Finance must resume natural role in real economy
Internal and external risks are weighing on China’s financial system, and an “explosion” of any of these problems could endanger the stability of the entire system.
Domestically, economic downward pressure has been increasing, and financial risks that were formerly concealed by rapid economic growth have been emerging. Chaotic conditions exist in some areas: there is an overheated real estate industry with related nonperforming loans, local government debt is at risk of default, and Internet finance and shadow banks are putting intense pressure on systemic liquidity.
In particular, the rapid expansion of shadow banks and their innovative products have posed great challenges to the supervisory authorities. The shadow banking system in 2016 was equivalent to 64.5 trillion yuan ($ 9.59 trillion), with three core products: entrusted loans, trust loans and the undiscounted bank acceptance notes.
Property risks can’t be ignored. Unlike other sectors, the real estate industry is more tightly connected with the financial industry and associated with rapid development of related financial derivatives. The credit exposure of banks to real estate in China was about 29.8 trillion yuan at the end of the first quarter of this year.
But the total may be much larger than the figure for direct loans suggests. For example, many financing platforms of local governments and corporate loans have used land and buildings as collateral, and this represents indirect credit exposure to real estate for banks.
Meanwhile, domestic regulators have often failed to keep up with the pace of market development. In some cases, regulators only act after the financial impact of excessive innovation emerges.
All these factors show that mounting risks in the financial system require close attention.
In addition, with the deepening of financial globalization, turmoil in the international financial markets is driving up China’s systemic risk. Of particular concern are the monetary policies of major economies, a source of uncertainty to the domestic financial markets.
The US interest- rate cycle is on the upswing. The interest rates cut at the end of 2015 by the US Federal Reserve caused a crash in global financial markets, including China’s stock market.
In March, China took small steps to follow the Fed in raising rates, which caused extremely tight liquidity among banks domestically. This outcome reflected a lack of preparation for a cycle of global liquidity tightening.
Compared with the interest- rate rise, greater risk may come from the balance sheet contraction of the Fed, which could start in the second half of this year. This will affect global liquidity more seriously. Meanwhile, the regulatory experience of the US after the Global Financial Crisis in 2008 deserves our attention. For instance, regulating the shadow bank system at the national level and carefully monitoring the risk from the insurance industry are important factors. Almost all financial crises in history have resulted from abandoning the real economy to pursue financial speculation. To avoid systemic risk, finance must resume its natural role in the real economy. The sector should develop a belief in serving the real economy as its ultimate purpose, put customer needs first and optimize the financing system. These actions will be conducive to the real economy’s development. It is necessary to establish effective mechanisms to identify, prevent and resolve risks. These will allow regulators to determine the sources of risk, conduct real- time monitoring, issue timely warnings and prevent risk. The specific design of such systems can combine international and domestic factors and resolve problems over a longer span. This year’s National Financial Work Conference proposed to establish a committee under the State Council to deal with financial stability and development and strengthen supervision. It also emphasized serving the real economy effectively. Providing proper financial services to the real economy is the only fundamental way to prevent systemic financial risk.
It is necessary to establish effective mechanisms to identify, prevent and resolve risks. These will allow regulators to determine the sources of risk, conduct real- time monitoring, issue timely warnings and prevent risk.