The non-financial sector is still largely unregulated in China. The reasons for this are numerous, including the fact that the sector is relatively small and, as a result, relatively opaque. That being said, the sector is also rapidly changing and will only continue to evolve over the coming years. In the coming months and years, we believe that the Chinese banking sector will continue to face regulatory challenges. Currently, the sector is undergoing a period of rapid change. New financial products are being introduced that are not yet widely adopted by banks. Moreover, regulatory uncertainty has created an environment in which forward-looking risk management and strategic financial planning are givens rather than habits.
Regulation of Bank-Based FX and Commodity Trading
The FX and Commodity trading sectors of the banking industry have been relatively unscathed by the regulatory landscape in China. With the exception of a few banks that have been operating under license, many other financial institutions have operated without government permission. In fact, many domestic banks have avoided using the official banking system to buy and sell financial products, opting instead to conduct their business as chartered banks.
This practice has presented regulators with difficult choices. On the one hand, not all of these banks are behaving maliciously. On the other hand, given the enormous potential for abuse, it is not clear how these practices should be treated as legitimate banking activities.
The Potential of Digital Currencies
China has a long history of implementing nontraditional payment and accounting systems. This tradition continues to this day, with many people using online wallets to hold and manage money. Among these online wallets, Wechat Pay and Alipay have become the de facto payment systems for retailers and businesses. We believe that the potential for digital currencies in China is great. With the Chinese government working hard to normalize the financial system, we believe that digital currencies could be one of the first digital assets to be integrated into the financial system. The rule of law must be upheld and business practices must beodox.
What Caused The Recent Financial Fragility?
According to Deloitte, the precipitous drop in the value of financial assets in China between November 2016 and February 2017 was primarily due to a decline in market sentiment towards stocks and other stocks-related instruments. This sentiment drop was caused by an unexpected drop in the average amount being bet on stocks.
Increased interest rate pressures and the prospect of rising inflation also contributed to the decline in stocks’ weightings. This drop in market sentiment and corresponding reduction in trading volumes were accompanied by a sharp downturn in the investment bank Lehman Brothers’ creditworthiness. This led to a steep fall in the value of financial shares.
What Can Be Done To Preserve China’s Financial stability?
While we believe that the recent financial fragility in China was the result of external factors rather than a deliberate policy choice by the central bank, there are several aspects of the banking system that can be preserved by the government.
First, the government must maintain a healthy regulatory balance between ensuring stability and promoting competition. This requires the government to balance its desire to promote banks’ competitiveness on the one hand with the need to protect the financial system from harmful effects of instability on the other. At the same time, the government must ensure that financial services remain affordable and accessible for the majority of the population. Finally, the government must promote core financial products such as loans, bonds, and shares that benefit the general public.
We believe that the recent financial fragility in China can be directly linked to the lack of clarity in the regulatory environment. China’s financial regulations are still being formulated in a haphazard manner, and it is unclear how the sector will evolve in the coming years.
At the same time, we believe that the changes that the banking sector is experiencing can be beneficial. Over the coming years, the banking industry in China will continue to face numerous challenges. These changes, however, can be positive, in that they can encourage banks to be more prudent and avoid risky practices. The transition to a new financial model can also be challenging, but necessary.