Financial Reform, With Chinese Characteristics

Despite this growth, serious questions remain about the efficacy of both programs. Though corporate debt-for-equity swaps are rising, reaching 480 billion yuan by March, they represent a tiny fraction of total corporate debt outstanding, which now stands at between 17 trillion to 18 trillion yuan. Moreover, unless paired with significant industrial and corporate restructuring efforts to make companies, especially in the state sector, more productive and profitable, debt-equity swaps do little to limit the state-owned banking sector's exposure to corporate bankruptcies. This concern explains, in part, why many banks initially balked at the initiative. Likewise, though local government debt-bond swaps help bolster local government finances in the short-term by lowering debt-servicing costs, the program does little to address how localities (which often face intense funding pressures) will actually repay the principal on their outstanding debts. Both programs lower the risk of widespread corporate and local government bankruptcies in the short-term, but neither offers a solution to the looming question of how to metabolize a decade's worth of unpaid debt, much of which is likely unpayable.

Eliminating Regulatory Silos

The third area of financial sector reform refers to central government efforts to improve financial regulation. In the 1990s and early 2000s, as China's economy took off (especially after China joined the World Trade Organization), this endeavor led Beijing to create separate banking, insurance and securities regulators to better manage the financial system's growing complexity. In recent years, improving financial sector regulation has moved in the opposite direction, toward building a unified regulatory framework encompassing banks, non-bank financial institutions (such as trusts and mutual funds), and insurance companies.

The primary thrust behind this shift has been the rise of regulatory arbitrage as banks and other investors take advantage of discrepancies in regulations among banking, securities and insurance sectors to channel funds into a wide array of opaque and risky products. This regulatory arbitrage became acute when authorities, in an effort to prevent China's economy from overheating, tightened controls on bank lending in 2011 and 2012, leading to the growth of informal lending tools such as wealth management products. Because they were sold by non-bank financial institutions under the jurisdiction of the CSRC (which, at least initially, placed fewer controls on investments into high-risk assets like real estate), these tools gave banks new avenues to channel investor funds into otherwise prohibited assets.

Despite Beijing's periodic efforts to rein in wealth management products and other so-called shadow lending devices, there has been a proliferation of a wide range of those tools as banks and other financial institutions seek new ways to evade regulatory shifts. As indicated by numerous anecdotal reports, by 2015, arbitrage among the different regulatory regimes of CBRC, CSRC and CIRC was an important feature of most major financial firms' ordinary business operations. Naturally, as state-owned banks relied increasingly heavily on non-bank lending tools to generate higher returns for their investors, they (and the trust and insurance companies into which they invested, along with commissions charged with overseeing them) developed a strong interest in preserving their access to them, and thus in combating any move to unify and tighten regulation of these products. This began to shift in late 2015 after the stock market collapse sparked calls from senior Chinese officials for a single "super regulator" to replace the existing tri-partite regime. The February 2017 announcement that the People's Bank of China would draft unified regulations for asset management products, particularly wealth management products, marked the first concrete step toward building a super regulator.

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