ED ZHANG Tack­ling the shadow bank­ing is huge task

China Daily (Canada) - - BUSINESSVIEWS -

Agov­ern­ment doc­u­ment to reg­u­late shadow bank­ing, re­ported by the Chi­nese busi­ness me­dia last week, has high­lighted more than ever be­fore the dilemma in China’s fi­nan­cial sys­tem and a daunt­ing task in its fi­nan­cial re­form.

Some say this year will be a time of make-or-break for the coun­try. One thing to watch will be Bei­jing’s suc­cess or fail­ure in rein­ing in the risk in the coun­try’s fi­nan­cial sys­tem while al­low­ing it to grow, di­ver­sify ser­vices and to ex­pand to many coun­tries — to fol­low in the foot­steps of Chi­nese in­vestors in the world.

But how can new re­stric­tions be rec­on­ciled with greater de­vel­op­ment? There seems to be an in­her­ent con­tra­dic­tion in that.

But this is ex­actly what China has to do — if it wants to con­tinue to grow rel­a­tively fast and avoid a full-blown fi­nan­cial cri­sis. Ac­cord­ing to the res­o­lu­tion adopted by the na­tional lead­er­ship’s third plenum last year, one of the goals of the next round of re­form is pre­cisely to build a large, ver­sa­tile fi­nan­cial sys­tem able to guard its hard­core from in­dis­creet or un­eth­i­cal prac­tices.

This is where a multi-layer fi­nan­cial sys­tem fits into the pic­ture, as many Chi­nese econ­o­mists have pointed out.

This sys­tem would con­sist of a layer in which a few in­sti­tu­tions hold the coun­try’s most im­por­tant fi­nan­cial re­sources on be­half of the gov­ern­ment, a sec­ond layer in which many in­sti­tu­tions, not nec­es­sar­ily all State-owned, com­pete in the mar­ket­place — al­lowed to con­duct their own in­no­va­tions but not ex­pect­ing a gov­ern­ment bailout if things go badly — and a third layer that is left for small ser­vices left alone to sink or swim and that there­fore can­not do ma­jor harm to the main body of the na­tional fi­nan­cial sys­tem.

There will be some shadow bank­ing, but it should not be al­lowed to grow so large and to fund so many lo­cal gov­ern­ment projects.

With bet­ter rules and more in­sti­tu­tions, China should be able to re­di­rect lo­cal gov­ern­ments’ fundrais­ing chan­nels from shadow bank­ing to a more open and bet­ter-reg­u­lated bond mar­ket.

Bei­jing re­cently said it would al­low lo­cal gov­ern­ments to is­sue bonds to pay back their debt. The ques­tion now is who will hold their bonds and who will help float them. This year it would not be too dif­fi­cult for China to make a few more good moves in this di­rec­tion.

But erect­ing the frame­work for a multi-layer fi­nan­cial sys­tem will re­quire a much larger ef­fort, en­tail­ing a tug-of-war be­tween in­ter­est groups.

In the process, the per­for­mance of many listed com­pa­nies, and in­deed all com­pa­nies in the fi­nan­cial ser­vice in­dus­try, along with a huge amount of wealth in China, will be af­fected.

If the fi­nan­cial ser­vice in­dus­try con­tin­ues to be dom­i­nated by a few very large State-owned bank­ing cor­po­ra­tions, the change de­sired would not ma­te­ri­al­ize and the real econ­omy would prob­a­bly con­tinue to de­pend on shadow bank­ing for a great por­tion of its credit. That would pose a per­ma­nent risk for the coun­try’s growth.

If there is to be a real change, there will have to be di­verse in­sti­tu­tions and ser­vices for all play­ers in the econ­omy. The re­sult would in­evitably be more fi­nan­cial ser­vice com­pa­nies in the stock mar­ket, which would pre­sum­ably be smaller than the State-owned bank­ing gi­ants, and be good at gen­er­at­ing growth from their ex­per­tise in spe­cial­ized ser­vices.

The State-owned bank­ing cor­po­ra­tions can spin off some of their bet­ter-man­aged and more com­pet­i­tive de­part­ments. They may also sell some of their not-so-prof­itable ser­vices to lo­cal banks. All fi­nan­cial ser­vices, in­clud­ing those built by pri­vate in­vestors, would be forced, not by the gov­ern­ment but by mar­ket com­pe­ti­tion, to build a strong man­age­ment and de­fine a mar­ket niche.

Un­til a change of this kind takes root, China can­not hope it will walk out eas­ily from the long shadow of shadow bank­ing and the risk it in­evitably en­tails.

A dan­ger is that if China waits for too long in defin­ing the game rules and play­ground for smaller fi­nan­cial in­sti­tu­tions, which would be tan­ta­mount to pro­tect­ing the mo­nop­o­lis­tic sta­tus of the Sta­te­owned bank­ing gi­ants, shadow bank­ing would grow even more out of con­trol. The au­thor is ed­i­tor-at-large of China Daily. Con­tact the writer at edzhang@ chi­nadaily.com.cn.

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