The financial crisis is a major concern for the Chinese Communist Party (CCP). In 2017, during the CCP’s 19th National Congress, preventing and resolving financial risks was listed as the top priority in the “Three Critical Battles.” At the end of October 2023, the CCP convened its first “Central Financial Work Conference” (upgrading the previously held national financial work conference every five years). In January of this year, “Promoting High-Quality Financial Development” became the theme for the first time at a “Provincial and Ministerial-Level Leading Cadres’ Special Research Seminar.” In February, the chairman of the China Securities Regulatory Commission, Yi Huiman, suddenly stepped down and was replaced by Wu Qing, known for his strict regulatory oversight. On April 12, the third set of “Nine Articles” for the capital market was introduced (the first two were enacted in 2004 and 2014). In July, the long-delayed “Third Plenary Session” of the CCP is set to take place, with finance being inevitably one of the main topics.
However, despite the frequent actions taken by the CCP, they have been unable to “effectively prevent and resolve financial risks, firmly holding the line to prevent the occurrence of systemic risks.” Overall, the CCP’s financial policies since 2012 have been deemed unsuccessful. This article summarizes the top ten performances based on related academic research.
Due to the inherent flaws of the CCP’s “reform and development,” the Chinese economy has transitioned from a planned economy to a “flawed” market economy, including “excessive financialization.” On one hand, according to the central bank’s statistics, by the end of 2023, the total assets of China’s financial institutions amounted to 461.09 trillion yuan, which is 3.66 times the GDP of that year (126 trillion yuan), with a growth rate of 9.9% far exceeding the GDP growth rate (5.2%). This indicates that the financial industry’s proportion within the economy is increasing, with the scale and growth rate of financial assets deviating from the real economy. On the other hand, in recent years, the proportion of the value added by China’s financial industry to GDP has been around 8% (reaching 8.7% from January to September 2023), while the average share in OECD member countries is only 4.8%, in EU member countries only 3.8%, both higher than the world’s largest financial country, the US. The significant proportion of value added by the financial industry largely represents the costs borne by the real economy to obtain financial services, with an excessively high share indicating a shift in the Chinese economy towards “from the real to the virtual,” with national income and wealth distribution tilting towards the financial industry. It is worth noting that while China’s economy is overly financialized (excessive speculation), it also faces problems with the insufficient degree of financialization of the real economy (such as issues with financing channels, various production factors lacking liquidity, lack of pricing standards, lack of a complete unified trading market, etc.).
The current global financial system is broadly divided into market-driven models typified by the US and the UK, and bank-driven models typified by Germany and Japan. However, based on the evolution of finance, it is observed that in the early stages of development, any financial system is initially led by banks. With economic development and the increasing complexity of the financial system, the financial structure gradually transitions from being bank-led to market-led. Currently in Germany, the proportion of bank loans to total financial assets in the financial sector is approximately on par with the US and UK, and Japan’s loan ratio is in a continuous decline, nearing the levels seen in the US and UK in the 1990s. However, since the global financial crisis, the proportion of direct financing in China has decreased rather than increased. By the end of 2021, the balance of loans compared to the average at the end of 2007 had increased by 25.6%, with a ratio to GDP of 173.6%, up by 61 percentage points from the end of 2007. As of the end of 2021, the ratio of securities assets, including stocks and bonds, to GDP was 126%, down by 34 percentage points from the end of 2007. In other words, since the global financial crisis, China’s economic growth has been debt-driven, with banks playing a key role in stimulating investment by increasing lending when the economy is weak. The banking sector in China is currently facing a very difficult situation, with extremely high non-performing loan ratios (official data not trusted). More importantly, the target model of China’s financial system is in question. Some analysts argue that the Chinese model not only relies on the massive credit funds provided by banks to support the stable operation of the entire economy but also requires the investment and financing functions under the risk diversification mechanism of the capital market to promote technological innovation. How to design and execute this roadmap remains a crucial question.
In 2012, coinciding with Xi Jinping’s rise to power, a joint report by the World Bank and the Development Research Center of the State Council of China stated that “China has reached a turning point in its development path” and recommended a shift in development and growth models. The central theme of the report’s conclusion was that “China needs to promote the modernization of the domestic financial foundation, establish a public financial system at all levels of government that is characterized by transparency and accountability, operate under more streamlined and powerful regulatory institutions, and assist in financing the ever-changing economic, environmental, and social agendas.” The Chinese authorities also encouraged financial innovation, emphasizing the combination of the internet with finance, and internet finance saw a significant surge. Jack Ma even remarked, “If banks do not change, we will change the banks.” However, “financial innovation” also brought about numerous financial irregularities. The emergency suspension of Ant Group’s IPO in November 2020 marked a turning point, with authorities reversing their policies on internet finance, no longer supporting internet finance as an investment sector due to concerns about risks, as internet technology lacks risk prevention functions. Additionally, the CCP has completely banned virtual currency trading. The once high-profile “financial innovation” in China has mostly led to chaos, with the most prominent being peer-to-peer (P2P) lending.
P2P (peer-to-peer lending) is a type of small-scale lending model facilitated through online credit platforms, aggregating small funds to lend to individuals in need of capital. P2P lending in China emerged around 2007, and entered a period of rapid development after 2011. By the end of December 2015, there were 2,595 operating platforms in the P2P industry, with 896 problematic platforms throughout the year. The total transaction volume for the year was 982.304 billion yuan, with an industry loan balance of 439.461 billion yuan, an average loan period of 6.81 months, and 5.86 million investors and 2.85 million borrowers in the industry, with average individual investment and borrowing amounts reaching 75,000 yuan and 154,200 yuan respectively. However, numerous P2P platforms began defaulting frequently at that time, leading to a significant contraction in the industry and the beginning of its decline. The China Banking and Insurance Regulatory Commission included P2P lending in its regulatory scope in 2018. By 2019, nine provinces and cities had initiated clean-up and shutdown operations against P2P businesses within their jurisdiction. By mid-November 2020, all operational P2P lending institutions in the country had been completely cleared out. However, as of June 2020, “more than 800 billion yuan of loans from lenders remain outstanding,” leaving many financial refugees with huge losses, yet the authorities failed to address the aftermath adequately.
The CCP emphasizes that financial management is a central issue under its authority, with the Party Central Committee’s concentrated and unified leadership over financial industry affairs. However, local development requires local financial support. In 2002, Shanghai established the first provincial-level financial office in the country, and in the following decade, 31 provincial-level governments nationwide formed their own financial offices. The role of these financial offices is to serve local governments and financial institutions, coordinate financial resources, be accountable to local governments, and work according to local requirements. The central government made certain compromises by assigning local supervisory roles over “7+4” local financial organizations. The “7” refers to small loan companies, financing guarantee companies, regional equity markets, pawnshops, financial leasing companies, commercial factoring companies, and local asset management companies; the “4” refers to investment companies, agricultural professional cooperatives engaged in credit mutual assistance, crowdfunding institutions, and various local trading venues. However, in reality, local financial supervision has become a mere formality, leading to a proliferation of financial irregularities at the local level. Under immense pressure, in 2023, the authorities proposed a reorganization plan for the local financial regulatory system: “Establishing a local financial regulatory system primarily composed of local offices dispatched by the central financial management department, optimizing the setting and staffing of central financial management department local offices. Local government-established financial regulatory institutions will focus on supervisory responsibilities, without additional affiliations such as financial work bureaus or financial offices.” A prominent example is the rampant growth of local financial trading platforms ten years ago, with several provinces hosting numerous local trading exchanges; now, a wave of comprehensive clean-ups has unfolded. However, effectively supervising the more than 30,000 “7+4” local financial organizations remains a challenge.
In 2022, four village and town banks in Henan almost simultaneously and unexpectedly shut down their online withdrawal and transfer channels, leaving depositors unable to withdraw their money. The China Banking and Insurance Regulatory Commission stated that the incident originated from collusion between the bank’s shareholders. This case involved billions of yuan in funds and four hundred thousand depositors. To this day, depositors have organized multiple rights protection and protest activities, creating broad repercussions. This event symbolizes the survival predicament of village and town banks. In late 2006, the China Banking Regulatory Commission established pilot village and town banks in six agricultural rural areas, originally intended to support the construction of the “new countryside” and to support small and medium-sized enterprises and farmers in rural areas. However, the logic behind establishing village and town banks is somewhat strained since the original positioning of rural credit cooperatives was to serve “agriculture, farmers, and rural areas,” providing fund services for members. Yet village and town banks have very low entry barriers, and all social capital and financial institutions have been opened up to them, resulting in their rapid development. By 2021, there were already over 1,600 village and town banks nationwide, covering almost all provinces. However, village and town banks face numerous problems and high risks. According to the People’s Bank of China, by the end of the second quarter of 2021, 122 village and town banks were classified as high-risk institutions, accounting for about 29% of all high-risk institutions. Research reports from Huatai Securities show that the non-performing loan rate of village and town banks reached a high of 4% in 2020, much higher than other financial institutions. Village and town banks are considered the most vulnerable part of the Chinese financial system. Additionally, by the end of 2021, there were 1,596 rural commercial banks and 577 rural credit cooperatives nationwide, exceeding the number of village and town banks across the country, with similar target clients and positioning almost identical. However, rural credit cooperatives have a longer history and deeper roots. These factors raise questions about the necessity of village and town banks.
Firstly, China has long accumulated foreign exchange reserves, holding over $3.3 trillion in foreign exchange reserves, including over $1 trillion in US treasury bonds. However, within 72 hours of the outbreak of the Russo-Ukrainian War, the US froze $300 billion of Russia’s foreign exchange reserves. In the event of a conflict between China and the US, the security of China’s foreign exchange reserves and overseas assets becomes a major concern. In early December 1950, the US imposed severe “blockade” and “embargo” measures against China. The CCP then made efforts to “seize” and “purchase” materials from Western countries. By the time the UN passed an embargo on China in 1951, the CCP had used up all its accumulated foreign exchange reserves. Presently, circumstances are vastly different, and such fortune is unlikely to favor the CCP again. Secondly, despite consistent annual current account surpluses, since 2014, China’s overseas net assets have remained at over $2 trillion. Where has the accumulated current account surplus gone? Although China ranks as the world’s third-largest net creditor country, its returns on investments are negative, and in 2022, China’s investment returns deficit amounted to $203.1 billion. In other words, China lends money to other countries but ends up paying interest. This contrasts sharply with the situations in the US and Japan. Thirdly, there is a risk of “currency overvaluation.” After the currency reform in 2015, the Renminbi (RMB) broke through the psychological barrier of “7” against the US dollar three times, dropping back below 7 within a few months. However, after breaking through “7” in May 2023, it became a common occurrence, making the Renminbi exchange rate a nerve-wracking concern.
China’s A-share market is often referred to as a “garbage stock market.” It not only fails to bring the best companies for IPOs but also turns good companies into bad ones after going public, with the stock market acting as a cash machine for listed companies. Stock markets of all countries are meant to be barometers of their respective economies, but this is not the case for China’s stock market. Since 2007, there have been over 5,000 listed companies in China, with a total market value exceeding 80 trillion yuan (the world’s second-largest), but the Shanghai Composite Index has been hovering around 3000 points over the years, with the “defense of the 3,000-point mark” occurring dozens of times. Even on January 18 and 22, 2024, the Shanghai Composite Index dropped below 2800 points twice. The comprehensive registration system reform implemented by the authorities lacked follow-up supportive measures, resulting in an increase in the number of listed companies on the A-share market by over 1000. In April this year, new “Nine Articles” were introduced by the authorities. While these measures are necessary, they are far from sufficient, as a fundamental reform of the basic system, adjustment of interest patterns, a fundamental change in current economic policies, and the pursuit of a “competition-neutral” concept are essential. This essentially means challenging the authorities’ established practices.
Firstly, the bond market in China is segmented. The issuance of the first national bond in 1981 marked the beginning of the Chinese bond market. The total market size now exceeds 100 trillion yuan (the world’s second-largest), but it is fractured across interbank, exchanges, and over-the-counter markets. The unified bond market has yet to be seriously considered. Secondly, there is low liquidity. Over the long term, the turnover rate of China’s bond market (trading volume/custodian volume) has remained stable at around 250%-300%, with the turnover rate of national bonds roughly stable at around 200%, while developed countries generally maintain rates of over 1000%. This inactive market makes it challenging to discover reasonable prices and accurately price bonds during trading. This also means that the yield curve in China’s government bonds has not matured and is not widely applied compared to developed markets. There is a significant disparity between China’s government bond yield curve market foundation and that of developed markets. Thirdly, bond ratings are unreliable and untrustworthy. Particularly in the last two years, there have been defaults of AAA-rated high credit-level bonds, severely undermining industry credibility. Fourthly, most Chinese bonds are held by financial institutions (accounting for over 65% historically), making it difficult for the bond market to leverage its function of raising market levels of monetization. This situation distorts market funds supply and demand relationships. Moreover, risks occurring in the bond market and those on the balance sheet of commercial banks could easily overflow into each other. Lastly, there is low support for real enterprises. As of the end of 2023, credit bond balances in the bond market totaled 46.3 trillion yuan, with corporate and company bonds combined accounting for only 28.78%. This includes 13.3 trillion yuan in corporate bonds and company bonds, with just 3.94% of this corresponding to sustainable corporate bonds. Even worse, net financing for private enterprises has been negative for several years, totaling approximately -600 billion from 2021 to 2023.
One of the primary functions of finance is to facilitate capital circulation, yet data from the People’s Bank of China shows that from early 2020 to January 2024, household deposits increased by a total of 58.24 trillion yuan, with 82% being time deposits. The total increase over these four years is equivalent to the sum from 2009 to 2019. Household deposit balances have also continued to grow in the last four years, rising from 15.284 trillion yuan at the end of 2020 to 19.693 trillion yuan at the end of 2023, indicating a 32.4% increase. This suggests that China’s financial system is inefficient in converting savings into investment capital (among other reasons). Moreover, financial corruption within China’s system is alarming. Looking solely at financial anti-corruption efforts by the authorities, over 70 individuals were investigated in 2022, over 100 in 2023, spanning across banking, insurance, and securities sectors. Bank system officials constituted nearly 70% of those investigated, with 36 officials investigated in government-controlled banks, these were the “Big Five” state-owned banks. At the beginning of 2024, officials in various levels of financial institutions saw a series of investigations and removals from their positions. Overall, it is evident that China’s financial system is underperforming, combined with rampant financial corruption, economic tremors, deteriorating international economic environments, and a lack of effective response from the authorities, the probability of a financial crisis erupting in China is growing.
The Chinese financial system exhibits three main characteristics: extreme bank orientation (with bank assets accounting for over 90% of financial institution assets), governmental involvement rather than market forces playing a decisive role in financial resource allocation, and relative closedness. These qualities determine the unparalleled influence of the CCP’s financial policies on China’s financial and economic environment. However, as the political situation in China leans further to the left, financial policies are becoming increasingly rigid, losing practical response capabilities and steering China’s financial industry towards a crisis.