BANKING SYSTEM
1. Private analyst estimates of the actual ratio of NPAs range from 6–7 percent to as much as 20 percent, with even higher ratios of around 25 percent for some of the smaller banks.
2. Banks have kept nonperforming assets (NPAs) off their books by “evergreening” their loans, i.e., giving even weak and unprofitable companies new loans to pay off their old loans. Most of their funding comes from bank deposits, which tend to be stable, rather than from debt.
3. Losses from loans made to companies that become insolvent or go bankrupt can be covered utilizing a combination of two types of measures—sweeping nonperforming assets into asset management companies and infusing new capital into the banks. This will ultimately result in a fiscal cost. This cost would be reduced by partial loan recoveries, asset sales, and the use of loan loss provisions that banks maintain.
4. While there has been modest progress on banking reforms, at a minimum addressing the legacy problems created by state-directed lending and distorted incentives in the banking system will incur significant costs. Banks are not totally freed up g freed up from government directives and allowed to operate on a commercial basis.
SHADOW BANKING
1. Definitions of the shadow banking system vary, but the major categories of credit that fall under its rubric include
(i) entrusted loans, which involve nonfinancial corporates as borrowers and lenders, with banks acting as intermediaries but bearing none of the credit risks;
(ii) trust loans, which are financial transactions undertaken by trust companies that are regulated separately from banks and have some characteristics of banks and fund managers; and
(iii) bank acceptances, instruments issued by banks that commit to pay a fixed amount in a given period and that are backed by deposits of the party seeking these certificates.
2. The shadow banking system is not large relative to that in many advanced economies based on data from Moody’s, shadow banking assets amount to 65 percent of GDP in China, compared with 150 percent in the United States and a world average, weighted by country size, of about 120 percent.
3. In its present form and at current levels, it is unlikely that the shadow banking system by itself poses significant threats to overall financial stability.
4. With rising concerns about the financial stability implications of the shadow banking sector, various regulatory agencies have stepped up their oversight of this sector. This has resulted in a decline in shadow banking. In recent months, the flow of credit associated with shadow banking has been small or even negative.
STOCK MARKET SWINGS
1. After a sharp run-up during 2014 and the first half of 2015, Chinese stock market indexes have fallen sharply. This prompted a series of measures by the government to limit the stock market turmoil.
2. The key measures to mitigate downward pressures on stock prices include:
• Limitations on short selling, with the China Securities Regulatory Commission threatening to arrest those engaged in “malicious short selling”
• A ban on initial public offerings for four months starting in July
• Suspension of trading in the shares of over a thousand firms
• A six-month ban on stock sales by stockholders with a 5 percent or higher equity stake in a given company
3. Measures to prop up prices through direct intervention include:
• New rules allowing pension funds to invest up to 30 percent of their net assets in equities (previously, pension funds could not invest in equities)
• Relaxation of rules on margin financing
• Giving banks permission to make corporate loans using equity as collateral
• A PBC pledge to lend RMB 250 billion ($40 billion) to major brokerage firms through the China Securities Finance Corporation to help them cope with liquidity shortages
• State-owned funds and institutions encouraged to buy stocks
4. Chinese stock markets have been prone to concerns about weak corporate governance, limited transparency, weak auditing standards, and shoddy accounting practices. In the absence of broad institutional and regulatory reforms that are necessary to support effective price discovery and the overall efficient functioning of stock markets, these markets could remain unstable.
POLICY INSTABILITY
1. The 13th five year plan echoes many items from the previous plan, including further restructuring of state enterprises, liberalization of the services sector so new firms can more easily enter this sector and operate with fewer restrictions, streamlining of the tax and public expenditure systems, and easing of restrictions on labor mobility within and across provinces.
2. China’s economy and the RMB’s rise have also been impeded by the lack of a robust institutional framework—including transparency in the policy-making process, sound corporate governance and accounting standards, and operational independence for the central bank and regulatory authorities—that ought to supplement financial and other market-oriented reforms.
3. A more fundamental concern is that the government seems to be caught in a deep internal conflict between its stated objective of letting markets operate freely and its desire to maintain stability and control above all else.
