FINANCIAL SYSTEM
OF CHINA
Lecturer – Oleg Deev
oleg@mail.muni.cz
Contents
• Statistical results of financial reforms in China
• Reformation of the banking system
• Key challenges for Chinese banking system
• Development of financial markets in China
• Financial regulations and supervision
• Key challenges for Chinese financial markets
The financial system of China
• Disproportionally important to the global financial
system
• 30% of global financial assets
• 60% of world’s foreign reserves
• System design
• To sustain an undervalued exchange rate
• To maintain stability and Communist Party’s control of
the financial system
• Presumably the weakest banking system in the
world
Financial deepening
Heavy reliance on bank financing (2006)
Banking system before 1978
PBOC
As central bank the People’s
Bank of China has an
objective of promoting
economic growth and price
stability.
It focused on monetary policy
issues and financial system
liquidity.
CBRC
The China Banking Regulatory
Commition (CBRC) managed
the functions of supervision. It
focused on the restructuring
of the banking sector
PBOC remains still very influential, it has considerable regulatory
power (common overlapping of functions)
Reforming Chinese banking system (1)
Phase One (1978-1994)
• 1978 - The People's Bank of China (PBC) was designated
as a central bank and became independent of the Ministry
of Finance resulting in more effective conduct of monetary
policy
• A two-tier banking system was created in which the PBC
emerged as the central bank, while the following banks
emerged as the specialized banks
• the Bank of China (BOC)
• the China Construction Bank (CCB)
• the Agricultural Bank of China (ABC)
• the Industrial and Commercial Bank of China (ICBC)
Reforming Chinese banking system (2)
Other bank and Non-bank financial institutions
• Regional banks (partially owned by local governments)
• City commercial banks (with business restricted to home
city)
• Cooperatives banks (Rural Credit Corp., similar to credit
unions in the U.S. and Urban Credit Corp.)
• Non-bank financial intermediaries (such as the Trust and
Investment Corporations; finance companies, financial
leasing companies, auto financing companies)
Reforming Chinese banking system (3)
Phase Two (1994-1998)
Three policy banks were set up to undertake the policy
driven financing earlier assigned to specialized banks:
• the China Development Bank,
• the Agricultural Development Bank of China and
• the Export-Import Bank of China
Reforming Chinese banking system (4)
Phase Three (1998-2006)
• Reform initiatives (as part of its WTO accession):
• 13 cities have been opened for foreign banks to conduct “renminbi”
business
• 100 eligible foreign banks were permitted to conduct “renminbi”
business
• 55 of them were allowed to provide “renminbi” services to the
Chinese enterprises
• Recapitalization of state banks
• 4 asset management companies set up in year 2000 to take over
US$1,600 billion of non-performing loans
• US$1108 billion NPLs disposed up to March 2006,
• cash recovery rate 20.8%
• US$45 billion capital injection in 2004 for BOC and CCB
• US$15 billion capital injection in 2005 for ICBC
Reforming Chinese banking system (5)
Phase Four (2006-?)
• 2006 – removing of all geographic and (most) business
restrictions for foreign banks. Foreign Banks allowed to
provide 12 categories of services in China. Nevertheless
they play rather small role
• The permitted equity holding in Chinese financial
institutions by a single foreign investor has been raised
from 15 to 20%, while the maximum foreign equity holding
remains at 25 %
• CCB listed in Hong Kong in 2005, BOC and ICBC in 2006
• Reorganization and recapitalization of China Agricultural
Bank and Postal Savings Bank for listing
Design of the banking sector
• The assets of the banking sector account for around 95% of the total
assets of all financial institutions in China.
• 62% of the fixed-asset investment in China are funded by banking
Sector.
• The big four SOE banks are the major players in the Chinese financial
market, with their assets accounting for 52.7% of the total bank assets
in China.
China Banking Regulatory
Commission
Policy
Banks
(3)
Joint stock
Commercial
banks(10)
State-Controlled
Commercial
Banks(4)
Foreign
Banks
(225)
Regional
Banks
Postal
Saving
Banks
City
commercial
banks
Co-
operated
banks
Non-bank
financial
companies
Industrial and
Commercial
bank of China
Bank
of
China
China
Construction
bank
Agricultural bank
of China
Chinese banking system
State dominance in the banking industry
(2006)
62%
19%
7%
2% 9%
1%
Assets (%)
State-owned banks
Joint stock banks
City commercial
banks
Foreign banks
Rural credit unions
Urban credit unions
Banks in China
• State-owned banks: ICBC, CCB, BOC, ABC
• 70% of all assets in the Chinese financial system
• Among the largest 25 banks in the world (in total assets)
• Owners of large amounts of equity in Chinese corporations
• Hold over 70% of all bonds issued in China
• Joint stock banks: Bank of Communication, China
Merchants Bank, Guangdong Development Bank,
Minsheng Bank
• City banks and credit unions: Bank of Shanghai,
Bank of Nanjing, Ningbo Commercial Bank
• Foreign banks: HSBC, Citibank, Standard
Chartered
• Lack of transparency
• Weak governance and
lack of commercial
mindset
• Operational weaknesses
in lending and risk
management
• Decentralized structure
with local autonomy
• Underground lending
Root causes of weak
performance
• Renewed NPL build-up
• Sharp reductions in liquidity
and profitability, due to
concentration of profits,
from:
• Foreign bank entry
• Corporate bond
market development
• Real estate exposure
Key vulnerabilities
Weak bank performance creates
vulnerabilities
The non-performing loan problem (NPL)
• A residue of casualties of economic reform
• The Government’s response a combination of:
• Worst loans moved to asset management companies
(“bad banks”)
• Capital injections
• Enhancement of recovery rates
• Restrictions of “political” lending
Key challenges for Chinese banking system
Fundamental banking industry reform is far from complete
• Ensure large state-owned banks, that have been cleaned up
and recapitalized, do not repeat past mistakes
• Upgrade management expertise
• Improve risk management and internal control
• Adopt risk-based pricing
• Implement proper incentive system
• Further lower high NLP ratios and address thin capitalization of
other underperforming banks
• Eliminate influence by central and local governments (introduce
real competition, reduce corruption)
• Further improve regulatory/legal framework (for example,
deposit insurance)
• Improve retail banking
Financial markets
• Two domestic stock exchanges:
• Shanghai Stock Exchange Market (SHSE)
• Shengzhen Stock Exchange Market (SZSE)
• At the end of 2005, the combined total market
capitalization of the SHSE and SZSE ranked 15th among
the largest stock exchanges in the world, 2007 – the 5th.
• Bond Markets: government bonds, “policy financial
bonds”, corporate bond
• Private Equity/Venture Capital
• In years 2000-2007 the performance of the stock markets
has been volatile
• This is somewhat surprising given the robust performance of
the real economy
Chinese capital market
• 1540 publicly listed companies on domestic exchanges,
143 on overseas (Feb 2007)
• Equity market capitalization of around US$3 trillion (2007)
• State Shares 33.1%, (non-tradable until 2005)
• Legal person shares 16.7% (non-tradable until 2005)
• Tradable individual shares 50.2%
• Government bond market cap US$ 364 billion
• Corporate bond market cap US$35 billion
Equity market
• Great Leap Forward in Equity Market
• An average of US$9 billion raised per year from 1991 to 2006
• In 2007, $50 billion new A-shares were issued, taking the first place
in the world (the second place US equity markets raised less than
$40 billion in 2007)
• Shanghai Stock index increased by almost 100% in 2007
• Private Equity
• Size estimated around 620 billion RMB in 2007, much of it comes
from abroad
• Enormous Potential
• Great demand in a vibrant economy for private equity
• High risk and cost due to poor legal and financial infrastructure
Chinese stock market reform
• Before 2005, state-owned and legal person-owned shares
could not be traded on stock exchanges. Large
shareholders paid little attention to the prices of tradable
shares held by the public
• In 2005, the government initiated reforms that made nontradable
shares tradable
• This aligned the interests of large shareholders with that
of outside shareholders
Equity market
• Starting in 2006, China’s stock markets witnessed a stellar rise.
Average daily trading volume reached USD 26 bn, making it
one of the most actively traded markets worldwide.
• After the stock market started to correct in October 2007,
market capitalization declined to around 50% of nominal GDP
as of end-2008. Trading activity also dropped, reaching USD
17 bn on a daily average basis
Shanghai Stock Exchange
• Founded in 1891, closed in 1949, reestablished in 1990
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
99 00 01 02 03 04 05 06 07 08 09 10 11
Share categories
• Non-tradable shares (until 2005)
• Legal person shares
• State-shares
• Tradable shares
• A-shares: denominated in RMB
• B-shares: denominated in US$ and HK$
• H-shares: PRC-registered listed in HK$
• Red-chips: Chinese companies registered
overseas and listed in Hong Kong
Bond market
Bond market
• Although total annual issuance has surged since the early
2000s China’s bond market is still relatively small as a
share of nominal GDP (35% in 2007) especially when
compared to mature economies
• Public sector issuance dominates. People’s Bank of China
(PBC) and treasury bonds accounted for almost 80% of
total issuance in 2007
• Domestic commercial banks are the major players in
China’s local bond market, holding close to 60% of the
total amount outstanding
Financial regulations (1)
• Entry regulations
• Geographic and business restrictions for foreign
banks and insurance companies
• Foreign stake in commercial banks capped at 25%
• Foreign partners can take up to 33% in brokerage
firms and fund management companies
• Approval required for branches & offices
• License required for domestic institutions
• Private individuals can only have a minority position
Financial regulations (2)
• Interest rate regulation
• Both lending and deposit benchmark rates are set by
the central bank
• Lending rate has no upper limit and the lower bound
is 90% of the benchmark rate. The rates for mortgage
loan can be 85%
• Deposit rate has the benchmark rate as the upper
limit and is allowed to float downward
• Interbank rate SHIBOR was introduced on Dec. 1,
2006 and determined by market forces
Financial regulations (3)
• Regulation of international accounts
• Current account deregulated
• Closed Capital/Financial account with a few
exceptions
• Managed floating exchange rate regime
• The RMB pegged to USD at RMB 8.27/USD from
mid-1990s to 2005
• It is supposed to be pegged to a basket of currencies
since July 21, 2005
• The RMB/US$ exchange rate allowed to float no more
than 0.5% of the previous day’s closing, 1.5% against
other currencies
• No timetable for full convertibility
Financial supervisory bodies
• The China Securities Regulatory Commission (CSRC in
end of 1992)
• The China Insurance Regulatory Commission (CIRC in
1998)
• The China Banking Regulatory Commission (CBRC in
2003)
A joint mechanism has been developed among the CBRC,
the CSRC and the CIRC for co-operation among
themselves
Financial regulatory structure
The State
Council
CBRC CSRC
Commercial
Banks
Credit
Cooperatives
CIRC
Trust &
Investment
Securities
Firms
Exchanges
Fund
Management
Insurance
Companies
Key challenges for Chinese financial
markets
• Availability of information for investors (information
disclosure / transparency)
• Institutional investors’ involvement in the market
development
• Problem of insider trading
• Monitoring and control of credit rating institutions
• Minimization of the financial panic
• Encourage small banks to raise capital
• Development of the corporate bond market
• Government intervention
China’s financial system (1)
• Financial institutions
• Policy banks
• Commercial banks
• state-owned
• partially state-owned
• private-owned and foreign
• Non-bank financial institutions
• RCC, UCC, Postal Savings
• TIC, Mutual Funds, Finance companies
• Non-standard financial sector
• Informal Financial Institutions
China’s financial system (2)
• Financial Markets
• Stock market (SHSE, SZSE, HKSE)
• Bond market
• Government bond
• Corporate bond
• Venture capital
• Real estate
• Foreign sector (FDI)
Main characteristics of China’s financial
system
• China has made steady advances in modernizing its financial
system and in mobilizing savings, reflected in the doubling of
China’s stock of financial assets relative to GDP over the past
ten years
• China’s banking sector plays a large role in its financial system
• Capital allocation in the system is poor: wholly and partially
state-owned companies continue to absorb most of the funding
from the financial system, while private enterprise, the engine
of China’s growth, receives a disproportionately small share. As
a result, China’s investment efficiency is declining
• China’s financial system’s remaining problems are intricately
linked across its component markets, and will therefore require
an integrated approach to reform
Is China’s financial system
sound and safe?
China’s economy is experiencing the fastest growth in the
world, and is expected to maintain a relatively high growth
in a considerable long period. With further implementation
of financial sector reforms and liberalization of the sector,
China’s financial sector has the potential to achieve the
fastest growth in the global context
Financial crisis in China?
• Possible spike in NPLs
• General inefficiency of the banking system
• Potential asset bubbles
• Sovereign default risk
• Crisis of confidence caused by endemic
corruption
Key challenges for financial system
• Banks still serve as the primary channel for corporate
financing with very limited ability to lay off risks outside the
banking system
• Domestic stock market is growing
• Domestic bond market remains underdeveloped
• Emerging universal banking trend poses increasing
complexity for regulation
• Banks are allowed to set up asset management companies
• Underground lending
• The biggest issues are probably cultural
• Credit focus, not formula lending allocations
• Creative tensions within banks, and between banks and regulators
• Institutional loyalties
Readings for the next topic
1. Perotti, E.C. (2002). Lessons from the Russian
Meltdown. The Economics of Soft Legal Constraints.
CEPR Policy Paper No. 9.
2. Guriev, S. and A. Rachinsky (2005). The Role of
Oligarchs in Russian Capitalism. Journal of Economic
Perspectives, vol. 19(1), pp. 131–150