Academic journal article The Journal of Social, Political, and Economic Studies

Modernizing China's Banking and Financial Sectors

Academic journal article The Journal of Social, Political, and Economic Studies

Modernizing China's Banking and Financial Sectors

Article excerpt

In 1978, China embarked on a gradual but far-reaching economic reform, as a result of which its economy has been significantly modernized and opened up to the rest of the world. The reform process has affected all sectors of the economy, the most dramatic change having taken place in 1992, when the Party officially recognized that a market system was not incompatible with the ideals of socialism and subsequently proclaimed the idea of establishing a "socialist market economy." This implied an economy in which market mechanisms govern economic interactions but the public sector maintains ownership of the most important means of production. In the wake of this decision, the Chinese leadership outlined and approved a comprehensive reform strategy which explicitly identified financial reform as a key element in efforts to create efficient financial markets which would strengthen the authorities' ability to effect macroeconomic management using indirect monetary instruments.

Major Achievements Since 1978

Institution building started in the early years of reform with the establishment of a two-tier banking system. Gradually, the People's Bank of China (PBC) was divested of all its "commercial" activities. In 1984, the PBC became China's central bank. However, monetary and credit policy continued to take the form of a credit plan that was implemented through a set of credit quotas for each bank and direct bank financing of enterprises. Since the credit plan was an aggregation of sectoral and local financing needs done from the bottom up, an expansionary bias was inherent in the system. This impaired the PBC's ability to manage monetary developments - a problem that was not really addressed until 1992-93, when work on a new central bank law started. Central banking received a new impetus in 1995 when this law was enacted, giving the central bank the legal foundation to operate in a market environment under the leadership of the State Council.

Despite the above-mentioned dilemma, monetary policy's role in macroeconomic management has significantly increased. The PBC has introduced reserve requirements and lending facilities to commercial banks to support its monetary policy actions, which remained guided by the credit plan. However, the effectiveness of the credit plan has been decreasing since the late 1980s, mainly because its institutional coverage has lagged behind the expansion of the banking sector. In 1994, direct central bank lending to the government was discontinued, and preparations for increased reliance on indirect monetary policy instruments were started in earnest.

In the early reform years, four state-owned specialized banks the Agricultural Bank of China (ABC), the People's Construction Bank of China (PCBC), the Industrial and Commercial Bank of China (ICBC), and the Bank of China (BOC) - were established to improve the allocation of financial resources to specific sectors. Starting in 1984, selected new banks were permitted to operate alongside these four banks, and during the second half of the 1980s, a flourishing network of nonbank financial institutions (NBFIs) emerged. Since then, the four state-owned specialized banks have been used to implement the government's financial policies, as laid out in the credit plan, and other banks and NBFIs have enjoyed more freedom in their operations.

The establishment in 1994 of three policy lending banks, intended to channel credit to infrastructure and other priority areas, and the enactment of China's new commercial bank law in 1995 are meant to encourage market-based management and pricing principals. Chinese lawmakers also intend to separate banking from other business. New legislation designed to regulate and streamline NBFIs is being formulated.

The development of financial instruments has been limited to the capital market. No nationally integrated money market has as yet been developed, and most banks lack the skills to develop new products that could create competition in the financial sector. …

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