A clear agenda of true reform must emerge now if China wishes to become a leader in global finance as it has become in manufacturing and trade. The aims should be to roll back the role of the state in the financial system in order to facilitate a culture of commercially based lending.
Tweaks such as removing lending-rate restrictions, raising the quota for qualified foreign institutional investors and turning parts of Shanghai into a free trade zone do not address the underlying challenges. Meanwhile banks face increasing pressure on earnings and capital ratios as they continue to lend to well connected borrowers for policy reasons.
This requires developing capital markets, to wean companies from their overdependence on bank loans. Deposit rates must be liberalised, both to boost per-income wealth as well as to force companies to pay market prices for access to loans. Such a move also suggests the need for a deposit insurance scheme for failed lenders.
Another step is to make it easier for private capital to obtain banking licences, with improvements in corporate governance and a more sophisticated regulatory system to prevent abuses. Allowing M&A among city and provincial financial entities enables a more effective financial industry. It is time for the Communist Party to let go of these levers of power.
The results of November’s important Party third plenum will take months or even years to truly become apparent; government at all levels will take time to digest the reforms. Much rides on President Xi Jinping’s ability to push through change. It is not clear the Party wishes to make substantial reforms, but expectations are rising.
Although reform must be bold, it need not be mindless: while the measures above would pave the way to opening its capital account, China should proceed cautiously with convertibility of the renminbi. China rightfully aspires for its currency to be a global reserve, but that would be the culmination, not the starting point, of financial reform.
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