Wokai's China Microfinance Series: Financial Sector Development in China

Geri Mason & Jason Korsmeyer

The quaint town of Pingyao has been deemed a UNESCO World Heritage site not only for its charm but also for being the first banking hub in China. Strategically located on the Silk Road, it provided an ideal location to develop banking services.  The creation of “piaohaos,” or banking firms, pioneered currency conversion and credit in China during the Qing Dynasty (early 19th century). There were as many as 22 draft banks in the city in the height of its career on the Silk Road, around 1823. (Global Heritage Fund)

 

In spite of these early origins, modern finance in China did not begin until after the founding of the People’s Republic of China in 1949.  The construction of the financial sector can be divided into three distinct eras: the “mono-bank” era, the “experimental reform” era, and the “market liberalism” era.  This article will briefly explain how these three eras shaped the current financial sector.

October 1, 1949 marks the inauguration of the PRC.  Under the direction of Mao Zedong, the PRC embarked on creating a society focused on eliminating class distinctions and disparities. To achieve this end, the Chinese Communist Party (CCP) implemented a centralized planning system that allocated all goods and services within China.  Out of this rigidly planned society, a financial sector was developed.  Due to this unique formation, all financial services were performed by one bank, the People’s Bank of China (PBOC).  Specifically, it allocated and collected funds for all government economic programs.  This period is known as the “mono-bank era.”

While China has maintained a unitary political system, there has been much reform in the financial sector.  In 1978, the CCP launched decentralizing economic reforms, beginning the “experimental reform” era.  The first fiscal reform created a new revenue sharing system.   This system established 3 new categories – national, local, and shared revenue – giving individual provinces greater control over revenue collection and expenditures. Additional state banks were chartered, ending the mono-bank era.

While this reform enabled the government to collect taxes, there were still inherent budgeting difficulties in a centrally planned economy.  Therefore, in 1983 the CCP shifted away from direct grants to interest bearing loans as a mechanism for distributing funds to the provinces.  This change gave the financial system more strength, which in turn shifted the focus of the loans towards performance. 

As policies strengthened local economies, the central government’s budgetary revenues steadily declined. In 1994 the tax sharing system was launched to increase the revenue of the central government and make China’s tax system more transparent.   Thus, the “market liberalism” era began.
It is important to note that while China was reforming economically, it was also adjusting politically. 

The early 1990s saw a shift in Chinese politics.  This was due to a new set of politicians who were willing to adopt market-based approaches to solve China’s financial and economic challenges.   On July 1, 1995, as part of this new approach, China enacted the Commercial Bank and Central Bank laws.  The Commercial Bank law directed the four major state-owned banks to commercialize,  while the Central Bank law made the People’s Bank of China the central bank of China responsible for monetary policy. 

These laws were enacted in order to make commercial banks more economically efficient and less politically motivated.  It was specifically stated in the Central Bank law that these reforms were enacted to be “free from intervention by local governments, public organizations, individuals, or other administrative organs at all levels.”

It is also important to note that in 1994 three “policy” banks were established.  These “policy” banks were responsible for directing government funds devoted to development and welfare objectives.  The creation of these banks was intended to limit the government’s credit allocation, allowing for greater supervision while maintaining a channel for the government to address poverty alleviation goals. 

However, the goal of easing local pressure on state banks was not realized.  Continued pressure to take on bad loans to mitigate poverty and employment concerns caused state banks to accumulate a massive number of non-performing loans.   So, in 1999 the CCP established four asset management corporations (AMCs) which would take over non-performing loans and debts.  The AMCs would repackage these loans and sell them to investors.  Unfortunately, the AMCs were ineffective and by the end of 2003 the four major state owned banks’ non-performing loans totaled 2 trillion Yuan.  

Since 1999, China has continued to liberalize its financial system to correct market inefficiencies.  Highlights include the first bank public offerings in 2000, China’s entrance to the WTO in 2001, and the creation of the China Banking Regulatory Commission (CBRC).  However, the CCP’s regulations still severely hinder the financial market.  As of 2003, less than one percent of the loans from state owned banks were going to private enterprises, leaving a large demand for credit throughout China.   While this abundance of demand is a pronounced indicator of inefficiencies, it also signals a large potential market.  China’s economic reform, while sporadic, has consistently liberalized. Further reform of the banking and financial sector (including the microfinance sector) will improve economic efficiency and strengthen market growth.

Reference:

Global Heritage Fund website. Retrieved March 16, 2009. www.globalheritagefund.org/where/PingYao.html

Jun Zhang, Guanghua Wan, Yu Jin. (February 2007) The Financial Deepening-Productivity Nexus in China: 1987-2001 United Nations University

Lardy, Nicholas (1998) The Challenge of Bank Restructuring in China Brookings Institution Press

Mingming Zhou. Hasan, Iftekhar. (August 2006) Financial Sector Development and Growth United Nations University

Tsai, Kellee. (Fall 2004) The Unintended Consequences of Fiscal Federalism in China Journal of Chinese Political Science, vol.9, no.2

United States Department of Commerce website.  Retrieved October 10, 2007. www.commerce.gov

Yasheng Huang. Saich, Tony. Steinfeld, Edward. (2005) Financial Sector Reform in China. Harvard Univerty Asia Center

Zhicheng Liang. (August 2006) Financial Development, Growth, and Regional Disparty in Post-Reform China. United Nations University

Comments

[Kingsley]

Good
African states must emulate to fastract development and reduce poverty in their states