Systemic Financial Risks Prevention

Since the implementation of the reform and opening-up policy 40 years ago, China has achieved breathtaking development, as has its financial industry. After China entered a “new normal” in economic development, potential financial risks have emerged such as an overheated real estate industry and related bad loans, defaults on local government debts and problems resulting from internet finance as well as shadow banking, all of which are posing great challenges for the security of the country’s financial system.

On April 25, 2017 when the Political Bureau of the Central Committee of the Communist Party of China (CPC) held its 40th group study session, General Secretary Xi Jinping had some words on the issue. “Finance is the core of the modern economy and financial security is an important part of national security,” he pointed out. “We must fully recognize the important role and function of finance in economic development and social activities. We should consider it a big governance task to effectively maintain financial security and do it well.” In this year’s government work report, Chinese Premier Li Keqiang also suggested that the government accelerate financial system reform.

The key to financial system reform is the reduction or elimination of financial risks.

Finance plays an important role in Xi Jinping Thought on Socialist Economy with Chinese Characteristics for a New Era. Navigating systemic financial risks is a major chunk of China’s current economic work. The aim of financial system reform is to avert systemic financial risks.

One of the largest scales in the world, China’s financial industry has effectively served the country’s economic growth. Without the financial industry’s “blood infusion” into the real economy, China’s growth would not have improved in quality and efficiency to meet the demand of enterprise transformation and upgrading. However in recent years, problems in the financial sector have become glaring. For instance, shadow banking continues expanding and its most practitioners penetrate the real estate industry and financing platforms of local governments, which makes it more difficult to regulate and control asset price bubbles.

Accordingly, the prevention of systemic financial risks is considered a perennial theme of financial work, which is a highlight of Xi Jinping Thought on Socialist Economy with Chinese Characteristics for a New Era and an innovative measure to handle increasingly complex domestic and international economic situations. China pays close attention to the relationship between finance and the real economy and stays on high alert for the emergence and growth of bubbles in the economy. “Our country’s strength must depend on the real economy rather than the bubble economy,” said Xi.

Meanwhile, the government needs to treat financial risks in a dialectic fashion by staying simultaneously committed to financial regulation and financial development. Reform of the financial sector considers that finance plays a key role in the modern economy and forestalling financial risks is the primary objective. The financial system reform also needs to focus on upgrading institutions, setting up sound modern financial regulators to promote the development of the financial sector and better coordinate domestic and international supervision of systemic financial risks as well as control of systemic financial risks faced by the central government and local governments.

China has adopted the model of separate supervision. As financial innovation and globalization develop rapidly, the current supervision model can hardly cover all areas. Financial risks can happen across a wide range and spread in complicated ways to related areas, which poses a great challenge for supervising personnel, policy-makers and coordinators. As a result, supervision departments usually intervene after excessive innovation of financial products causes negative effects. The Chinese stock market endured turbulence in 2015, which remains a glaring example. Tighter monetary policies globally have given rise to uncertainties in financial markets around the world. Accordingly, in July 2017 at the National Financial Work Conference, China decided to set up a committee under the State Council to oversee financial stability, with an aim to solve problems that emerge during financial development and supervision.

And present work is intended to establish the committee as an independent entity in charge of financial supervision and coordination at all levels. This would guarantee supervision work is more professional and specific, prevent wasting of supervision resources, facilitate the spread of information on financial risks and smoothen supervision procedures.

Financial reform should focus on improving laws and regulations. Borrowing from international supervision experience and standards can help authorities identify weak points that open the door to financial risks and eradicate them quickly. By doing so, finance can more effectively serve the real economy.

Countries around the world have reached consensus to uphold macro-prudential surveillance. Britain’s Financial Policy Committee is responsible for macro-prudential policy framework. In July 2010, the United States enacted a policy to better supervise shadow banking to reduce financial risks, which enabled the country to recover more quickly from the financial crisis than many other countries.

China considers potential risks in the financial sector to be extremely important, as evidenced by successive reiterations of the need to tame systemic risks at the National Financial Work Conference, the economic work meeting of the Political Bureau of the CPC Central Committee, the 19th CPC National Congress and the Central Economic Work Conference. Targeting problems such as the lack of information transparency in the capital market and stock market manipulation, the China Securities Regulatory Commission has stepped up enforcement and improved regulations concerning mergers, acquisitions and listing of enterprises. Also, the China Banking Regulatory Commission has strengthened the oversight of shadow banking and standardized the governance of joint-stock banks, which has greatly decreased the volume of idle funds that fail to flow into the real economy.

Considering the dynamic nature of the industry, financial organizations navigate many uncertainties which regulators must also battle with measures that often lag behind. Financial reform should not only set up a sound law-based system in which financial firms operate healthily, but also enhance the prognosis and control of risks.

The author is a researcher with Chongyang Institute for Financial Studies at Renmin University of China.