Conceptualizing the Regulatory Thicket

China's Financial Markets after the Global Financial Crisis

Shen Wei

• Publisher: Routledge
• Year: 2020
• ISBN:
  9781000200348
• Edition: 1
• Topic: Economics
• Subtopic: Banks & Banking
• Index: Economics

This book examines the regulatory framework, regulatory objectives, regulatory logics, regulatory instruments, regulatory failures, and regulatory responses in China's financial market after the global financial crisis. The book provides an in-depth analysis of China's contemporary financial regulatory system, focusing on risks, regulation, and policies in practice. By drawing on public and private interest theories relating to financial regulation, the book contends that the controlled development of the banking sector, and the financial sector generally, has transformed China's banks into more market-oriented institutions and increased public sector growth. However, China's financial market and financial regulation have some inherent weaknesses and deficiencies. This book also offers insights into how this can be improved or adapted to minimize systemic risks in China's financial sector. This book tries to prove that financial regulation is not just a vehicle for maintaining efficient financial markets but a primary tool through which the Chinese government achieves its political and economic objectives. More fundamentally, according to the law and finance theory, strong market and vibrant judicial systems are needed to further modernize China's financial markets and market economy.

The book will be a useful reference for anyone interested in learning from the Chinese experience.

1Changing landscapes and persisting puzzles

This book looks at China’s financial system (largely the banking system) and financial regulation in the past decade after the global financial crisis starting in 2007–2008. The book focuses on the changing landscape of China’s financial sector and some interconnected puzzles or “China myths” about its banking system and financial regulation.

1.1 China’s financial landscape before and after 2008

We can divide China’s last four-decade high-speed economic development into two phases: before 2008 and after 2008. Before 2008,¹ there was a relatively straightforward roadmap—China’s was attempting to reform its financial system by (a) commercializing the banking system including: partially privatizing the state-owned banks by involving foreign investors and listing them in China and abroad; (b) by formalizing, or modernizing, its financial regulatory system; and (c) switching from the so-called sole-regulator model, or mono-banking system, to a sectoral, or function-based, regulatory model.

In this first phase, China’s accession to the World Trade Organization (WTO) basically legalized its efforts to commercialize its banking system and formalize its regulatory structure. At that point, China’s financial sector was defined as being in its early stages. That legal status may be one cause of the future puzzles stemming from the second phase, which witnessed vibrant growth in the sector. Under China’s WTO Accession Agreement, it made a commitments to banking sector reform and the gradual opening up of the banking sector to foreign participants in the context of General Agreement on Trade in Services (GAAT) rules governing international trade in financial services and the obligations that applied after its WTO accession.²

China’s entry into the WTO certainly had a hugely positive impact on its financial sector. The general consensus is that the involvement of foreign banks in China’s banking sector after its entry into the WTO was a big win for China’s depositors, financial consumers, and its economic growth.³ Empirical studies, however, have drawn a much clearer picture attributing this great success to factors, such as a growing pool of well-trained personnel, domestic and foreign development experiences, and the continuous advancement of financial infrastructure.⁴ Chinese banks did not benefit from technological change and scale expansion in the pre-WTO period but the reverse happened in the post-WTO period. By contrast, the profit margin caused by technological change for the banking sector before China’s accession to the WTO was larger than in the post-WTO period.⁵ Economic freedom was related negatively to cost efficiency and positively to profit efficiency in the pre-WTO period, but the opposite happened in the post-WTO period. In addition, there was an efficiency gap between joint-stock banks and state-owned banks in the pre-WTO period but that gap disappeared after China joined the WTO.⁶ These findings have policy implications for supporting the gradual removal of restrictions on foreign banks in the interests of Chinese banks.

The real puzzle comes after the global financial crisis. There are two key perspectives which are related to the change of the landscape. Before the global financial crisis, China’s banking sector was largely underdeveloped, which allowed it to have a phase-in scheme to slow the process of involving foreign investment or privatization. When China joined the WTO, the Big Four banks were technically almost bankrupt. But after the global financial crisis, the Big Four banks did far better than their counterparties in the US, the EU, and Japan in terms of profitability and equity return ratio. In 2013, for the first time, the Industrial and Commercial Bank of China Limited (ICBC) displaced the Bank of America to become the largest commercial bank in the world. In 2019, the Big Four banks were the biggest in the world in terms of their Tier 1 capital. Among major economies, China has twelve of the largest commercial banks in the world’s top fifty (the US has just seven) and it now has over 120 of the world’s 1,000-largest commercial lenders. There are two puzzles here.⁷ One is why the Big Four banks, together with other Chinese banks, are doing well but their Western counterparties are not. The global financial crisis did not appear to hit China’s banking sector at all; indeed, it may even have helped to enhance it. The second is why the Big Four are doing well, but other State-owned Enterprises (SOEs) are not, given the fact that most academics, including legal scholars and economists, are not big fans of state-owned banks and argue that they, like other SOEs, represent low efficiency, low profitability, and poor corporate governance. Apparently, there is a mismatch between the Big Four’s status of being an SOE and their success among the major global banks after the financial crisis.

Related to these two primary puzzles, there are other secondary or more technical puzzles. For instance, when China joined the WTO, foreign banks held roughly 2% of China’s total banking assets, which stabilized up to 2013 according to the World Bank.⁸ After almost two decades, this percentage has now dropped to 1.29%.⁹

The other puzzling story of China’s banking and financial system is its non-performing loans (NPLs) ratio, which, as the Chinese government claims, stood at around 1.9% of banking assets by the end of 2019.¹⁰ Historically, the NPL ratio was extremely high, making up roughly 30% of China’s banking sector back in 2001.¹¹ Even now, China’s banking sector often makes the headlines given its sizable NPLs and high leverage ratio, which have the potential sources to cause financial instability. In the broader picture, excessive debt has become a serious problem in China. China’s total borrowing rose to 266% of GDP in 2018, from 162% in 2008. According to the IMF’s forecast, China’s total debt will be 300% of GDP by 2022. The puzzling thing is how the NPLs were resolved and why they have never affected China’s financial stability. China’s financial system is key to the success of its state capitalism, its state-owned sector and mercantilist approach to the global economy. State capitalism, or the government-managed market economy, may provide the answer to the questions that this book tries to answer.

The next three sections offer a different lens through which we may observe China’s complicated financial system, though they often pose more questions than answers. These confusing facts indicate the dynamics of China, its economic system, and its financial system.

1.2 Fortune 500 in 2019¹²: Who is who?

Fortune magazine published the list of the world’s top 500 companies in 2019. For the first time in its history, the number of Chinese companies included in the list (129) surpassed the United States (121). Every year, Fortune publishes its famous Fortune 500 list, which is regarded as the most authoritative ranking of enterprises in the world using the annual income and net profit of each company as the selection criteria.

The total operating income of the 500 companies listed in 2019 was nearly US$32.7 trillion, an increase of 8.9% year-on-year; the total profit reached a record US$2.15 trillion, an increase of 14.5%; the net profit margin reached 6.6%, the return on net assets reached 12.1%, both of which exceeded those ratios last year, reflecting the economic recovery of the 500 largest companies.

The top ten companies in the Fortune 500 are: WALMART, China Petrochemical Corporation, Royal Dutch Shell, China National Petroleum Corporation, China National Grid, Saudi Aramco, UK National Petroleum Corporation (BP), Exxon Mobil, Volkswagen, and Toyota.

According to Fortune, there are twenty-five newly listed and re-listed companies in the world’s top 500 list in 2019. There are thirteen new Chinese companies, accounting for more than half the total number of newly listed companies.

The new Chinese companies on the list are: China Development Bank, China Railway Group, Qingshan Holding Group, Jinchuan Group, Zhuhai Gree Electric Co., Ltd., Anhui Conch Group, Huaxia Insurance Company, Tongling Nonferrous Metals Group, Shanxi Coking Coal Group, Xiaomi Group, Hailiang Group Co., Ltd., China General Technology (Group) Holding Co., Ltd., Formosa Petrochemical Co., Ltd.

Zhuhai Gree Electric Co., Ltd. (No. 414) and Xiaomi Group (No. 468) were both on the list for the first time. Nine-year-old Xiaomi was the youngest company in the world’s top 500 in 2019.

In addition to Sinopec, PetroChina, and China National Grid, the top ten companies in the Fortune 500, Chinese companies ranked ten to fifty include: China State Construction Engineering Corporation (No. 21) and Hon Hai Precision Industry Co., Ltd. (No. 23), Industrial and Commercial Bank of China (No. 26), China Ping An Insurance (Group) Co., Ltd. (No. 29), China Construction Bank (No. 31), Agricultural Bank of China (No. 36), Shanghai Automotive Group Ltd. (No. 39), and the Bank of China (No. 44).

Among other well-known Chinese companies, Huawei ranked 61st, Jingdong ranked 139, Alibaba Group ranked 182, Lenovo Group ranked 212, Zhejiang Geely Holding Group ranked 220, Tencent Holdings ranked 237, Suning E-commerce ranked 333 and Haier Intelligent Co., Ltd. ranked 448.

According to Fortune’s statistics, in terms of ranking changes, the fastest rise in 2019 was China’s Country Garden, which jumped 176 spots. It is worth mentioning that six of the top ten companies with the fastest jumps are from mainland China. Apart from Country Garden, the other five are: Alibaba (up 118), Sunshine Longjing (up 96), Tencent (up 94), Suning Tesco Group (up 94), and China Evergrande (up 92).

In terms of the industrial sector, there are a total of fifty-four banks among the world’s top 500 companies, which means the banking industry has the most companies listed. Their profits account for 47.5% of the profits of all Chinese companies.

There are seven internet-related companies, including Jingdong, Alibaba, Tencent, Xiaomi, Amazon, Alphabet, and Facebook from both China and the United States.

Among the top fifty most profitable companies on the Fortune 500, the top ten companies are: Saudi Aramco, Apple, the ICBC, Samsung Electronics, CCB, JP Morgan Chase, Alphabet, ABC, Bank of America, and BOC. China’s Big Four banks are also included in the top ten.

Boeing ranks first in terms of return on investment (ROE), while Zhuhai Gree Electric Co., Ltd., Country Garden, Evergrande, Huawei and Anhui Conch Group are among the top Chinese companies with higher ROE ratios.

In the profit margin list, the highest ranked is Micron Technology Co., Ltd., while Facebook ranks second. Among mainland Chinese companies, the ICBC has the highest profit margin on the list.

However, compared with the world’s top 500, the profit indicators of Chinese companies are relatively low. The average profit of the world’s top 500 companies is US$4.3 billion, while the average profit of Chinese companies on the list is US$3.5 billion. Compared to US companies on the list, the gap is even more pronounced.

The two indicators of return on sales and return on net assets reflect the pros and cons of the business operation. In 2019, 119 Chinese companies (excluding Taiwanese companies) were listed, with an average sales income of US$66.5 billion, an average net asset of US$35.4 billion, and an average profit of US$3.5 billion. Based on these three figures, the average sales yield of Chinese companies on the list is 5.3%, which is lower than 7.7% of US companies and 6.6% of the global average; the average return on equity is 9.9%, which is lower than 15% of US companies, and is also lower than the global average of 12.1%.

Chinese companies have reversed the downward trend in recent years in terms of both sale...

Table of contents

• Cover
• Half Title
• Series Information
• Title Page
• Copyright Page
• Dedication
• Contents
• List of figures
• List of tables
• Preface
• Acknowledgements
• List of abbreviations
• 1 Changing landscapes and persisting puzzles
• 2 A multi-tiered capital market solution to non-performing loans and the debt crisis
• 3 Small, big, and deadly: Is opening the banking sector a mission impossible?
• 4 Private lending and regulatory responses: A pluralistic analysis
• 5 P2P lending in the dilemma of the sharing economy
• 6 Three paradoxes of shadow banking: A political economy paradigm
• 7 Renminbi internationalization: State-driven pragmatism
• 8 By way of conclusion: Finance and regulation in the jungle
• Bibliography
• Index