Recently, the State-owned Assets Supervision and Administration Commission of the State Council of China has issued a requirement for central and state-owned enterprises to divest their financial assets from financial institutions. Analysts believe that a large number of financial assets within these enterprises have been criticized for not focusing on their core businesses. In response to the chaos, the Chinese government has introduced the “restriction on finance decree,” which may lead to the virtual disappearance of the stock market and have a devastating impact on the economy.
According to a report by the Economic Observer last Sunday (September 15), in June, the State-owned Assets Supervision and Administration Commission of China decided that central enterprises should, in principle, refrain from establishing new financial institutions, acquiring or investing in various financial institutions where the service to the main industry is minimal, and the risk is significant. They should also refrain from participating or increasing holdings in such institutions.
This move has been dubbed the “restriction on finance decree.” Central enterprises such as Sinochem, China Poly Group, and Angang Group have started selling the financial institution stakes they hold. Public information reveals that at least 17 central and state-owned enterprises have publicly listed their holdings of financial assets in the first half of the year.
The purpose behind the regulation is to strengthen supervision and risk prevention in the financial business of central enterprises, focusing on the “financial,” “high-risk,” and “non-core business” aspects.
Currently, financial assets constitute a significant proportion within central enterprises, especially listed enterprises where over 80% of their assets are related to the financial sector.
American financial scholar David Huang analyzed for Epoch Times, stating that the “restriction on finance decree” for central and state-owned enterprises indicates that the State-owned Assets Supervision and Administration Commission has segregated the risks of the financial services industry that will be subject to strict scrutiny and crackdown in the next phase. This implies that the ongoing or future rectification of the financial services industry might be devastating for many financial enterprises.
He explained, “If these central and state-owned enterprises get involved deeply in these sectors, they might transfer the financial risks to these enterprises, and that’s the reason.”
He believes that even though the official order prohibits new acquisitions or participation in financial institutions, these enterprises likely have internal notices instructing them to divest quickly. This is because these financial institutions may face stringent rectification in the future, leading to significant downside risks, even the risk of collapse.
The report quoted a source from the State-owned Assets Supervision and Administration Commission acknowledging that the focus on regulating central enterprises’ participation in and control of financial institutions aims at addressing the increasingly apparent financial risks.
Regarding the financial institutions mentioned in the “restriction on finance decree,” Huang mentioned that it doesn’t target the major state-owned banks but primarily focuses on four categories: local small and medium-sized banks, insurance industry, trust industry, and securities trading. These sectors have experienced rampant growth and expansion in the past.
He elaborated on the specific financial services covered in the “restriction on finance decree,” including lending, equity participation, trust services, and insurance business, highlighting the unhealthy nature of the insurance industry in China.
Huang pointed out that these industries relied on monopolies in the past to make profits. However, as they expanded disproportionately, problems arose. He emphasized that these unbridled growth of financial service industries not only failed to support the real economy but also diverted a significant portion of social capital into the virtual economy. Hence, the authorities are now demanding a rectification of the financial services industry.
While the Chinese government is currently restructuring the financial services sector, including issuing the “restriction on finance decree” to central enterprises, financial stocks have been rising lately, particularly the shares of the four major banks.
Regarding the continued interest of companies in investing in financial stocks, researcher Wang Guochen from the Chinese Economic Research Institute explained, “Essentially, it’s a hedge. As it appears now, the stock prices and yields of financial stocks still remain stable.”
“We estimate that they have grown by about 50% compared to the bottom of the market. Besides the central government’s investments, it’s believed that state-owned enterprises are also investing. I’ve observed a slight increase in the proportions of A-share trading through the Stock Connect program.”
He explained that due to the sluggish mainland China real estate market and the overall poor performance of the stock market, there is a shortage of investment opportunities, leading state-owned enterprises, especially local ones, to follow suit. Local financial institutions are also joining in the trend.
The four major banks controlled directly by the state (Ministry of Finance, Central Huijin Investment Ltd.) include the Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, and China Construction Bank, representing China’s substantial financial capital.
However, Wang mentioned, “The risks in the financial industry are expanding rapidly, and the only reason they haven’t burst yet is that there’s nowhere else to put the money. Therefore, money remains in the four major banks or is used to buy their shares, keeping the situation stable.”
But can this stability be sustained? Wang pointed out that the net value deficit of the four major banks has reached 1.5%, with Beijing’s alert threshold set at 1.8%. In other words, the lending return rate for China’s four major banks, or banks in general, is exceedingly low.
He added, “Their net profit asset ratio has dropped to 0.6, approaching the critical threshold of 0.6. This implies that their return on investment is also extremely low, meaning they are essentially running at a loss from the get-go; it’s just a matter of how long they can last.”
Regarding the “restriction on finance decree” by the State-owned Assets Supervision and Administration Commission, a central enterprise insider mentioned that this also signifies the end of the era when central enterprises made quick money through financial business.
Analyzing this wave of financial services industry rectification, Huang stated, “Of course, it aims to redirect funds back into the real economy, but during this rectification process, it will undoubtedly trigger significant upheavals or even bankruptcies in many of these small and medium-sized financial institutions, especially in the trust, insurance, and securities sectors. Consequently, central enterprises must timely disengage.”
Wang also opined, “Its real purpose is, of course, not to encourage speculation in financial stocks but to divert funds toward strategic enterprises led or advocated by the government.” He added, “It’s not just about promoting the official ‘new three,’ such as chips, semiconductors, and others.”
“But these enterprises are speculative and prone to bankruptcy,” said Wang. For these state-owned enterprises, it’s not just about following central orders but also about performance evaluations. If their investment performance is poor, they won’t be promoted. Therefore, they might drag their feet or resist, ultimately refusing to hold or increase their ownership of these stocks.”
“This also indicates the country is out of money. Therefore, seeing the Shanghai stock index fall to 2700 points. Under the condition of fiscal constraints, the hope is that state-owned enterprises can provide support.”
On Wednesday, following the Federal Reserve’s significant interest rate cut, global market risk appetite increased; however, the A-share market continued to decline.
China experienced a stock market crash in January, with the Shanghai Composite Index dropping to 2655.09 points. After a massive government intervention, the index peaked at 3174.27 on May 20. However, it has been on a downward trend since then.
Wang analyzed, “Back when it could hold up to 3000 points, it was mainly due to central enterprises, state-owned enterprises, and the central government pumping money in. They poured in the money, and while some received it, they quickly withdrew.”
“Through this cycle of inflow and outflow, it’s now September. Central enterprises, state-owned enterprises, and banks no longer have the funds to continue supporting stock prices. This is why prices have been steadily declining since the end of last month.”
Regarding the possibility of the stock market shutting down, Wang stated, “It won’t happen since the money is tied up inside, so no shutdown is needed; there’s just a lack of liquidity.”
Assessing the crisis in the financial industry, Huang analyzed, “In the short term, the excessive expansion and unchecked growth of China’s financial service and financial securities industries, especially in securitization, have had a significant impact on the economy.”
“An abundance of private and social capital has poured into the virtual economy, hindering real economic support, resulting in a devastating blow to the economy.”
He further commented, “Everyone is engaging in this financial fraud game, deceiving each other to survive, which leads to a cycle of fraudulent wealth accumulation based on monopolies, privileges, and deceptions that is unsustainable.”
On the other hand, Wang focused on the potential risks looming in the banking sector. He noted that over the past few years, notably since last year, there has been a noticeable decrease in corporate debt defaults.
He explained, “The significant reason behind this is that banks continue to pour money into these troubled companies, which can’t repay their debts, not just the principal but even the interest. Consequently, banks are essentially giving citizens’ savings directly to these troubled corporations.”
He elaborated that banks have to pay interest to these depositors and affirmed that the banking problem is substantial and escalating. Therefore, the crucial question is how long can this situation be sustained. If it collapses, there could be a significant impact on people’s livelihoods and the economy.
Wang suggested that if the four major banks face liquidity issues, they could reduce reserve requirements to inject more liquidity. If that’s not sufficient, they might resort to direct money creation or structured monetary policies to provide additional funds to banks.
He pointed out that printing money could exacerbate the issue of overvaluation in the exchange rate, leading to more severe consequences. Whether they can maintain or withstand the exchange rate is a crucial checkpoint.
“If they can’t manage it, it will lead to external shocks that trigger internal issues, potentially causing rampant inflation. At that point, it’s a genuine collapse.”