China’s Financial System Past, Present, and Future

China’sFinancialSystem:Past,Present,andFuture*FranklinAllenJun“QJ”Qian†MeijunQianFinanceDepartmentFinanceDepartmentFinanceDepartmentTheWhartonSchoolCarrollSchoolofManagementNUSBusinessSchoolUniversi[e-mail]@[e-mail]:March28,2007(Forthcominginthebook“China'sGreatEconomicTransformation,”editedbyT.RawskiandL.Brandt,andpublishedbytheCambridgeUniversityPressin2007.)AbstractWeexaminetheroleofChina’sfinancialsysteminsupportingeconomicgrowth,andexploredirectionsoffuturedevelopment.First,thecurrentfinancialsystemisdominatedbyalargebutinefficientbankingsector.Reducingtheamountofnon-performingloansamongthemajorbankstonormallevelsisthemostcriticaltaskforreformingthefinancialsystemintheshortrun.Second,theroleofthestockmarketinallocatingresourcesintheeconomyhasbeenlimitedandineffective.FurtherdevelopmentofChina’sfinancialmarketsisthemostimportanttaskinthelong-term.Third,themostsuccessfulpartofthefinancialsystem,intermsofsupportingthegrowthoftheoveralleconomy,isanon-standardsectorthatconsistsofalternativefinancingchannels,governancemechanisms,andinstitutions.Thissectorshouldco-existwithbanksandmarketsinthefutureinordertocontinuetosupportthegrowthoftheHybridSector(non-state,non-listedfirms).Finally,inordertosustainstableeconomicgrowth,Chinashouldaimtopreventandhaltdamagingfinancialcrises,includingabankingsectorcrisis,arealestateorstockmarketcrash,anda“twincrisis”inthecurrencymarketandbankingsector.JELClassifications:O5,K0,G2.Keywords:banks,non-performingloans,markets,corporategovernance,hybridsector,financialcrisis.*WeappreciatesuggestionsfromLorenBrandtandThomasRawski(co-editors)andothercontributorstothebook“China'sGreatEconomicTransformation”thatsignificantlyimprovedthepaper.WealsowishtothankDongChen,DonClarke,EdKane,NickLardy,AnthonyNeoh,KatharinaPistor,PhilStrahan,MengxinZhao,andseminar/sessionparticipantsatBaruchCollege,ColumbiaLawSchool,FederalReserveBankofSanFrancisco,UC-BerkeleyLawSchool,PennLawSchool,YorkUniversityandthe2006ChineseFinanceAssociationmeetingsfortheircomments,JasonMao,YingXia,andJasonXuforresearchassistance,andMichaelChuiandRichardHerringforprovidingdataonfinancialintermediariesandbondmarkets.FinancialsupportfromBostonCollege,theSmithRichardsonFoundation,WhartonFinancialInstitutionsCenterandChinaInternationalCapitalCorp.,Ltd.(forsponsoringthebestpaperawardattheChineseFinanceAssociationmeetings)isgratefullyacknowledged.Theauthorsareresponsibleforremainingerrors.†Correspondingauthor:FinanceDepartment,CarrollSchoolofManagement,BostonCollege,MA02467.Phone:[phone],fax:[phone],E-mail:[e-mail]roleofChina’sfinancialsysteminsupportingthegrowthofitseconomyandexplorethedirectionsofitsfuturedevelopment.Almosteveryfunctioningfinancialsystemincludesfinancialmarketsandintermediaries(e.g.,abankingsector),buthowthesetwosectorscontributetotheentirefinancialsystemandeconomydifferssignificantlyacrossdifferentcountries.AlthoughthereisnoconsensusregardingtheprospectsforChina’sfutureeconomicgrowth,aprevailingviewonChina’sfinancialsystemspeculatesthatitisoneoftheweakestlinksintheeconomyanditwillhamperfutureeconomicgrowth.AcomprehensiveexaminationofallaspectsofChina’sfinancialsystem,andextensivecomparisonswithothercountrieswheredataisavailableareprovidedbelow.Wealsodiscusswhathasworkedandwhatremainstobedonewithinthefinancialsystem,andexaminehowfurtherdevelopmentcanbetterservetheentireeconomy.Finally,weprovideguidelinesforfutureresearchandpolicymakingonseveralimportantunresolvedissues,includinghowChina’sfinancialsystemshouldintegrateintotheworld’smarketsandeconomy.WedrawfourmainconclusionsaboutChina’sfinancialsystemanditsfuturedevelopment.First,whenweexamineandcompareChina’sbankingsystemandfinancialmarketswiththoseofbothdevelopedandemergingcountries,wefindChina’sfinancialsystemiscurrentlydominatedbyalargebutunder-developedbankingsystem.Evenwiththeentranceandgrowthofmanydomesticandforeignbanksandfinancialinstitutionsinrecentyears,China’sbankingsystemisstillmainlycontrolledbythefourlargeststate-ownedbankswithalargeamountofnon-performingloans(NPLs).Threeofthe‘bigfour’bankshaverecentlybecomepubliclylistedandtradedcompanies,withthegovernmentbeingthelargestshareholderandretainingcontrol.Thecontinuingefforttoimprovethebankingsystem,inparticular,toreducetheamountofNPLsofthemajorbankstonormallevels,isthemostimportantaspectofreformingChina’sfinancialsystemintheshortrun.OursecondconclusionconcernsChina’sfinancialmarkets.Twodomesticstockexchanges,theShanghaiStockExchange(SHSEhereafter)andShenzhenStockExchange(SZSE),wereestablishedin1990.Theirscaleandimportancearenotcomparabletothebankingsector;andtheyhavenotbeeneffectiveinallocatingresourcesintheeconomy,inthattheyarehighlyspeculativeanddrivenbyinsidertrading.Goingforward,however,financialmarketsarelikelytoplayanincreasinglyimportantroleintheeconomy,andtheirfurtherdevelopmentisthemostimportantlong-termtaskforChina’sfinancialsystem.Weproposesev