China’s financial system could face more reforms


China may be the world’s second-largest economy, but its financial system still answers to strict state controls that critics say hold back the country’s development.

The free market plays little role in determining how China’s currency is valued, how banks set interest rates or how much capital is allowed to flow in and out of the country.

But in the last two weeks, a series of moves has raised hopes that financial freedoms could be expanding in the so-called birdcage economy.


Chief among them was Chinese Premier Wen Jiabao telling a national radio audience Tuesday that the nation’s four biggest state banks were a monopoly that profited too easily.

The criticism took aim at the country’s across-the-board interest rates that prevent lending institutions from having to compete.

With one-year deposit rates set at 3.5% and lending rates nearly double that, China’s banks need only sit back and rack up heavy loan volumes to reap their rewards.

The “big four” banks -- Agricultural Bank of China, Bank of China, China Construction Bank and Industrial & Commercial Bank of China -- saw earnings rise 26% last year to about $100 billion despite a slowing economy and souring real estate market.

“The banks don’t want to loosen their grip because it’s very easy for them to profit,” said Yi Xianrong, an economist at the Chinese Academy of Social Sciences, a government think tank.

The restrictions prevent China’s banks from pricing risk into their lending portfolios. As a result, state-owned companies receive the lion’s share of loans rather than riskier small- and medium-sized private enterprises.


On the day of Wen’s radio address, the China Securities Regulatory Commission more than doubled the amount of money foreign institutions could invest in Chinese equities from $30 billion to $80 billion.

Though that was a small increase in the grand scheme of things, a boost in foreign investment could help reduce the volatility of the Shanghai and Shenzhen stock markets, whose roller coaster swings are often driven by speculators.

“The announcement sends a clear and positive message to international investors that the central government is encouraging further opening up of China’s capital markets,” wrote Jing Ulrich, JP Morgan’s head of Global Markets, in a research note.

A week earlier, the Wen-led State Council unveiled a pilot program in the entrepreneurial city of Wenzhou to legalize and regulate underground lending as well as broaden access to investments overseas.

Economists say there’s growing recognition in Beijing that reforming the nation’s financial system is crucial if leaders want to internationalize the country’s currency. That would allow China to free itself of its dollar reliance.

Whether Wen, who will step down later this year, has the political capital to force interest rate or capital account reform remains to be seen. To do so would mean breaking powerful interest groups.


“The longer you wait, the larger the economic stake becomes for those who like the status quo,” said Louis Kuijs, an economist formerly at the World Bank and now at the Fung Global Institute in Hong Kong. “Maybe Premier Wen feels like we should really get it going.”


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