Financial Reform in China by Zhao Changwen;Zhu Hongming; & Hongming Zhu

Author:Zhao, Changwen;Zhu, Hongming; & Hongming Zhu
Language: eng
Format: epub
Publisher: Taylor & Francis Group
Published: 2017-06-16T00:00:00+00:00

Restrictions on access and asset substitution

Two other policies under a financial restraint system are as supportive to the interest margin protection policy: restrictions on access and asset substitution. The interest margin protection policy cannot be formulated without two restrictions. Fiercer competition inside the financial system, inside the banking sector or between banks and the capital market will erode the interest margin and make it hard to maintain a high interest margin. Restrictions on access and asset substitution help with the implementation of the interest margin protection policy by restricting competition or reducing the intensity of competition.

For over a decade, China has imposed strict restriction on access to the banking sector, due to lack of a smooth withdrawal mechanism and the need to maintain financial stability. The China Minsheng Bank was the only depository financial institution established in the period from 1996 to 2013. The number of financial institutions in China’s banking sector keeps declining due to the reform of rural credit cooperatives. At the end of 2006, there were 19,797 financial institutions with legal status in the banking sector, including 19,348 rural credit cooperatives; and at the end of 2013, these two figures were down to 3,949 financial institutions with legal status and 1,803 rural credit cooperatives. According to the financial restraint theory, such strict access control helps prevent excessive competition inside the banking sector and maintains the banks’ “rent” or “franchise value” endowed by the interest margin protection policy.

China has formulated no policies concerning asset substitution restriction. Instead, China developed the multi-layer capital market and enhanced the proportion of direct financing as the main features of its financial policy. Then, does that deny actual existence of asset substitution restriction in China?

The answer is no. As a matter of fact, excessive expansion of the banking sector squeezes development space for other financial sectors in the financial system. Considering the stage of economic development that China was in and its special economic and financial system, China’s had a typical bank-dominated financial system before the financial restraint policy was adopted. Banks had the upper hand, compared with the financial market. Against such a backdrop, interest margin protection, as a strong stimulus to the banking sector, further reinforces the advantageous position of banks, and plays the same role as the asset substitution restriction. Laggard development of non-bank financial institutions restricts asset substitution. Therefore, as far as the effect of the previous round of financial reform is concerned, despite constant financial deepening, residents have few options for financial investment other than deposit and investment products provided by banks (Table 4.5). That means there are asset substitution restrictions in China’s financial system.

It is because of actual access control and objective asset substitution restriction that the high interest margin in the banking sector as well as its post-2008 high profit rate can be maintained. Thus the law of the average rate of profit fails (Marx, 2004).

Table 4.5 Allocation of household financial assets (Unit: RMB1 trillion)

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