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China’s central bank is paying unprec- edented attention to the stability of the financial sector. On May 24， the People’s Bank of China （PBC）， the country’s central bank， issued the Financial Stability Report 2013， saying that one of the key tasks for 2013 would be to improve the system of monitoring， assessing and disposing of systemic risks， which include local government debt and shadow banking.
When China entered the WTO in 2001， it made the commitment to open its banking sector by 2006. However， little progress has been made in that regard because the central bank is concerned about the possibility of a financial crisis.
But the potential for a crisis in the financial industry is not lessened because of a slowopening banking sector. The emergence of local government debt and shadow banking poses huge risks to the financial industry.
The financial sector is the core of a modern economy， and financial stability is closely related to a country’s economic security. If a financial crisis took place in China before the U.S. crisis comes to a complete end， the world economy would suffer a catastrophe. China’s part in defusing risks to the financial system means its role in the global economy is indisputable.
Potential crisis
How probable is a financial crisis in China？
Most people think the Chinese economy is sound， and the present slowdown of economic growth is just a result of intentional control by the government. The risks China’s financial system faces， particularly the risks of local government debt and shadow banking， are under control.
However， Yi Xianrong， a researcher with the Institute of Financial and Banking of the Chinese Academy of Social Sciences， says the bigger issue is determining the actual size of the real estate bubble and when or if it will burst， which would hit China’s financial system hard. “Without eliminating such risks or squeezing out real estate bubbles， a financial crisis is bound to burst in China，” said Yi.
Financial risks are also reflected in the country’s broad money （M2） supply. According to the PBC figures， the balance of China’s M2 at the end of the first quarter this year was 15.7 percent higher than in the same period last year， and the newly added amount during the first quarter surged by 40.88 percent over a year ago. In comparison， China’s GDP in the first quarter only rose by 7.7 percent. The faster growth of M2 over economic growth indicates the presence of bubbles in the financial industry， and such bubbles may cause significant unbalance. At present there are signs of unbalance， said Yi. On one hand， various monetary and financial indicators maintain high growth， newly added credit surpasses 8 trillion yuan（$1.29 trillion） every year and the official interest rate has dropped； on the other hand， it has become increasingly difficult and expensive for small and micro-sized enterprises to get loans， and the actual interest rate keeps rising. Many are confused as to where the newly added credit has gone. In fact， the credit has never left the financial system： Many new loans are put into banks again to become deposits， and many new deposits are lent out to become loans； financial institutions are borrowing from each other and purchasing financial products issued by each other. Financial credit looks quite active， but actually it’s based on “inside circulation.” As a result， the debt ratio of the overall economy will be higher and higher， while profitability keeps dropping， which will inevitably drag down the real economy and increase the ratio of non-performing loans and lead to a financial crisis.
Reform is the solution
The central bank has been focused heavily on how to effectively prevent and control financial risks to avoid a financial crisis. After the financial crisis broke out in the United States， China’s financial industry has strengthened supervision to prevent risks.
According to the Financial Stability Report 2013， the major task this year is to deepen financial reform and advance the development of private financial institutions. On May 24， the State Council released guidelines to deepen economic reform， including market-oriented reform measures to liberalize interest rates and the convertibility of the yuan under the capital account. Zhao Xijun， Deputy Dean of School of Finance at Renmin University of China， says the new round of reform in China’s financial sector has begun， including interest and exchange rates and convertibility.
The market-oriented reform of interest rates is to allow for better fluctuation of deposits and credit interest rates， establish a sound system for the benchmark interest rate and set up a deposit insurance system. This can better solve the risks associated with shadow banking. “The root cause for the problem of shadow banking emerging in recent years is the control of interest rates，” said Zhao.
The aim of the reforms is to eventually loosen state controls on exchange rates in order to boost the country’s market economy. Zhao says exchange rate fluctuation shouldn’t be the focus of reform. The aim instead is to make the yuan more market-based， an important task for the Central Government this year. As market-oriented reforms of interest rate and exchange rate are advanced， a major task of financial reforms—convertibility under the capital account—becomes increasingly urgent because it decides the process by which the yuan becomes an international currency.
According to Zhao， free convertibility under the capital account should be the last step of China’s financial reform. The State Council’s guideline on deepening economic reform requires that the financial supervising authority bring forward schemes for the yuan’s convertibility under the capital account.
Still， fluctuation in economic growth and the possible massive outflow of capital could undermine reform plans， says Yi. “Currently the reforms are being tested， and that will test the government’s resolve.”
China’s Financial Sector
Banking
By the end of 2012， there had been 3，747 institutions in the banking sector， with total assets of 133.6 trillion yuan （$21.62 trillion）， up by 17.9 percent； their total debts amounted to 125 trillion yuan （$20.23 trillion）， an increase of 17.8 percent. Nonperforming loans stood at 1.07 trillion yuan（$173.14 billion）， which was 23.4 billion yuan（$3.79 billion） higher than the previous year； and the non-performing loans ratio was 1.56 percent， a decline of 0.22 percentage points from a year ago.
Insurance
At the end of 2012， China had eight insurance holding groups， 37 domestic property insurance companies， 21 foreign-funded property insurance companies， 22 domestic life insurance companies and 25 foreignfunded life insurance companies. In 2012， the premium income totaled 1.55 trillion yuan （$250.81 billion）， and the compensation expenses amounted to 471.63 billion yuan（$76.32 billion）.
When China entered the WTO in 2001， it made the commitment to open its banking sector by 2006. However， little progress has been made in that regard because the central bank is concerned about the possibility of a financial crisis.
But the potential for a crisis in the financial industry is not lessened because of a slowopening banking sector. The emergence of local government debt and shadow banking poses huge risks to the financial industry.
The financial sector is the core of a modern economy， and financial stability is closely related to a country’s economic security. If a financial crisis took place in China before the U.S. crisis comes to a complete end， the world economy would suffer a catastrophe. China’s part in defusing risks to the financial system means its role in the global economy is indisputable.
Potential crisis
How probable is a financial crisis in China？
Most people think the Chinese economy is sound， and the present slowdown of economic growth is just a result of intentional control by the government. The risks China’s financial system faces， particularly the risks of local government debt and shadow banking， are under control.
However， Yi Xianrong， a researcher with the Institute of Financial and Banking of the Chinese Academy of Social Sciences， says the bigger issue is determining the actual size of the real estate bubble and when or if it will burst， which would hit China’s financial system hard. “Without eliminating such risks or squeezing out real estate bubbles， a financial crisis is bound to burst in China，” said Yi.
Financial risks are also reflected in the country’s broad money （M2） supply. According to the PBC figures， the balance of China’s M2 at the end of the first quarter this year was 15.7 percent higher than in the same period last year， and the newly added amount during the first quarter surged by 40.88 percent over a year ago. In comparison， China’s GDP in the first quarter only rose by 7.7 percent. The faster growth of M2 over economic growth indicates the presence of bubbles in the financial industry， and such bubbles may cause significant unbalance. At present there are signs of unbalance， said Yi. On one hand， various monetary and financial indicators maintain high growth， newly added credit surpasses 8 trillion yuan（$1.29 trillion） every year and the official interest rate has dropped； on the other hand， it has become increasingly difficult and expensive for small and micro-sized enterprises to get loans， and the actual interest rate keeps rising. Many are confused as to where the newly added credit has gone. In fact， the credit has never left the financial system： Many new loans are put into banks again to become deposits， and many new deposits are lent out to become loans； financial institutions are borrowing from each other and purchasing financial products issued by each other. Financial credit looks quite active， but actually it’s based on “inside circulation.” As a result， the debt ratio of the overall economy will be higher and higher， while profitability keeps dropping， which will inevitably drag down the real economy and increase the ratio of non-performing loans and lead to a financial crisis.
Reform is the solution
The central bank has been focused heavily on how to effectively prevent and control financial risks to avoid a financial crisis. After the financial crisis broke out in the United States， China’s financial industry has strengthened supervision to prevent risks.
According to the Financial Stability Report 2013， the major task this year is to deepen financial reform and advance the development of private financial institutions. On May 24， the State Council released guidelines to deepen economic reform， including market-oriented reform measures to liberalize interest rates and the convertibility of the yuan under the capital account. Zhao Xijun， Deputy Dean of School of Finance at Renmin University of China， says the new round of reform in China’s financial sector has begun， including interest and exchange rates and convertibility.
The market-oriented reform of interest rates is to allow for better fluctuation of deposits and credit interest rates， establish a sound system for the benchmark interest rate and set up a deposit insurance system. This can better solve the risks associated with shadow banking. “The root cause for the problem of shadow banking emerging in recent years is the control of interest rates，” said Zhao.
The aim of the reforms is to eventually loosen state controls on exchange rates in order to boost the country’s market economy. Zhao says exchange rate fluctuation shouldn’t be the focus of reform. The aim instead is to make the yuan more market-based， an important task for the Central Government this year. As market-oriented reforms of interest rate and exchange rate are advanced， a major task of financial reforms—convertibility under the capital account—becomes increasingly urgent because it decides the process by which the yuan becomes an international currency.
According to Zhao， free convertibility under the capital account should be the last step of China’s financial reform. The State Council’s guideline on deepening economic reform requires that the financial supervising authority bring forward schemes for the yuan’s convertibility under the capital account.
Still， fluctuation in economic growth and the possible massive outflow of capital could undermine reform plans， says Yi. “Currently the reforms are being tested， and that will test the government’s resolve.”
China’s Financial Sector
Banking
By the end of 2012， there had been 3，747 institutions in the banking sector， with total assets of 133.6 trillion yuan （$21.62 trillion）， up by 17.9 percent； their total debts amounted to 125 trillion yuan （$20.23 trillion）， an increase of 17.8 percent. Nonperforming loans stood at 1.07 trillion yuan（$173.14 billion）， which was 23.4 billion yuan（$3.79 billion） higher than the previous year； and the non-performing loans ratio was 1.56 percent， a decline of 0.22 percentage points from a year ago.
Insurance
At the end of 2012， China had eight insurance holding groups， 37 domestic property insurance companies， 21 foreign-funded property insurance companies， 22 domestic life insurance companies and 25 foreignfunded life insurance companies. In 2012， the premium income totaled 1.55 trillion yuan （$250.81 billion）， and the compensation expenses amounted to 471.63 billion yuan（$76.32 billion）.