
One of the great outstanding questions is why
this occurs and how it might change in the future.
There are at least five broad reasons for this
lending bias, some of which also apply in Western
markets.
Strong business positions. Some of the major
borrowers are simply very good credit risks because
of their strong business positions, resulting
from monopolistic or oligopolistic power, superior
business models, or other factors. (In recent
years, firms with majority state ownership reportedly
represented 35% of business activity in
China, but earned 43% of the profits.3) Firms may
also have grown large because of their strengths.
Further, size can bring a degree of diversification
that in its own right reduces credit risk and makes
them more attractive borrowers. In all of these
cases, there is no particular mystery as to why
these SOE’s would be favored customers.
Implicit government guarantees. There is a widely
held perception that the government would not
let a large state-owned enterprise formally default
on their loans. This implicit guarantee is potentially
of great value, although it does not preclude
the lender suffering economic losses by being
forced to accept modifications to the loan terms
that fall short of default. There are also degrees
in the strength of these implicit guarantees. For
example, SOE’s that are owned, or controlled in
practice, by powerful central ministries have a
greater certainty of support than entities owned
by less powerful government bodies.
Career safety. The large state-owned banks are
now sufficiently commercial in their outlooks that
loan officers do risk their jobs if their borrowers
default. However, there is a clear perception that
lending to a large SOE will never be a career-ending
decision, whereas lending to private borrowers
could be.
Personal relationships. Senior officials at large
SOE’s are in a position to favor bank officers, including
through their Party influence, and there will often be social relationships as well, such as
school connections.
Direct government or Party influence. Sometimes
an influential official will strongly urge a
loan to be made, essentially circumventing normal
credit procedures. This is apparently less common
than in the past, and there is more likelihood
of resistance, but it certainly still occurs today to
an extent that is hard to quantify. One reason it
is hard to measure is because there are legal limits
on how strongly one can push a loan officer to
make a specific loan, intended precisely to reduce
the extent to which such pressure is exerted.
Government and party leaders have recognized
that it is too easy for large SOE’s to acquire loans
and too hard for many smaller, purely private
firms to compete. As a result, leaders are encouraging
the banking sector to lend more to smaller
firms and have also become more open to other
avenues of credit provision, such as the informal
sector. One of the analytical debates about China
is the extent to which the large banks will be able
to change their behavior toward smaller firms. On
the one hand, China’s leaders have proven adept
over the years at generating the changes that they
wish to see. On the other hand, it is not clear that
the key incentives described above will change.
Some analysts also believe that the big banks simply
do not have the culture and systems necessary
to lend successfully to small, private firms.
There is also much analytical debate about the
sources of bank profit. Pessimists contend that the
large banks are fat and happy, benefitting from a
combination of a ceiling on interest rates for deposits,
(their main source of funding), and credit
quotas set by the Chinese central bank, which allow
banks to charge higher lending rates for those
loans they do make. These government interest
rates and credit quotas are becoming increasingly
flexible, and may even disappear, over time. Even
now, they can be circumvented in various ways,
such as through the use of certain “wealth management”
products that are deposit-like, but pay higher rates. If the pessimists are right, banks
could have serious problems as their net interest
margins become squeezed. This could lead them,
like some Savings & Loans in the US in the 1970s
and 1980s, to take unreasonable risks to restore an
acceptable level of profitability. It could also lead
to a slowdown in loan growth, as banks’ internal
capital generation slows and external capital
sources find the banking industry less attractive.
Optimists believe the large banks will be considerably
more flexible and intelligent in their responses,
and that the government and Party will
sensibly manage the process of change with an eye
towards avoiding these potential problems.
Bond markets are another source of credit for
companies, particularly larger firms. However,
the Chinese corporate bond market is smaller
and less sophisticated than in the US and Europe,
and at present the banks are the largest holders
of these corporate bonds. But, the corporate bond
market is growing rapidly. Net issuance of corporate
bonds increased by 65% in 2012, according to
the PBOC’s figures on the size of various components
of finance, and now represents about 16% of
net new credit.4 In addition to serving as competition
to the banks, and an alternative way for them
to invest, the development of the corporate bond
market may also take some pressure off the banks
to act as a quasi-fiscal arm of the government.
Chinese stock markets provide another source of
funding for businesses. However, there are several
problems that hold these markets back from
reaching their full potential. First, the markets
are dominated by speculators to a far greater extent
than in Western nations. There are multiple
reasons for this, the most fundamental of which
is that Chinese law, regulation and governance
patterns considerably constrain the control that
shareholders can exercise over management.
These problems are exacerbated for the many
publicly traded firms where the government owns
a majority stake. Lacking the ability to influence
business choices and dividend levels, or to sell the firm as a whole, shareowners place less reliance
on underlying firm value and focus more on likely
stock price movements in the short run. Many
Chinese also attribute speculation to a national
love of gambling, but it is very hard to know
whether this stereotype applies and the extent to
which it affects investment decisions.
Another factor contributing to the speculation,
and holding back the stock markets in its own
right, is the relative dearth of institutional investors,
who may make more informed and reasoned
decisions than individuals. Even if they were no
more rational in their behavior, their absence
reduces the potential size of the stock markets
and therefore the ability to generate new capital
through sales of stock by firms.
Chinese regulators also limit the size of the stock
markets through very close control of Initial Public
Offerings. Western nations generally allow a
new issuance as long as appropriate documentation
is provided to investors to allow them to
make informed decisions, whereas China only
allows an IPO to proceed with specific approval
that takes into account, on an ad hoc basis, a wider
range of considerations. Regulators apparently
maintain informal quotas that hold down issuance
volumes.
Other parts of the regulated financial system remain
fairly undeveloped in China, although they
are generally growing strongly from low levels.
The insurance industry is about two-fifths of
the size of the US market, relative to the size of
its economy. The asset management industry is
even smaller in relative terms at a mere fraction
of American or European levels. Trust companies
are an increasingly large part of the overall system,
but the sector remains relatively smaller than
the non-bank lending sector in the US.
In response to the gaps and rigidities in the formal
financial system, China, in line with many developing
countries, has a large and diverse informal
financial sector. Lenders in this sector include loan sharks, pawn brokers, formal and informal
cooperatives of locals lending to each other, State-
Owned Enterprises (SOEs) re-lending out excess
cash, and many other privately, (and sometimes
secretly), raised funds that invest in start-ups. The
informal sector has an uneasy relationship with
the Chinese state and regulators.
Chinese officials are currently wrestling with how
to harness the potential of this informal sector to
provide funds to worthy borrowers neglected by
the formal sector, while avoiding predatory behavior
and excessive risk-taking by institutions
and individuals that are less regulated. How effectively
the government manages this balancing act
will have a major impact on the financial system
and wider economy in the years ahead.
There are two other debates about the financial
sector that are significant enough to warrant noting
here. First, many analysts are concerned that
Chinese banks have large undeclared pools of bad
loans, which may deteriorate further. The prime
cause of the concern is the huge growth of lending
that came out of China’s massive stimulus
program in response to the global financial crisis,
which primarily consisted of bank-financed activities.
It is true in any financial system that a large
spurt in lending, for whatever reason it occurs,
raises a real potential for the creation of bad loans.
The better loans were presumably already being
funded, so one would expect a decrease in average
loan quality. In addition, a big jump in volume almost
certainly comes with less careful underwriting,
especially in a case such as the stimulus where
there was strong pressure from the top to make
loans if at all possible.
The sector of borrowers that is most concerning
comprises local governments and parties related
to them. The national government pushed localities
to fund the substantial majority of new
stimulus spending in their areas, which forced
them to borrow large sums of money. It is clear
that many of them overcommitted or invested in
bad projects and will end up defaulting on their loans unless they receive help from the national
government or forbearance by lenders. This is a
large-scale problem, with some analysts seeing it
as substantially higher than the government and
the banks currently admit. But even the more pessimistic
estimates remain in a range where a rescue
by the national government would be feasible
without seriously compromising the strength of
China’s sovereign debt.
There are also concerns about loans to industries
with over-capacity, such as shipbuilding and solar
energy, and to small and medium-size enterprises
that are squeezed by the weaker export environment.
Another key debate is the degree to which China
will experience a real estate crisis and the resultant
effects that would have on the banking system.
The central government has concluded that
real estate bubbles have built up in at least some
sectors and geographic areas, and is taking explicit
action to restrain real estate speculation. Pessimists
fear that the problems are more extensive
than admitted and that it will be impossible to
successfully balance the twin goals of restraining
bubble behavior while avoiding a crash of real
estate prices, with attendant huge damage to the
lenders and the economy. Optimists see the problems
as both smaller and more capable of being
managed by the leadership.
The real estate debate ties into a parallel debate on
bad loans, since many of the loans to local governments
and their affiliated parties are based either
on real estate as collateral or on the ability of the
governments to sell land in order to maintain an
adequate flow of revenues.
There is an analytical debate in China on the level
of implicit support given to various financial obligations
by governments or financial institutions.
Implicit government support of state-owned enterprises
is a major factor allowing them to borrow
so much at such a low cost. A similar logic,
with somewhat more risk, applies to the local government financing vehicles that fund much of the
nation’s infrastructure investment. Many observers
believe that banks and trusts implicitly back
the loans they make that are packaged into wealth
management products. Even deposits operate
with an implicit guarantee and not an explicit one.
The widespread use of implicit support represents
a serious risk to the Chinese financial system,
because of the large volume of these contingent
obligations and because their informal nature
can easily lead to misunderstandings. Should a
financial crisis begin somewhere in the nation’s
complex financial system, contagion could spread
through a sudden loss of confidence in these implicit
guarantees.
Overall, we tend towards guarded optimism on
the points in debate, while conceding that the
level of uncertainty about the current and future
workings of the financial system make it impossible
to be sure that the problems that inevitably
arise will be worked through effectively. However,
China has earned the right to a presumption that
it will continue to find the way through its growth
challenges, although both the Chinese leadership
and outside observers need to watch carefully how
things actually develop and not become complacent
as a result of past successes.
In order to assist the reader in navigating the
complexities of China’s opaque financial system,
the remainder of this paper is organized as a series
of questions and answers. This is intended to
provide a coherent conceptual framework while
allowing the reader to easily jump from topic to
topic, depending on interest. Please note that we
attempt to show what is not known, as well as to
lay out the facts and circumstances as we know
them. Given the degree of opacity and uncertainty
pervading this complex subject, it is important
not to be lulled by a false sense of certainty, but
instead to remain aware of what is unknown.
The questions that will be addressed are listed below
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Key Questions list
Overview
What is the overall structure of China’s financial
system?
Who regulates the financial system?
How does political influence on personnel appointments
affect the large state-owned financial
institutions?
What are the accounting standards in China?
How prevalent are accounting frauds in China?
Banking Sector
What is the structure of the banking sector?
How profitable is the banking sector in China?
How are lending and deposit interest rates determined?
How did the government reduce Non-Performing
Loans?
How did efficiency at the state-owned banks
improve over the years?
How do foreign exchange interventions affect
China’s banks?
Bond Market
What is the state of development of the Chinese
bond market?
What is the structure of local government
debt?
How did the local governments raise money?
What is the situation of rating agencies in
China?
Stock Market
What is the structure of the Chinese stock
market?
Why is the Chinese stock market so speculative?
What is the regulatory framework for IPOs?
What financial innovations have occurred in
the Chinese stock markets?
What are the ownership structures of the listed
State-Owned Enterprises?
Other Financial Institutions
How developed is China’s asset management
industry?
What is the situation of the trust industry in
China?
What is the situation of the insurance industry
in China?
What is the situation of the Venture Capital
and Private Equity industry in China?
How open is China’s financial system to foreign
participation?
Informal Sector
Why does China have an informal financial
sector?
What is the situation of the informal financial
sector in China?
The Intersection of the Financial System and the
Real Economy
What is the financial market’s role in China’s
real estate market?
Conclusions
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II. Key Questions
Overviews
What is the overall structure of China’s financial
system?
Banks dominate the Chinese financial system, providing
the private sector with credit amounting to
about 128% of Gross Domestic Product (GDP)
in 2012,5 compared to 48% for the US.6 The bond
market, however, is under-developed, providing
credit equivalent to approximately 41% of China’s
GDP,7 compared to 243% in the US.8 Chinese stock
markets, for their part, had an aggregate market
capitalization of about 44% of domestic GDP in
2012.9 This contrasts with Western economies,
where the stock market is typically smaller than
the bond market.
Unfortunately, Chinese stock markets are often
aptly compared to casinos, driven heavily by
speculation rather than end-investment. For example,
the average annual turnover rate in the
Chinese stock markets over the past 5 years was
205%, reaching a recent high of 293%, compared
to the US rate of 188%.10 This high turnover rate
is particularly striking given that large portions
of Chinese shares are non-tradable, generally because
they are owned by government entities. (The
government has self-imposed restrictions on share
sales in order to alleviate fears that their shares will
flood the market, reducing prices.) When only negotiable
shares are taken into account, the average
turnover rate over the past five years increases to 341%, and in recent years the annual rate has been
as high as 666%.11 The market for initial public offerings
(IPOs) is particularly prone to speculative
excess, with participants bidding for many multiples
of their desired allocation, and putting up
the required deposits for that full amount, just in
hopes of gaining at least a modest allocation.
Insurance companies are another under-developed
part of the Chinese financial system, holding
$1.2 trillion in assets, or just over 14% of GDP.12
The scale of the insurance industry is thus relatively
small compared to countries with more developed
financial systems. For example, US insurers
have over $4.8 trillion in total assets, amounting to
over 30% of GDP.13
China’s asset management industry is even less
developed compared to the West, particularly
compared to the prominent role played by mutual
funds in America. Assets under management in
China are equivalent to only about 5.1% of GDP,
compared to 240% in the US.14 However, China’s
asset management industry has been growing
rapidly since emerging in the late 1990’s, with the
number of funds increasing markedly, and the total
assets under management projected to rise to
approximately 6.8 trillion RMB by 2015 (which
would constitute over 10% of projected GDP).15
(The “renminbi”, or “people’s currency”, is abbreviated
“RMB” and is sometimes also referred to as
the “Yuan”. It currently trades between 6.1 and 6.2
RMB to the US dollar.)
China Capital Market
The relative size of the different financial sectors
and their respective ratio to GDP is summarized
as follows:16
As in most countries, there are also a number of
other types of financial intermediaries in the Chinese
formal sector, such as trust companies, rural
credit cooperatives, urban credit cooperatives, and
several others. Most of them are regulated by the
China Banking Regulatory Commission (CBRC),
but under different rules than for banks. It is difficult
to locate comprehensive data on the size of
these other financial intermediaries, but they appear
to have grown fairly quickly in recent years.
For example, the assets owned by cooperative financial
institutions grew from 5 trillion in 2007 to
about 7.8 trillion RMB in 2010, amounting to 12%
of all household deposits.17
In addition to formal financial institutions, China
has a large and diverse informal lending sector
that helps fill the gaps left by a formal sector excessively
focused on funding state-owned enterprises
and politically favored businesses. Lenders
in this sector include loan sharks, pawn brokers,
formal or informal cooperatives of locals lending
to each other, State-Owned Enterprises (SOEs) relending
out excess cash, and many other privately,
and sometimes secretly, raised funds that invest in
start-ups. The informal sector has an uneasy relationship
with the Chinese state and regulators.
Since 2002, the Ministry of Finance and the State
Administration of Foreign Exchange has cracked
down on over 500 underground banks, whose assets
totaled more than 100 billion RMB.18
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The Concept of “Total Social Financing”
The Chinese authorities generally report figures for
the overall size and composition of their financial
system in terms of a concept that they devised and
which is unique to China. They report “Total Social
Financing”, which includes the following categories:
bank loans, foreign currency loans, trust
and entrusted loans, bank acceptance bills, corporate
bond financing, nonfinancial enterprise equity
financing, foreign direct investment, foreign debt,
and other funding sources such as insurance, micro
lending, and industry funds.
The concept is a broad measure of the nation’s yearly
flow of liquidity, described by officials as “indicating
total funds the real economy obtained from
the financial system over a certain period of time.”
Total Social Financing aggregates the primary
sources of credit with a number of non-credit
items, such as equity and foreign direct investment.
At the same time, it is not fully inclusive of all financing
sources. As a result, it is not comparable
to figures reported by other countries either for
credit origination or for overall financing. This paper
therefore generally does not report figures for
Total Social Financing, but attempts to calculate
figures that match the concepts that are used in
other nations. For example, in order to determine
the ratio of credit provided from bank loans, one
must exclude financing equity and other sources
that are not identifiable as credit from the Total Social
Financing figure. “Bank acceptances,” are also
excluded in the adjusted calculation, as these represent
bank credit, but are generally collateralized
at least in part by an equivalent deposit at the same
bank. Collateralization of this nature reduces the
true credit risk taken by the bank.
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Who regulates the financial system?
China’s regulators are divided primarily by the
broad types of activity they oversee, although,
there are some overlaps and oddities, as is the case
in most countries. Banks are regulated primarily
by the China Banking Regulatory Commission
(CBRC), securities and financial markets by the
China Securities Regulatory Commission (CSRC),
and insurance by the China Insurance Regulatory
Commission (CIRC). The Chinese central bank,
the People’s Bank of China (PBOC), also has important
regulatory responsibilities, in addition to
managing monetary policy.
It is in charge of drafting
regulatory bills, regulating systemic risks, and
managing financial stability. As is true for virtually
all central banks, it can serve as a lender of last resort during a financial crisis. The PBOC also sets
limits on deposit interest rates and lending interest
rates. Further, it controls the State Administration
of Foreign Exchange, which manages the exchange
rate. However, both the exchange rate and the interest
rate limits are largely decided at a higher
level, ultimately by the State Council, the highest
government body.
The Ministry of Finance (MOF) also touches on financial
regulation through both its share holdings
in the major commercial banks and its control over
the Central Huijin Company, through which it indirectly
owns substantial stakes in commercial banks.
Beyond this fairly traditional division of regulatory
responsibilities, the high level of state control of the economy means that other important bodies
have quasi-regulatory duties. Most important,
the leading role of the Chinese Communist Party
means that various party bodies and important
party members have considerable influence over
personnel decisions at the financial institutions
and over detailed decisions about financial activity,
including at times decisions about specific large
loans. The Organization Department of the party,
which is mainly in charge of personnel appointments
of government officials, is also in charge of
naming key executives in the state-owned banks
and the other state-owned financial institutions.
Usually the executives are members of the party,
and they, like local or central government officials,
tend to transfer to different assignments every 5
years or so.
The complete regulatory framework is shown on
the previous page in a graphic from the IMF:19
Who regulates the financial system
How does political influence on personnel
appointments affect the large state-owned
financial institutions?
Executives in the large state-owned financial institutions
are also effectively high-level government
officials, in practice if not in theory. This is evident
in the following three aspects:
First, they all have political ranks similar to local
and central government officials. For example, the
political rank of the CEO of Bank of China is the
same level as that of a vice president of the PBOC,
or a vice governor of a province. One of the reasons
that political ranks matter is that they provide
banks with bargaining power with local government
officials who are often of lower ranks. Providing
bank executives with political rank grants
them implicit political capital that they can use to
bargain with local governments on terms of loans,
including resisting pressure to make uneconomic
loans for political reasons. But, this does not prevent
a local official from using connections with a
higher-ranking patron to create sufficient pressure
to get their way, and interestingly may make them more susceptible to this form of political pressure
from above.
Second, the highest executives in the banks are all
appointed by the Organization Department of the
party, comparable to the manner by which all the
high-level local government officials and central
government officials are appointed. Political integrity
is one of the most important factors under
consideration for their appointment. Given the
hierarchical nature of the party structure, this implies
a requirement to take very seriously the views
of higher ranking party officials.
Third, many bank executives ultimately aspire to
top government jobs. The government divisions
they move to include the regulators of the finance
industry, such as the PBOC or the Ministry of Finance,
but also include local government positions,
such as provincial leader, and central government
appointments, such as vice prime minister. Former
Prime Minister Zhu Rongji, for example, once
was the CEO of China Construction Bank. Some
scholars believe that this appointment system distorts
the incentives of the executives (See Allen,
Qian, Zhang and Zhao, 2012 for references).
This
is because taking their future career path into account,
executives’ decisions about bank operations
may not be completely based on their institutional
interests. Financial institutions are thus utilized
as tools to acquire political capital for their future
promotions.
What are the accounting standards in China?
How prevalent are accounting frauds in China?
The Ministry of Finance sets accounting standards
in China and the CSRC determines what specific
disclosures companies with publicly traded securities
must make. The most recent disclosure standards
were set in 2007.
Unfortunately, there have been a number of prominent
accounting frauds in China. The lack of sufficient
regulatory resources and the principal-agent
problem between listed firms and accounting agencies also exist in other countries, but there
are factors specific to China that encourage such
fraud.
One major incentive comes from the local governments,
which have major influence on the firms in
their territory. Local governments have incentives
to raise money for local firms through the stock
market. Governments play an active role in helping
their local firms get listed. This can sometimes
result in the presentation of figures that are exaggerated
or situations where risks are hidden.
Accounting frauds provide opportunities for
hedge funds such as Muddy Waters to find potential
frauds and to publicize them after selling short
the stock of the firms, in order to profit from the
ensuing fall in their stock prices. Since 2010, that
fund alone published around 20 reports accusing
different Chinese firms listed on the NYSE or
NASDAQ of engaging in accounting frauds. Some
firms suffered a drop in stock price of more than
70% in the days after the reports on them were out,
and eight firms faced a 60% or greater depreciation
in stock prices due to Muddy Waters’ reports.20
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Banking Sector
Share of Total Assets by Bank Type
What is the structure of the banking sector?
China’s banking sector has developed rapidly since
the onset of the reform era. In 1978, the People’s
Bank of China (PBOC) functioned as both the
central bank of China and as the only commercial
bank. In the 1980s, four state-owned banks were
established out of parts of the PBOC: the Bank
of China (BOC), the Agricultural Bank of China
(ABC), the China Construction Bank (CCB), and
the Industrial and Commercial Bank of China
(ICBC).
The PBOC has functioned as a more traditional
central bank since then, without significant
direct commercial banking functions. During the
late 1980s to early 1990s, joint-equity banks, such
as CITICS and the China Everbright Bank, were
founded by raising money from both the government
and the private sector. They are not completely
privately owned, but the government’s stakes in
them are significantly less than the government’s
stakes in the “Big Four” state-owned banks. A
number of smaller local banks and local microcredit
companies have also started to develop.
Market Share of Banks in China
The banking sector in China is highly concentrated,
with the five largest commercial banks (the
fifth largest being the Communication Bank of
China) controlling about half of the total assets in
the banking industry. They are all owned predominantly
by the government. The second largest category
of banks are the 12 “joint-equity banks”, 12
banks which make up about 16% of total banking
assets.
Then there are also the three policy banks —the Agricultural Development Bank of China,
the Export-Import Bank of China, and the China
Development Bank—which make up 8% of total
bank assets and are responsible for funding stateled
development projects. As of the end of 2010,
there were an additional 349 commercial, township
banks, 85 rural commercial banks, 223 rural
cooperative banks, and about 2,650 rural credit
cooperatives operating in China.22
Breakdown of Market Share of Banks in China
The five largest banks’ relative position in the sector
has shrunk in recent years reflecting the faster
growth rate of other institutions, both in terms of
number of banks and in relative share of total assets.
As shown in the following graph by the IMF,
the share of total assets of the five largest banks
(called LCB below) fell from 78% to about 50%,
from 2003 until 2010.24 By the end of 2012, this
share was down to 44%.25
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How profitable is the banking sector in China?
Profitability rose strongly in the banking sector
over the past decade for almost all banks, not just
the largest. The return on assets for the major commercial
banks grew from about 0.6% to about 1.4%
from 2006 to 2010. For Chinese commercial banks
as a whole, returns on assets have also been steadily
increasing over the past 5 years, reaching 1.3%
for 2011 and 2012.26 (For comparison, the longterm
average in the US is roughly 1%.27) This figure
may seem to represent a low level of profits, but
it must be remembered that banks are inherently
highly levered firms. If only a twentieth of the assets
are funded with common stock, the return to
common shareholders it twenty times that of the
return on total assets.
The main driver of the rise in profits was the increased
net interest margin, the difference between
the interest rate earned on loans and the
cost of funding the loans, mostly determined by
the deposit interest rate. The net interest margin
contributed 79% of pretax income in 2010. Some
observers believe that high bank profitability in
recent years comes from the oligopolistic position
of the banking system combined with the rigid interest
rate constraints set by the People’s Bank of
China, discussed below.
Profit levels were also aided significantly by a drop
in the non-performing loan rate from 9% of total
loans in 2006 to less than 1% by 2013.28 The drop
in non-performing loans was universal among
types of banks, as can be shown from the following
graph by the IMF:29
How profitable is the banking sector in China
There is a more detailed description on how the
government reduced the non-performing loans
below.
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How are lending and deposit interest rates determined?
Banks are allowed to set their own deposit and
lending rates, but only within strict limits set by
the PBOC, which determines the base and the upper
and lower limits of these rates. For example,
the announcement of June 8th, 2012, stated, in part:
“The PBOC decided to adjust the base rates of oneyear
deposits downward by 0.25%, from 3.5% to
3.25%. Other deposit base rates will adjust accordingly.
The PBOC also decided to adjust the upper
limit of deposit rates to 1.1 times the base rate, and
adjust the lower limit of the lending rates to 0.8
times the base rate. This adjustment will take place
on June 8th, 2012.”30
Therefore, by fixing the base rates along with the
range of the deposit and lending rates, the PBOC
has multiple tools to affect rates. Historically, when
the deposit rates and the lending rates were completely
set by the PBOC, the gap between them
was usually fixed at about 300 basis points (a basis
point, or “bp” is one hundredth of a percent, so 300
bps is 3%). The 1-year deposit rate and lending rate
from 2002 to 2012, for example, are shown below:31
Within the limits set by the PBOC, banks have
generally been paying the highest deposit rates
they are allowed to pay. Their lending rates vary
with the risk level of the loans they are making,
although many observers believe that there is insufficient
variation in pricing given the true differences
in risk.
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How did the government reduce NonPerforming Loans?
The non-performing loans that were worked
through in the 2000’s mainly came from excessive
loans to small state-owned enterprises before
2000. Starting in the late 1990s, then-Prime Minister
Zhu Rongji started a campaign to promote
efficiency in the state-owned enterprises in China.
The campaign included a plan to close down
a large number of SOEs over three years. The
closing down of small SOEs forced the banks to
recognize their previous loans to these firms as
non-performing. After the Asian currency crisis
in 1997, the central government began to realize
the importance of a strong banking sector. Therefore,
they started to act to reduce the large volumes
of non-performing loans in order to ensure confidence
in the banking system and lower the risk of
the crisis spreading to China.
Foreign reserves held by the PBOC and bonds issued
by the Ministry of Finance were the two main
sources of funds used to rebuild the commercial
banks’ balance sheets.
The foreign reserves were mainly injected into the
commercial banks through a state-owned company
called the Central Huijin Company. Central
Huijin is controlled by the State Council, the highest
government body in China,32 and is dedicated
to “inject equity to the state-owned financial institutions.”
The Ministry of Finance provided Central
Huijin’s initial capital, but the PBOC was also
another important stakeholder, injecting foreign
reserves into Central Huijin as equity.33
Central Huijin in turn injected the funds from the
PBOC and Ministry of Finance as equity into the
commercial banks, with these equity infusions totaling
approximately $156 billion by 2012.34 These
investments enhanced the capital adequacy ratio
of these banks and allowed them to write off some
of the non-performing loans on their balance
sheets without going bankrupt.
Another approach employed by the government
to reduce the non-performing loans was the establishment
of four asset-management companies
(AMCs). These AMCs purchased non-performing
loans from the banks, in exchange for bonds
issued to the banks by the AMCs. The bonds were
mostly ten-year bonds with a very low annual
yield of 2.25%. The non-performing loans were
generally sold to the AMCs at full face value, although
later transactions were sometimes transacted
at substantial discounts. (The very low yield
on the bonds meant that even a purchase at full
face value was effectively a discounted purchase
from an economic viewpoint, although it did not
show up as such for accounting purposes. In simple
terms, if the annual yield is 4 percentage points
below market for 10 years, this would be roughly
equivalent to a 40% economic discount, ignoring
compounding effects.)
The four AMCs purchased 1.4 trillion RMB of
non-performing loans from 1999 to 2000, and another
1 trillion RMB from 2003 to 2004. The Ministry
of Finance indicated that they would back the
payment of the bonds by the AMCs, which made
some credit rating agencies consider the bonds
part of the sovereign debt of the Chinese government,
even though it was not clear whether the
Ministry of Finance’s moral commitment was legally
binding. (This does not mean that the bonds
are not effectively guaranteed. It would be a great
surprise if the AMC bonds were allowed to default.
Look for example at the case of Fannie Mae and
Freddie Mac in the US, where the markets were
correct in their belief in government backing even
though the US Treasury consistently and strongly
disavowed any such guarantee and there was no
legal requirement for such support.)
After acquiring the non-performing loans from
the banks, the four AMCs slowly sold them off
to recover part of the losses. There is not much
information on their operations. We could only
readily determine that the “cash recovery rate”,
which means the cash the asset management firms
received from selling the non-performing loans,
stayed at the level of about 20% over the period
of 2001 to 2006, the period for which we found
data. The “asset recovery rate,” which means the
total value of all assets the asset management firms
received from selling the non-performing loans,
including non-cash items, varied from 40% to 24%
over the five-year period.35
Recently, these AMCs started to acquire local commercial
banks. There are several possible reasons
for these purchases. An optimistic explanation is
that the asset management firms are making profits
and seeking to expand their business.36 Yet there
is also the possibility that it represents bureaucratic
empire building or some other factor.
A third measure for reducing non-performing
loans was the introduction of “strategic investors,”
generally foreign investment banks or investment
companies. They injected their money into
the commercial banks as equity before the banks
went public, and therefore allowed them to write
off more of their non-performing loans. This also
helped achieve the government’s purpose of bringing
in needed foreign expertise as China’s banks
became more commercial in orientation.
The government used different measures for different
commercial banks to reduce the volume of
NPL’s. Some of the older records are hard to find,
but as an illustration, we show the measures employed
by the government on three different commercial
banks (Bank of China, the Industrial and
Commercial Bank of China, and the China Construction
Bank) in the following table:37
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How did efficiency at the state-owned banks improve over the years?
The main approach the government took to improve
efficiency at the banks was partial privatization. In
2002, the central government decided that the future
path for financial reform was to partially privatize
the four biggest banks. The government aimed
to address a number of issues as part of the process,
including corporate governance, non-performing
loans, incentive structures, risk management structures,
accounting standards, and other issues.
The government managed to address some of these
effectively. For example, the accounting standards
employed by the banks significantly improved
over time, and the listed banks’ accounting standards
appear to be approaching those employed by
international banks. In terms of risk management,
some of the biggest banks offered multi-million
dollar salaries to hire top risk managers from Wall
Street. However, it is widely recognized, even by
the Chinese government, that the incentive structure
and corporate governance problem are not
completely resolved.
Many reasons explain the lack of full resolution.
The ownership structure is certainly a critical issue,
since few executives are offered stock incentives
and their bonuses are not directly related to
their economic contributions. Another reason is
the close linkages between the SOEs and the stateowned
banks. Although we do not have data on
this issue, anecdotal evidence suggests that the
state-owned banks lend overwhelmingly to the
state-owned enterprises, which was one of the
direct causes of the situation with the non-performing
loans. Research papers such as by Xu and Cull (2003), demonstrated that the loans to the
SOEs were based on non-economic, unexplained
factors, including political pressure and personal
connections.
There is a lively debate about the extent to which
commercial considerations have replaced political
and other non-economic considerations. There has
clearly been a substantial movement in this direction,
but, equally clearly, politics and connections
remain significant factors in lending decisions.
The real questions are about the relative importance
of commercial and non-commercial factors
and the specifics of how non-commercial factors
affect the types of loans being made. One confusing
factor in this debate is with regard to the term
“commercial.” Some use the term to mean decisions
that reflect the underlying creditworthiness
of borrowers absent government support. Others
mean that managers make decisions intended to
maximize their bank’s profitability, including taking
into account implicit and explicit government
support for borrowers and other similar considerations
in a country in which the government and
party play a very large role.
China Lending vs. Deposit Spreads
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How do foreign exchange interventions affect China’s banks?
China has accumulated the world’s largest stock of
foreign exchange reserves, primarily in US dollars.
This is the result of a combination of large trade
surpluses, a desire to hold down the RMB/US
dollar exchange rate, and, at least initially, a goal
of building sufficient reserves to avoid a Chinese
version of the “Asian Crisis” of the 1990’s, which
centered around a collapse of exchange rates in
emerging market countries. Strong foreign exchange
reserves provide nations with the ammunition
to fight any such decline in their currency
caused by market pressures.
Foreign exchange reserves are built up by central
bank purchases of foreign currency using the local
currency as payment. This has the direct effect
of increasing the home currency money supply, which can fuel inflation. China, like many other
countries, attempts to offset the effect of these purchases
on its home money supply by “sterilization”
of the foreign exchange purchases. The most direct
way of doing this is to withdraw funds from
circulation by selling government bonds or other
local currency assets that are owned by the central
bank. In China’s case, the PBOC’s sterilization procedures
have essentially used up its discretionary
supply of local currency assets such as government
bonds, so it has gone further and sold “central
bank bills.” These are relatively short-term, interest-
bearing securities backed by the credit of the
PBOC.
Issuance of these bills creates the potential
for PBOC profits or losses based on the difference
between the value of the interest received
on foreign reserve assets and the interest paid on
the central bank bills. Normally this difference
produces a loss, unless the central bank pays below
market rates, since there would not be market
pressure for RMB appreciation if the expectation
were that holding dollar assets would produce a
better return than holding RMB assets after adjusting
for currency moves. When central banks push
against market forces, the expectation is that the
central banks will lose money over time in order
to achieve their larger policy goal.
In order to hold down the cost to the PBOC of issuing
central bank bills, they tend to bear a low,
below market interest rate. The PBOC is able to
sell the bills anyway, since banks and other financial
institutions are strongly encouraged, or mandated,
by the authorities to buy them. The difference
between these lower rates and market rates
represents a kind of tax on the buyers that reduces
their profitability, and shifts some of the burden
off the PBOC and onto these institutions. Beginning
in late 2010, and continuing through much of
2011 and 2012, the PBOC significantly decreased
the number of central bank bills that it issued, focusing
instead on re-inserting liquidity into the
system. The PBOC accomplished this task mainly
through a series of reverse repurchase agreements,
or reverse repos, where the PBOC bought securities
from Chinese banks under the agreement that it would sell them back, with interest, at a later date.
Repurchase and reverse repurchase agreements allow
the PBOC to manipulate the level of liquidity
on a much shorter time scale than by simply allowing
the central bank bills come to maturity.38
Similarly, the PBOC uses another sterilization
technique that acts even more clearly as an implicit
tax. Banks are forced to hold very high levels of “required
reserves.” That is, they are required to place
on deposit with the PBOC roughly one-fifth of the
deposits that they take from customers. These central
bank deposits receive little interest, creating a
loss for the banks equal to the difference between
the amount they pay to bring in the deposits from
customers and the amount they receive from the
PBOC. The following chart shows the rates paid
by the PBOC on central bank bills and on required
reserves. Both sets of rates have been well below
the returns banks could earn on other safe assets,
reducing their profitability.
Strategic Investors of Banks
Many nations set reserve requirements of this
nature, but China stands out with reserve requirements
of roughly 19% compared to 1% in
the Eurozone, none in the UK or Canada, 2.5%
in Russia and South Africa, between 5% and 6%
in India, a range of 5%-9% in Turkey, and 12% or under in Vietnam. Still, China’s required reserve
ratio is surpassed by those of Brazil, which has a
wide range averaging about 20%, and Lebanon,
which sets its minimum at 30%.40 Raising the level
of these requirements, as China has repeatedly
done in recent years, serves multiple purposes,
so it cannot be said definitively that the ratio is so
high solely because of the foreign exchange sterilization.
In particular, higher reserve requirements
discourage lending and have been used in recent
years to slow down the pace of credit growth. That
said, many observers do believe that the reserve
requirements are being used to hold down the cost
of sterilization efforts by the PBOC, or, more properly,
to transfer those costs to banks and away from
the PBOC.
Ming Zhang estimates that sterilization efforts
have cost the banks RMB 1.3 trillion between
2003 and 2010.41 It appears that one reason that
the PBOC sets minimum and maximum rates on
bank loans and deposits is to maintain an interest
margin that will help the banks remain quite
profitable despite this drag. This link is one reason
why there will be pressure to move in tandem on
interest rate liberalization and exchange rate liberalization.
Otherwise, a reduction in bank profits
would make it harder for them to bear the sterilization
costs while earning high enough returns
to raise the capital they need to support a growth
rate in lending commensurate with the needs of an
expanding economy.42
Sterilisation 绝育，消毒，灭菌 tools and costs
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Bond Market
What is the state of development of the Chinese
bond market?
We can see the relatively weak development of the
Chinese bond market from cross-country comparisons,
such as in the following graph from the IMF:
Over 35% of corporate bonds in China are owned
by banks, making them the largest holders by far.
Banks also dominate secondary trading in the relatively
inactive corporate bond market, with a 70% market share.43 (Trading of treasury bonds is considerably
more active.)
China’s Bond Market
In the past, complicated regulatory arrangements
often prevented firms from issuing corporate
bonds. The National Development and Reform
Commission, the China Securities Regulatory
Commission, and the People’s Bank of China all
had regulatory authority in certain segments of
corporate bond market. The NDRC required a
one-year process to approve corporate bond issuance.
This strict regulatory framework helped drive many firms to bank loans, as is shown in the
graph on the top of page 22.
Beginning in 2010, the three regulatory departments
started to coordinate better with each other
and steps were taken to reduce the difficulties
deterring bond issuance. The PBOC took the first
step by establishing a medium-term bond market
with registration issuance system, which means
that firms can issue bonds as long as they achieve
certain requirements and reveal certain information.
The CSRC followed by establishing a highyield
market with a registration issuance system.
China – Bond Holders
Kind of Bonds
Corporate bonds accounted for a very small proportion
of the bond market until recently, yet
between 2008 and 2012, total corporate issuance
more than doubled, and corporate issuance stood
just under 30% of the total bond market in 2012.44
It is still small relative to central and local government
bonds, even after several years of rapid
growth. Some of the growth was also exaggerated as part of the bonds that were counted as corporate
bonds in 2007, 2008 and 2009 were actually
bonds issued by corporations established by local
governments.
The number of corporate bonds issued in 2012,
484, was nearly 50% higher than the number issued
in 2011, and over 60% greater in total value.45
Corporate debt issuance
Corporate bond issuance in 2012 totaled nearly
2.3 trillion RMB,47 and analysts project that total
financing from this sector will reach 2.75 trillion
RMB by the end of 2013, accounting for some 16%
of the total social financing for that year.48 (“Total
social financing” is a measure used by the Chinese
government that includes most formal credit
provision, but also equity raising, foreign direct
investment, and some other non-credit items.) In
2007, corporate bonds only accounted for 4% of
total social finance.49
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What is the structure of local government debt?
Debt issued by local Chinese governments came
to prominence after the recent financial crisis. In
2008, the central government decided to allow local
governments to run official fiscal deficits. Then
in the 2008-2009 financial crisis, the central government
launched a 4 trillion RMB stimulus package,
which required that local governments should
be responsible for identifying projects and financing
two-thirds of all the money needed in those
projects.50
The local governments responded by establishing
numerous Municipal Investment Corporations
(MICs), which then issued corporate debt.
In 2012, the amount of capital raised in the bond
markets by these provincial, municipal and county
entities totaled nearly 640 billion RMB.51 In addition
to these local government investment corporations,
the central government also helped some
local governments to raise money. In March 2009,
the Ministry of Finance issued 200 billion RMB
of local government bonds. According to public
data, at the end of 2010, the total amount of debt
issued by the local governments exceeded 10 trillion
RMB.52
However, there has been speculation about the
local governments’ arrangements with the local
banks, as well as with the local branches of the national
banks. Moody’s, for example, questioned the
public data and claimed that the official figure is
about 3 trillion RMB less than the actual amount.
Victor Shih, a professor of political science at
Northwestern University, claimed that the local
government debt was between RMB 15 trillion to
20 trillion, with about 4 trillion on the brink of default.
53
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What is the situation of rating agencies in China?
The rating agencies in China are not well developed.
The largest domestic credit rating agency,
Dagong Global Credit Rating (Dagong Guoji), is
controlled by the State-owned Assets Supervision
and Administration Commission, which is a government
agency dedicated to supervising all the
state-owned enterprises. Therefore, there is a fear
that this rating agency is tilted towards the stateowned
enterprises and might easily compromise
under political pressure.
A recent example is its ratings for the Ministry of
Railroad’s bonds issued during the four trillion
RMB stimulus package in 2008. About one trillion
of stimulus spending was assigned to the Ministry
of Railroads, and the central government asked the
department to raise money on its own. Therefore,
the cost of financing became a very important issue.
The rating agency assigned a triple-A rating
for all the bonds issued by the Ministry of Railroads,
but only assigned an AA+ rating for the
treasury bonds issued by the Ministry of Finance.
When asked about the triple-A rating for the Ministry
of Railroads, the explanation provided by the
rating agency was that they believed that the Ministry
of Railroads would be able to pay off its debt
because the Ministry of Finance backed it.
In 2010, the SEC rejected Dagong’s request to enter
the U.S. market. The reason provided by the SEC
is that it does not allow “cross-border regulation.”
Therefore the globalization of Dagong is currently
limited to East Asian countries and Hong Kong.
Foreign rating agencies such as Standard and
Poor’s and Moody’s all have offices in Beijing. But
seldom do they rate bonds issued by the domestic
companies. Their main business in China is to provide
ratings for bonds issued overseas, and also to
serve as a financial consultant for domestic companies
that are listed abroad.
In 2006, Moody’s and Standard & Poor’s began
acquiring small Chinese credit agencies and turning
them into their affiliates. For example, China
Chengxin International Credit Ratings sold 49%
of its shares to Moody’s in 2006 and became one
of Moody’s affiliates worldwide. These affiliates do
provide credit ratings for a wide range of domestic
companies, including small companies that do not
issue bonds outside China.
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Stock Market
What is the structure of the Chinese stock
market?
There are two main stock exchanges in mainland
China: the Shanghai Stock Exchange (SHSE) and
the Shenzhen Stock Exchange (SZSE). Another
major stock exchange in China is located in Hong
Kong. The Hong Kong Special Administrative
Region (HKSAR) is treated for most government
and regulatory purposes as if it were a separate,
although closely allied, country. The Hong Kong
Stock Exchange (HKSE) traditionally focused on
the equities of locally based firms, but has expanded
to trade a considerable volume of “H-shares,”
shares of Chinese firms, usually majority owned
by the government, which have gained permission
to sell stock in Hong Kong. H-shares are generally
not permitted to be traded on the mainland
or to be converted into shares that can be traded
there. Listing in Hong Kong has been the main
route through which Chinese firms have accessed
foreign equity capital, since Hong Kong is a major
world financial center with investors from around
the globe participating in its markets.
There are also other kinds of shares listed in the
SHSE and SZSE. B-shares, for example, are the
shares of Chinese firms that are allowed to be
owned by foreigners and are often denominated in foreign currencies. The number of B-shares is far
below the number of A-shares, which are domestic
firms listed on the SHSE or SZSE. As of 2012,
there were only 54 B-share stocks in SHSE, with
the number of A-share stocks being 945.54
Since implicit quotas limit the number of firms that
can go public in each stock exchange each year, going
to NASDAQ or the NYSE used to be popular
among privately owned Chinese firms. However,
with funds such as Muddy Waters accusing Chinese
firms of accounting fraud, the recent trend for
Chinese firms listed in on the NYSE or NASDAQ
is to buy themselves private and try to get themselves
listed again on the HKSE or the SHSE.
Why is the Chinese stock market so speculative?
The word “speculative” refers to the propensity of
investors in the Chinese stock markets to invest
in certain stocks mainly because they believe that
other investors will purchase those stocks later for
a higher price, without much regard for the fundamental
underlying value of the firm. Speculative
behavior like this, when it is taken to extremes that
drive the markets, is commonly believed to have
damaging effects on the stock market’s function
of optimally allocating funds. (A certain amount
of speculative activity provides useful liquidity for
markets. The problems come when the level is too
high.) Speculation of this type can generate bubbles
and sudden crashes, especially when combined
with a trading mechanism that discourages
or forbids short sales, which might otherwise repress
excess price rises. (Restrictions on short sales
are being eased, which may make this factor less
important over time.) There are several reasons
why the stock market in China is more speculative
than many other stock markets around the world.
Most fundamentally, stock prices should theoretically
reflect the underlying value of a firm, because
shareowners have the ability to capture the value
of the future cash flows through the receipt of dividends
or by selling the firm. However, Chinese
investors have little ability to ensure that they will receive a stream of dividends and virtually no
ability to force a sale of the firm that they collectively
own. The most important firms are majority-
owned by the state, or at least have large minority
government stakes, which ensures that the
government and party will make the ultimate determination
on any key actions, such as firm sales
or major changes in dividend policy. Even purely
private firms are substantially protected from outside
influence by a regulatory approach that reflects
a leeriness of such pure market influences.
The weakness of shareholder rights in practice also
discourages fundamental investment approaches,
because there is too much risk that management
or well-connected individuals will find a way to siphon
off value from the firm.
In practice, listed firms are reluctant to deliver
cash dividends. The ratio between cash dividends
and profits declined from 41% to 30% from 2008
to 2011, and maintaining at least this 30% ratio
for the Shanghai exchange has recently been a
major concern among officials. Those firms who
fall beneath the 30% threshold are to account for
this failure in annual reports.55 The same ratio for
the S&P 500 averages 53% over the long-term (not
including share buybacks).56 Also, the delivery of
cash dividends is highly concentrated in blue-chip
firms, which make about 80% of aggregate dividend
payments.57 The lack of dividends from the
small to mid-cap firms makes the trading of their
stocks more speculative.
Another factor is the lack of institutional investors.
In China, investing in the stock market is mainly
conducted by individual investors through their
own accounts. On average, in China, institutional
investors have a turnover rate that is about 40%
lower than individual investors, suggesting less
speculation.58 Some large institutional investors,
such as insurance companies and pension funds,
are not allowed to invest in the stock markets. In
comparison, investment in the US stock market is
made overwhelmingly by institutional investors.
What is the regulatory framework for IPOs?
In contrast to almost all regulatory frameworks in
the developed economies, whose IPO procedures
are based on registration, the Chinese regulatory
framework is still based on approval. The administrative
control over the approval procedure is excessive.
It is widely agreed among bankers that the
regulators employ implicit quotas for different districts
and different industries. This rigid quota system
pushes many eligible firms to buy the “shells”
of firms that were listed but went broke, issuing
new stock under the name of the “shell firms.”
It is widely believed that the approval framework
benefits the SOEs and enterprises with close connections
to the government and that the limited
supply of new issues has increased speculative interest
in those that do come to market.
What financial innovations have occurred in
the Chinese stock markets?
In recent years, there were several new features
introduced to the Chinese stock market. The first
innovation was the promotion of stock index futures,
carried out in 2010. This was supposed to
be implemented in 2007, but was postponed by
the State Council for 3 years because they “needed
to reconsider the risks.” The other major financial
innovation was also carried out in 2010, allowing
traders to do leveraged trading and also short sales
on 180 stocks chosen by the CSRC.
These two innovations grant substantial edges to
the institutional investors in the markets because
they allow them to hedge their risks better, and
sometimes trade more aggressively. The bar for
permission to do futures trading, leveraged trading,
and short sales is high, making it hard for individual
investors to use these tools.
What are the ownership structures of the listed
State-Owned Enterprises?
Although the largest IPOs in the Chinese stock
market were all IPOs of the SOEs, the government
still holds most of the stocks of the SOEs. Therefore,
the capital structure of the SOEs usually incorporates
two parts under their equity account:
tradable shares and non-tradable shares. Usually
there are many more non-tradable shares than
tradable. Sometimes the initial ratio of tradable
shares to non-tradable shares was as low as 1:19.
This ratio will rise substantially over time, as the
non-tradable shares generally become tradable
gradually over a period of time that differs across
the specific companies.
This situation is caused by both political and historical
reasons. In the late 1980s, the State Council
assembled experts both from China and the US to
discuss the possibility of establishing a stock market.
One important goal, according to the minutes
released later, was to strengthen the SOEs by allowing
them to raise money in the stock market.
By the end of the 1980s, there had been a wave of
private enterprise development and social instability,
which led political leaders to believe that
the private sector development was undermining
the SOEs. Therefore, the discussion of the establishment
of the stock markets was premised on
state-owned enterprises avoiding full privatization,
avoiding potential losses on state-owned assets,
and still remaining the primary sector of the
economy. Therefore, from the beginning of the
stock market, the state kept firm control of the listed
SOEs by holding majority stakes. The state also
made those stocks non-tradable to prevent them
from being acquired by private firms or individuals.
In the late 1990s and early 2000s, after realizing the
incentive problems brought by these ownership
structures, the State Council three times launched
the so-called “Reduction of the State’s Shareholding”
campaigns. They all failed because the stock
market gave these campaigns extremely bearish responses, which would bring up the debate on the
“loss of good state-owned assets to the private sector.”
These debates and the political pressure that
came along with them were the main reasons why
these campaigns failed.
The fate of the 2001 campaign is a useful illustration.
The State Council, after several rounds of discussions,
proposed a document called “A Tentative
proposal to Reduce the State’s Shareholding and
Raise the Social Security Fund.” The document
stated that the state’s share in the SOEs should be
sold at the current market price, and the proceeds
be injected to the state’s social security fund.
The prospect of a sudden increase in the supply
of stocks made the market bearish. The index of
Shanghai Stock Exchange dropped from 2245 in
June to 1514 in October 2001, a more than 35%
drop in four months. (World markets were also
declining during this period, so presumably only
a portion of this drop was because of the Chinese
government’s potential share sales.) This forced
the State Council to cancel the enforcement of the
above proposal.
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Other Financial Institutions
How developed is China’s asset management
industry?
The development of China’s asset management industry
can be divided into three stages. The first
stage was from 1992 to 1997. In this stage, the first
closed-end mutual fund was established in 1992
and the whole industry experienced a wave of fast
growth from 1992 to 1997. However, the lack of
regulation allowed frauds and led to social instability.
The first set of regulations for the asset management
industry was issued in 1997 by the CSRC,
which was followed by a period of low growth in
this industry.
The second stage of rapid development started in
2001, when the first open-end mutual fund was
established in response to a CSRC proposal to develop such funds in China. (Most US mutual
funds have traditionally been “open-end,” meaning
that investors can pull their money out or add
new money in on any working day and the fund
managers will adjust their holdings accordingly.
Closed-end funds maintain their same size, but
allow investors to buy and sell their shares on the
market.) The domestic open-end mutual fund industry
has been the fastest growing sector in the
asset management industry from then on, as is
shown in the graph from Allen et al. (2012)
Other Financial Institutions
The third stage started in 2002. As part of the
agreements for joining the World Trade Organization,
the Chinese government agreed to allow
several Qualified Foreign Institutional Investors
(QFII) to invest in the Chinese market. The State
Administration of Foreign Exchange, in conjunction
with the China Securities Regulatory Commission,
approves and regulates the QFIIs, as well
as imposing a maximum quota on total QFII investments.
This quota has been expanded in recent
years, more than doubling in early 2012 to a maximum
of $80 billion.59 This expansion occurred in
the context of moderate increases in the value of
QFII assets, which stood at about $25 billion in
early 2012 (when the cap was at $30 billion),60 and
increased to $33.6 billion by the end of the year.
Part of this expansion was made possible by the relaxation of the qualification requirements for
prospective QFIIs, lowering the required size of
assets under management for QFIIs, relaxing the
rules pertaining to QFII operating history, and
raising the ceilings for total assets and proportion
of shares owned. Because of these changes, the total
number of approved QFIIs stood at 202 by the
end of 2012, with nearly one third of the approved
QFIIs, (as well as over one third of assets,) entering
the market during 2012 alone.61
In 2006, the Chinese government started to allow
a limited number of domestic asset management
companies to invest abroad. By the end of 2009, the
number of Qualified Domestic Institutional Investors,
which are approved by the State Administration
of Foreign Exchange to invest abroad, reached
75, and the assets managed abroad reached $73
billion.62
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What is the situation of the trust industry in China?
Trust companies in China are asset managers for
high net worth individuals and companies and, on
the other side, sources of credit for firms in need
of funding. Thus, they represent a cross between
banks and asset managers, since they act as financial
intermediaries, keeping some credit risk and
passing along other parts to wealthy investors. The
rapid growth in assets under management in this
sector makes it the third largest financial services
sector after banking and insurance, with RMB 7.5
trillion ($1.2 trillion) under management as of the
end of 2012,63 compared with RMB 3.0 trillion in
2010, 2.1 trillion in 2009, and a mere 380 billion
in 2006.64
There are 66 trust companies. Unlike most financial
sectors in China, this industry is not dominated
by a small number of large firms; the 10 largest
players only account for about 44% of the total net
profits in this industry.
The main value of the trust companies as asset
management companies is their ability to provide
alternative investments. The products offered by
trust companies differ greatly from those provided
by mutual funds and banks. For example, according
to data from the China Trust Association
in January 2010, among the 32 new products, 12
products focused on investment in firms, either
through equity or credit, 10 products focused on
real estate, 3 focused on infrastructure investment,
and 2 focused on investments in other financial institutions.
These various products satisfy the needs
for high net worth individuals and companies to
diversify their portfolios.
The principal service the trust companies provide
as a source of credit is through making loans. Although
they also invest in equity, the main component
of the portfolios held by these companies is
loans to other firms, which makes up about 40% of
their investments. Therefore, they are an important
source of funds for small and medium firms
and real estate developers. They also provided
finance for local government’s investment in infrastructure.
In a way, they are implicit holders of
local government bonds through their loans to the
MICs.
The trust companies have also become significant
partners helping the banks work around the
limits they face on maximum deposit rates. Trust companies offer “wealth management products”
to high net worth individuals, including participations
in loans made by the banks. The investor
receives the revenues from the loan, minus various
fees to compensate the bank and the trust
company. Even after these fees, the net rate is still
well above the permitted maximum deposit rate.
Policymakers are concerned that individuals are
counting on implicit guarantees by the bank and
the trust company, rather than relying on an individual
assessment of the loan’s credit risk. Thus,
banks may have significantly more credit risk
than is shown on their balance sheets, with the
risk of serious systemic consequences if one or
more banks fail to make good on their perceived
promise to guarantee the loans, leading to a panic
about other wealth management products. In this
respect, it is reminiscent of the US government’s
implicit guarantees of the debt of Fannie Mae and
Freddie Mac or the US banks’ implicit guarantees
of the borrowings of Structured Investment Vehicles.
Both analogies are disturbing as they added to
the problems of the recent financial crisis.
It should be noted that banks have increasingly
been offering wealth management products directly
to investors, in part because of a regulatory
crackdown on the cooperation between banks and
trusts in this area. Similarly, banks now sell some
third-party products that derive from private equity
and other types of firms rather than trusts.
Since 2010, there have been concerns about the
risks in trust companies for three reasons; the
slowdown of the real estate market; their holdings
of local government debt; and their rapid expansion
and product innovation. As a result, the regulator
for this sector, the China Banking Regulatory
Commission, required the trust industry to
re-evaluate risk according to a new risk metric and
to put up extra capital as buffers for potential risks.
Despite increased regulatory scrutiny and restrictions,
the trust sector boomed in 2012, with an increase
of RMB 1.3 trillion in trust loans outstanding,
compared to a growth of RMB 0.2 trillion in 2011.65 Many theorize that regulators eased back
again on some restrictions as the result of a concern
about the slowing growth of the economy in
2012, which was viewed as being exacerbated by
credit tightening.
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What is the situation of the insurance industry in China?
The insurance industry started its development
in 1980, with only one insurance company, China
Life Insurance. In 2012, the total number of insurance
companies reached 130, total assets reached
RMB 7.4 trillion,66 and premium income reached
1.4 trillion.67 The market is currently highly concentrated,
with the largest three companies holding
more than 70% of the market in both life and
property insurance markets.
Although growing rapidly, the insurance industry
is still relatively under-developed. There are usually
two indicators that measure the development of
the insurance industry in a given country: insurance
penetration and insurance density. Insurance
penetration is measured by the ratio between annual
premium income and a country’s GDP. Insurance
density is measured by per capita premium,
which reflects the average holding of insurance.
The depth of the insurance industry in China is
3.7%, and the density is RMB 1,085. For the US,
the same numbers are 7.9% and $3,124.
The assets managed by insurance companies were
mostly invested in treasury bonds, local government
bonds and deposits. Starting in 2010, the
CIRC enabled insurance companies to invest up to
5% of their total assets into the stock market and
other more risky asset categories.68
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What is the situation of the Venture Capital and Private Equity industry in China?
We examine these two different types of asset
management firms together because they are very
similar in China. In the US, venture capital firms
usually focus exclusively on investing in startups
and small to mid-cap firms, while private equity
firms usually focus on operations such as leveraged
buy-outs (LBOs) or the acquisitions of small
companies. But in China, since there are not many
LBO deals, both venture capital and private equity
focus on investing in firms that are not listed and
almost the only way for them to exit is to get those
firms listed in either Chinese or US stock markets.
This sector is among the fastest growing in the past
few years and its impact on the capital market is
now significant. This is due to the launch of the
Growth Enterprise Market in China at the beginning
of 2010, which allows many small and midcap
companies to list. From January 2010 to April
2011, among the 460 IPOs in China, 204 of them
are supported by PE and VC, and 153 of them have
at least a PE or VC holding more than 5% of their
total shares.
The market is not very concentrated and is packed
by small firms with less than RMB 500 million under
management. Among the 1703 PE/VC firms
in China, only 13 of them have more than RMB
10 billion under management, and 1134 of them
have less than RMB 500 million under management.
The average number of staff in a PE/VC firm
is 19.69
There are discussions in China about rent seeking
in the PE/VC business. Some family members of
the top political leaders in China are reported to
have been major players in this sector.
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How open is China’s financial system to foreign participation?
Foreign banks play a small role in China, with only
2% of loans coming from such entities. (For comparison,
foreign banks in the US account for over
20% of the market.) This is not from lack of interest,
as there are over 300 foreign banks operating
in China, and 4 of the 50 largest banks in China are
international.70 Foreign bankers argue that Chinese
officials make it difficult for them in various ways
to operate or expand, using the very considerable
administrative powers available to Chinese financial
authorities to favor local banks. Perhaps more
important, however, are the structural obstacles to
the foreign banks. These include the high level of
state ownership of corporations that are potential
customers of the foreign banks, the network of
Communist party and other connections linking
local bankers and local customers, and an inability
to compete for RMB deposits through higher rates
(given the limits on maximum deposit rates).
Foreign banks cannot overcome these obstacles by
simply buying well-established local banks. China
still has limitations in place regarding ownership
by foreign investors. An individual foreign investor
is limited to a 20% ownership stake in a bank,
and the combined share for investors in a joint
venture is limited to 25%. The foreign equity cap
in securities joint ventures is set at 49%, having
been recently raised from 33%.71 This 49% ceiling
also applies to joint ventures in the fund management
sector. Similar restrictions apply to foreign
insurance companies, who are limited to joint ventures
with an ownership share of 50% or less. In
2010, foreign insurance companies held only 4.3%
of the market in China, and the foreign share of
the property and casualty markets was even lower
(only 1.2% in 2012).72
It does not appear that foreign financial institutions
are likely to make major gains in market share in
the short run, but the field may become more open
as liberalization of interest rates, exchange rates,
and capital flows proceeds. The handicaps foreign
banks face should lessen as the direct role of the
state and party decrease in the financial sector and
in the wider economy.
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The Informal Financial Sector
Why does China have an informal financial
sector?
It is widely recognized that China has a very sizeable
informal financial sector, which refers to financial
intermediaries that are not registered with any regulatory agencies and therefore are not regulated.
This informal sector is often lumped together with
the wealth management products offered by regulated
banks and trusts and referred to as the “shadow
banking” sector, because they accept deposit-like
funding and provide credit outside the traditional,
and more highly regulated, banking model.
Technically, these financial intermediaries are often
in violation of Chinese law. But local governments,
knowing the existence of these financial
intermediaries, usually allow them to continue operating
unless there is evidence that they may have
done harm to the local economy. The composition
and size of the Chinese informal financial sector,
according to the IMF, is illustrated table73 on the
following page.
Several reasons have been proposed by leading academic
and business journals to explain the existence
of a sizable informal financial sector.
The first reason is the local government’s borrowing
behavior. Local governments have become the
main competitor with local firms for bank loans.
According to a recent report by the PBOC, onethird
of the outstanding loans in China were made
to the local governments. Over the last several
years, about 30% to 40% of total loans went into
government infrastructure projects. This massive
borrowing on the local government level crowded
out private borrowing.
The second reason is the structure of the Chinese
banking industry.74 As described above, several
large banks dominate the banking industry in
China. Large Chinese banks tend to lend to large
firms. In other countries, such as the US, small local
banks and other savings and loans companies
fill the gap left by large banks. Also, large banks
in those countries develop other financial instruments
targeted at small private firms. This is not
the case in China’s formal sector.
The third reason is the under-development of the
corporate bond market. This has made it very difficult for local private firms to issue corporate
bonds to raise money.
The fourth reason is the IPO regulatory framework.
As discussed above, the approval system
poses further difficulties for local firms with no
connections with the government to go public and
raise money.
Fifth, the periods of negative real deposit rates, due
to spurts of high inflation, while not the source of
the shadow banking sector, certainly exacerbated
its growth. Between February 2007 and October
2008, and from February 2010 to October 2011,
the real one-year interest rate on deposits in Chinese
banks was negative. During these periods,
there was a consequent growth in the informal
financial sector, as this sector avoids the government-
mandated ceiling on deposit interest rates.
The higher rate available to savers helps draw a
lot of wealth into the informal sector, especially
during these inflationary spells.
To sum up, local private firms have very limited
access to bank loans, the bond market and the
stock market. Therefore they are almost forced to
acquire funds from informal channels.
What is the situation of the informal financial
sector in China?
There is no official data or studies on the informal
financial sector on a national level. The related area
of wealth management products has been singled
out as especially concerning by Xiao Gang, the
chairman of the Bank of China. He has estimated
there to be over 20,000 of these WMP’s, reaching a
total value of 12.14 trillion RMD by 2012. Mr. Xiao
has characterized this ‘shadow banking’ sector as
“a potential source of systemic financial risk,”
whose model is “fundamentally a Ponzi scheme.”75
A more conservative estimate places the value of
these WMPs at only 7.1 trillion RMB,76 other estimates
agree that the value of these wealth management
products is not much greater than 14% of China’s GDP. This is still striking, given that they
were only just above 4% of GDP in 2010. The rapid
growth of this shadow banking sector can be attributed
to the period of negative real interest rates
on bank deposits during the majority of 2010 and
2011.77
Other informal financial flows, such as private
lending, are even more difficult to account for, with
analysts roughly estimating the later to amount to
some 4 trillion RMB per year. Overall, the informal
‘shadow’ banking sector is estimated to account
for just over 20% of total bank assets (2012),
an increase of about 33% since 2010.78
One way of evaluating the current situation of the
Chinese informal financial sector is by taking a
look at Wenzhou, which is one of the places that
the informal financial sector has thrived over the
past few years.
Wenzhou is a city in Zhejiang Province, one of the
most developed provinces along the east coast of
China. Wenzhou is famous for its industrial output
and at the beginning of the reform era generated a
group of high net worth individuals. It is reported
that the GDP of Wenzhou reached RMB 243 billion
in 2010, with per capita GDP being RMB 40
thousand, compared to a national average of RMB
30 thousand.79 About 300,000 small private firms
produce more than 90% of the local output, with
about 70% of them relying heavily on exports.
The informal financial sector went through two
stages in Wenzhou. The first stage started in around
1995 and lasted until the global financial crisis. In
this stage, the rapid development of the Chinese
economy and, most importantly, export-driven
economic growth, generated a large group
of wealthy individuals in this area. The informal
financial sector in this period mainly served as
underground asset management firms providing
alternative investment opportunities. For example,
it is claimed that about RMB 200 billion flew
into the real estate market in Beijing and Shanghai,
causing a boom in real estate prices. The informal financial sector was also accused of causing large
swings in cotton prices, meat prices and many other
commodity prices.
The second stage started after the financial crisis
and continues now. Since the Chinese economy
has slowed down and the global financial crisis,
combined with the ensuing Euro Crisis, has reduced
foreign demand, many local firms have experienced
a drying up of liquidity. The local informal
financial sector provided short-term liquidity
for the local firms during this period. The liquidity
provision was mainly done through very shortterm
but high-yield loans. For example a loan
could be as short as 3 to 5 days, and the annualized
yield could reach 70%. It is estimated that the magnitude
of the informal financial sector in Wenzhou
reached RMB 700 billion.80
The downturn of global trade as a result of the
global financial crisis also caused a large scale default
of local firms. Some owners of private firms,
who had significant debt within the shadow banking
system, went abroad to avoid debt collectors.
This, in turn, affected the fragile local underground
financial system, triggering defaults that
harmed their investors.
In 2011, the local court sentenced one of the CEOs
of the underground financial system to death, convicting
her of “illegally gathering investors’ money”.
This case was brought to national attention by
some very prestigious economists, who insisted
that “illegally gathering investors’ money” should
either not be a violation of the law or should not
receive such a severe sanction. Prime Minister
Wen Jiabao himself also asked the court to “reconsider
carefully the accusation and the final verdict”.
In the end the Supreme Court repealed the death
sentence. This case is widely seen as providing an
impetus for further financial reform in Wenzhou.81
The regulatory framework of the Wenzhou informal
financial sector has changed over time.
Before 2012, one could establish an “investment
company”, which was usually the entity for informal financial services, by registering in the local
commercial department. After that, there were no
government units that regulated these investment
companies. After 2012, since there have been several
very wide ranging defaults, and the government
seems to believe that the informal financial
sector could cause future systemic risks, there have
been discussions on how to regulate the informal
financial sector. In early 2012, the State Council
approved the establishment of new financial districts
in Wenzhou, in order to experiment with
the proper way to regulate the informal financial
sector.
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The Intersect ion of the Financial System and the Real Economy
What is the financial market’s role in China’s
real estate market?
Chinese real estate prices started to boom in the
2000’s and reached a point where many observers
diagnosed the existence of a bubble. One piece of
evidence supporting the existence of a real estate
bubble was that the growth rates of real estate price
indices were substantially higher than the growth
rate of income for most of the large cities. For example,
in the case of Beijing:
The boom in real estate prices then spread to middle-
sized cities such as Hangzhou, Nanjing and
Wuhan. In 2010, real estate prices on Hainan, an
island that is usually referred to as “the Hawaii of
China,” doubled in less than 3 months.
There are debates in both academia and the government
about whether the boom can be called
a bubble. The government finally concluded that
there were “bubbles in several major cities, due to
speculative behavior by wealthy individuals.”82
Beijing Housing Price
The boom of housing prices was a consequence
of multiple factors. The most direct cause was the
housing reform in 1998 that allowed people to
purchase houses directly from developers, instead
of waiting for their employers to distribute them.
However, the financial sector also played a role in
this boom. There were at least three ways through
which the financial sector may have influenced the real estate prices. The first was the development
of mortgages. Before 1998, the mortgage industry
was very under-developed due to the lack of demand.
But since the reform in the real estate sector,
it grew from a market of RMB 17 billion in
1997 to a market of over 7.2 trillion in 2012.83
China: Growth of Mortgage Lending
Real Estate Developer & Mortgage
The second factor was lending to real estate developers.
These loans could have influenced the
real estate prices in two opposite ways. If the loans
were widely available across all real estate developers,
then they could foster competition among developers
and therefore lower the real estate prices.
If the loans were only available to a handful of the
largest developers, then they could boost the real
estate prices by allowing them to bid more aggressively
in the land auctions. In the case of China, it
seems that the latter was the case. This factor may
not be as important because the real estate prices
did not fall after bank loans to developers fell
sharply in year 2009.
The third factor, which has been widely discussed
(e.g. Lardy, 2012) but cannot be directly proven,
is the lack of other financial assets for attractive
alternative investments. For example, it has been
argued by a number of scholars that if the Chinese
stock market became less speculative, or the Chinese
bond market was more mature, or if China
simply liberalized the capital account, the real estate
bubble would not have taken place because
people would have chosen to park part of their
money somewhere else.
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Conclusions
The Chinese financial system is of great importance
both for its role in enhancing or holding back the
development of China’s economy and because it
will also affect the rest of the world, depending on
how finance in China evolves over the next decade.
Although the system is vulnerable to a number of
risks and its opacity means that still more dangers
may lie under the surface, it has served China well
overall during the nation’s rapid development. As
the country slows its breakneck growth rate, and
works towards the necessary evolution to greater
economic sophistication and international integration,
the financial system is likely to continue
to support the larger economy. However, it will
have to evolve very considerably to do this effectively,
and all concerned should watch carefully
and help China avoid the many pitfalls. It is encouraging
that the new political leadership shows
signs of understanding the need for this evolution,
and its challenges. It is, though, much too early to
tell whether this apparent understanding will be
translated into workable reforms.
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