Financial Development and Regulatory Reform in China HUANG Ying China Institutes of Contemporary International Relations Joint workshop on Financial Evolution, Regulatory Reform and Cooperation IDEAs – SNU Center for Social Sciences – SNU Political Economy and Social Policy RC May, 2013

Structural shifts in financial sector Commercial banks Non-bank financial institutions Shadow banking sector Capital markets Local government debts

By the end of March 2013, the commercial banks expanded their assets to trillion RMB, equivalent to 270% of its GDP.

The top ten profit-making banks in the world in 2011 rankbank Profits billion dollars 1Industrial and Commercial Bank of China Construction Bank of China34.8 3Bank of China26.8 4JP Morgan Chase & Co26.7 5Agricultural Bank of China25.1 6Wells Fargo23.3 7HSBC21.9 8Mitsubishi UFJ Financial Group17.6 9Citibank BNP Paribas12.5

Expansion of non-bank financial institutions by the end of 2010 Financial institutions Total assets (trillion RMB) Change from 2006 (%) Securities company Fund management company Insurance company bank92116

Mushrooming of the non-financial institutions Non-financial institutions with financial functions by the end of 2011, 4,282 small-scale loan companies 5,237 pawn companies 8,402 financing guarantee companies

Rise of Alternative Financing

Local government debts by the end of 2010 (roughly 25 percent of GDP)

Shifts in Financial Structure

Expansion of M2 in China (trillion RMB)

High risks in the rapid expansion of the banking sector (1) Property price bubble (2) Local government debts How healthy is banking sector in China? How to reform it to create a more equitable competitive and resilient banking sector?

Commercial Banks Performances in 2011 bankCapital adequacy ratio (%) Non- performance loan ratio (%) Net profits (billion yuan) Industrial Commercial Bank of China Agricultural Bank of China Bank of China Construction Bank of China Bank of Communications All commercial banks

Financial reform Narrow sense: interest rate reform private capitals entry into financial sectors capital market development more open to foreign investments Broad sense exchange rate formation mechanism reform capital account opening internationalization of RMB

Interest rate reform Why reform: (1) the negative deposit rates help foster the shadow banking sector, which is a destabilizing factor (various trust products; questionable wealth management products; interaction between the banks and non-bank entities). (2) the big gap between deposit and loan rates raised the question why the banks are allowed to make money so easily. (3) believed to make the banks more competitive in the markets and more responsibility for their own choices.

Interest rate reform Liberalizing the interest rates mainly means increasing the lending rates and reducing the deposit rates. In June 2012, PBC announced that commercial banks will be allowed to set the interest rates charged on their loans at or above 80 percent of the governments benchmark rate, down from the previous 90 percent. The central bank also gave them permission to set deposit rates at or less than 1.1 times the government benchmark rates. Later, PBC further lowered the lending rates from 80 percent of the benchmark rates to 70 percent.

Three financial reform pilot zones (1) Wenzhou: transparency of private lending. (2) Zhujiang Delta: for internationalization of its financial services. (3) Quanzhou: to better service the real economy.

Measures to develop capital markets Future reforms as identified by the China Financial Stability Report 2012: (1) Expand the direct finance. (2) Encourage a multi-layered capital market system, to diversify Banking systems risks (3) Actively promote the securitization of credit assets guided by the principles of simplicity, transparency and reasonable share of risk costs. (4) Encourage the commercial banks to set up fund management companies in an orderly way, to support the healthy development of capital markets.

Exchange rate formation mechanism reform Reasons for pursue this reform (1)conform to the international mainstream practice under the great external pressures (especially from US). (2) Believed that a more resilient exchange rate system can dampen the speculative attacks on its currency, Which is against the experiences of many floating exchange-rate countries.

Chinas Current Account Surplus

Capital account opening Capital account opening has always been connected with the need to internationalize RMB. However, the link between the two is questionable. Historical experiences by Britain and America were clearly different. Japans efforts were fruitless. EU has never actively pursued it. For China, to promote the use of RMB is necessary, but opening the capital account may not be helpful.

Financial regulation system and reform Chinas financial regulation system is modeled on Americas. Chinas financial supervision system consists of one bank and three commissions. One bank refers to the Central Banks, and the three commissions are Banking Supervisory Commission, Securities Supervisory Commission and Insurance Supervisory Commission. As China moves to universal bank system, this supervision system will be less effective.

Some observations: Chinese governments mind is occupied by the needs to liberalize the financial sector for various reasons, not to revamp its regulatory system. China successfully withstood the two big financial crises, not because it had sound financial system. China also thinks that the western banking practices, including the new BASEL rules are more advanced than its own. Its still in the phase of learn and adapt.