Armstrong taylor debt and distortion; risks and reforms in the chinese financial system (2016)

Debt and Distortion Risks and Reforms in the Chinese Financial System pau l armstrongt ay l o r Debt and Distortion Paul Armstrong-Taylor Debt and Distortion Risks and Reforms in the Chinese Financial System Paul Armstrong-Taylor Nanjing University Nanjing, China Debt and Distortion ISBN 978-1-137-53400-2 ISBN 978-1-137-53401-9 DOI 10.1057/978-1-137-53401-9 (eBook) Library of Congress Control Number: 2016942868 © The Editor(s) (if applicable) and The Author(s) 2016 The author(s) has/have asserted their right(s) to be identified as the author(s) of this work in accordance with the Copyright, Designs and Patents Act 1988 This work is subject to copyright All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made Printed on acid-free paper This Palgrave Macmillan imprint is published by Springer Nature The registered company is Macmillan Publishers Ltd London Preface As China’s economy and financial system have grown, so too has the importance of understanding their development Unfortunately, the Chinese financial system is unique, complex, and rapidly changing, all of which aspects make it a challenging subject to grasp Almost every day, a new financial problem is revealed, an innovative product released, or a critical reform announced Even for someone who follows these developments closely it can be hard to keep up Surely, only a fool would write a book, a medium with unavoidable lags between creation and publication, on such a rapidly shifting subject A shortage of such fools may explain the lack of such a book Perhaps I am such a fool because this is such a book But before you close it, let me explain why I believe that a book, specifically this book, can offer something that other media cannot While a book cannot deliver commentary on daily events, it does offer a chance to step back and see the broader trends and forces that might be obscured by a focus on the latest news If it can’t show the trees, it can offer a map of the forest To construct such a map, I focus on a few key underlying distortions that can explain much of the Chinese system’s uniqueness, complexity and rapid evolution Most of China’s financial problems are manifestations of such underlying distortions, most Chinese financial innovations are attempts to bypass or exploit these distortions, and most of China’s financial reforms are attempts to correct these distortions These distortions have been around for a while and, unless addressed by reforms, will not go away soon They will continue to shape China’s financial system and drive reform for many years Writing a book on these distortions is, I hope, not entirely foolish, and reading such a book may be of value to even a wise reader v vi Preface This book should be of interest to anyone who wants to understand the broad trends in the Chinese financial system This might include business people, financial professionals, government officials, regulators, and those generally interested in world affairs Even those who not intend to work with China directly can benefit from understanding how changes in China will impact the rest of the world, and I believe this book can provide that understanding The book is written at a level that should be accessible to those without specialized knowledge of China or finance, but even those with such knowledge will, I hope, learn something This book is not intended to provide practical business or legal guidance, but could provide a valuable complement to such guidance Finally, I would be remiss if I did not acknowledge the help of a number of people without whom this book could never have been written A book on such a wide-ranging subject as this cannot be written without leaning on the work of others Much of what I know about China’s financial system has come from reading the work of others There are too many to list individually, but the bibliography should give an idea of the scale of my debt I was fortunate that Peter Baker, my editor at Palgrave Macmillan, was willing to walk a new author through the unfamiliar process of writing and publishing a book I am grateful for his patience The Hopkins-Nanjing Center has been a lot more to me than an understanding employer My time at the Center has been rewarding on both a personal and professional level My colleagues have helped me enormously with this book, among so many other things I have been fortunate to have had the opportunity to teach some talented and motivated students, and my discussions with them, both in and outside the classroom, have helped me develop many of the ideas in this book In particular, I would like to thank Antoine Cadot-Wood for sharing some difficult-to-find statistics and Sean Linkletter for feedback on an early draft of this book Finally, I would like to thank my family for their support from the other side of the world I fear I am not the most filial of sons Of course, any errors are my sole responsibility Nanjing, China Paul Armstrong-Taylor November 15, 2015 Contents Part I Current Economic Model 1 Growth Model How Did China Grow So Fast? Why Can This Growth Not Be Sustained? Financial Risks Minsky’s Theory of Financial Crises Japan USA China 11 12 13 16 19 Financial Repression What Were the Effects of Financial Repression? Transfers Wealth from Households to Firms and Government Excessive Investment Depressed Consumption Inefficiency High Asset Prices Why Did Investors Not Move Money from Deposits to Other Investments? Shadow Bank Products Stocks Bonds Real Estate 25 27 27 28 29 30 31 3 32 32 33 34 34 vii viii Contents International Investment What Would Be the Effects and Risks of Liberalizing Interest Rates? Deposits Loans Asset Prices 35 36 37 39 Government Guarantees Role of Financial System in Managing Risk Government Guarantees and Moral Hazard Effect of Government Guarantees on Financial Risk Solvency Risk Liquidity Risk Systematic Risk 41 42 45 47 47 49 51 International Distortions Undervalued Currency Problems Restrictions on International Capital Flows Advantages of Closed Capital Accounts Disadvantages of Closed Capital Accounts 55 55 55 58 59 60 Overview 63 Part II Domestic Reforms 35 65 Banking Liberalizing Interest Rates Competition for State-Owned Banks Better Incentives for Bank Officials Improved Risk Management 67 67 70 73 75 Shadow Banking Trust Companies and Wealth Management Products Purpose Risks Benefits Reforms Informal Lending and the Wenzhou Crisis 81 84 84 85 86 87 88 Contents Wenzhou Model Wenzhou’s Financial Crisis Lessons from Wenzhou Wenzhou Reforms Loan Guarantee Firms Purpose Risks Reforms Stock Markets Advantages of Equity over Debt Immaturity of China’s Stock Markets Volatility Corporate Governance Capital Controls Government Intervention Unlocking the Potential of the Stock Market Reduced Government Involvement Corporate Governance Capital Controls ix 89 89 91 92 94 94 95 97 99 99 101 101 104 107 108 110 110 112 114 10 Bond Markets Bonds over Banks: Market Forces and Liquidity Characteristics: Large but Illiquid Risks: Challenges to Banks and Government Control Reforms: Finding the Middle Path 117 117 118 121 122 11 Local Government Debt Causes, Scale, and Characteristics Conflict Between Central and Local Governments Centralization of Tax Revenue Distorted Incentives Scale and Characteristics of Debt Local Government Debt: A Nexus of Financial Risk Solvency and Liquidity Risk Links to the Financial System Links to the Real Estate Market Risks to the Broader Economy Balancing Local Government Debt Reform with Economic Growth Stock and Flow Problems 125 125 125 126 127 129 131 131 133 133 135 135 135 254 P Armstrong-Taylor so traumatic China’s financial system, on the other hand, is largely insulated from the rest of the world Capital controls mean that the vast majority of lending and borrowing by Chinese entities happens domestically Although China has gradually opened its financial system to the rest of the world, it remains closed relative to other major economies At the end of 2013, Chinese banks had foreign liabilities equivalent to around % of GDP compared to around 16 % in the USA and Japan This insulates the Chinese financial system from the international financial system, and vice versa This was illustrated after the subprime crisis by the lack of any distress among Chinese banks or other financial intermediaries Part of the reason China was able to undertake its debt-funded stimulus was because the banks were healthy This is also likely to be true in the reverse direction – a Chinese crisis is likely to have manageable effects on the rest of the world In summary, the impact of any financial crisis in China on the rest of the world should be limited since neither trade nor financial channels will spread shocks very widely The effect would probably be similar to or even less than the Japanese crisis of 1990 – something the global economy easily shrugged off Reference Armstrong-Taylor, P (2014) Effects of trade and financial links on the transmission of GDP growth Frontiers of Economics in China, 9(4), 556–572 21 The Future As I write this in September 2015, global financial markets have slumped on fears of a slowdown, even a crisis, in China I think this is as overly pessimistic as the prophecies of a “Chinese Century” were overly optimistic China is slowing, but this is both expected and desirable It is undergoing a necessary transformation from which it will emerge with slower but more stable growth The financial reforms that we have discussed in this book are an important part of that transition It will not be easy, and there may be minor disruptions on the way, but there is no reason to think that China cannot succeed Exaggerated Pessimism Pessimism about China’s economy is largely based on three pieces of evidence: a decline in many indicators of industrial activity, the stock market slump, and a slight depreciation of the renminbi While none of these is good news and some concern may be justified, they not necessarily imply the economy is in serious trouble Indeed, each could be seen as signs that market forces are beginning to play a greater role in the Chinese economy Growth in heavy industry is slowing, and this affects many indicators that investors watch, including the manufacturing purchasing manager index (PMI) and the components of the so-called Li Keqiang index (electricity consumption, railway cargo volume, and bank loans) While these indicators may have been appropriate for measuring the so-called old economy (particularly in heavy-industry-dominated Liaoning, where Li Keqiang was based when he made the comments), they not capture the whole economy and certainly © The Author(s) 2016 P Armstrong-Taylor, Debt and Distortion, DOI 10.1057/978-1-137-53401-9_21 255 256 P Armstrong-Taylor not account for growth in services A successful transition requires that these sectors of the economy decline, so this is not necessarily a cause for concern as long as the service sector is growing strongly Indeed, the decline in some of these indicators may actually reflect the impact of financial reforms and so could be considered positive The overriding goal of the reforms is to ensure that the financial system is able to fund efficient, solvent investment Industries suffering from overcapacity (some heavy industries and construction in some regions) should not be funded These sectors should see a decline in bank loans and output if the financial system is operating well Growth may slow in the short run but will become more sustainable in the long run This is a welcome change from the past, when China avoided short-term economic pain by boosting lending and investment, even when such investment was wasteful, most obviously during the 2009 stimulus package The decline in commodity prices, particularly in sectors where China has been the major buyer, such as industrial metals, has also been taken as a sign that China’s economy is slumping While some of the decline in demand represents slowing growth in the industrial sector as discussed previously, some of it may be due to the decline in the use of commodities as collateral for loans Research by Ke Tang and Zhu Haoxiang have estimated that such activity could have increased global prices for industrial metals by as much as 15 % between 2007 and 2014.1 The use of commodities for collateral has fallen in recent years as Chinese regulators have clamped down on such activity and the decline in commodity prices has made them less suitable for use as collateral The unwinding of this trade is likely to have released large quantities of commodities from storage and so depressed prices The decline in demand for commodities for collateral represents changes in financial regulations (probably for the better) and has no connection to the real economy The unwinding of the “commodities as collateral” trade not only suppresses commodity prices but could explain some capital outflows The practice was commonly used to facilitate the carry trade in which Chinese borrowers would borrow in dollars to take advantage of lower interest rates Such borrowing is a capital inflow, and so the unwinding of such deals would show up as an outflow Estimates of the size of such schemes are hard to make, but Goldman Sachs suggests that copper collateral borrowing alone could have accounted for $40 billion of inflows as of June 2013 The total amount of commodity collateral schemes, let alone all carry trades, could be several times higher.2 The unwinding of such trades, partly due to regulatory scrutiny and partly Tang and Zhu (2015) Kaminska (2013) 21 The Future 257 due to expected changes in interest and exchange rates, could explain some of the recent capital outflows While such outflows might cause some financial instability, they are not fundamentally linked to the real economy Over the course of two days in August 2015, the People’s Bank of China (PBoC) allowed the renminbi to depreciate by around % against the dollar This shocked financial markets, which had been used to the renminbi’s being effectively fixed against the dollar, and led to speculation that this was a desperate effort to revive a flagging economy This interpretation is unlikely because a % depreciation would be insufficient to have much effect on the economy – particularly if the problems were as serious as the critics allege – and would little to offset the large appreciation of the renminbi against most currencies over the previous year The depreciation was probably designed to achieve multiple goals Certainly a weaker currency will not hurt exporters, but that is not the only benefit As China opens up its capital markets, capital will flow more easily into and out of the country If the exchange rate is fixed, the PBoC must offset these flows with its foreign exchange reserves However, changes in the foreign exchange reserves also have an effect on domestic monetary policy (as discussed in Chap 3) Indeed, it is impossible for China to have open capital markets, a fixed exchange rate, and an independent monetary policy One result of allowing the currency to move more freely is that the PBoC gains some flexibility to use monetary policy for the benefit of the domestic economy Opening capital market and freeing the exchange rate are both important steps toward the establishment of the renminbi as an international currency This is not just about satisfying the International Monetary Fund’s (IMF) requirements for inclusion in the basket of special drawing rights (SDR) currencies but is important for any widespread international use Both these goals will take time to achieve as they are partially dependent on domestic reforms, as discussed earlier, but the government is clearly moving in this direction The Chinese stock market has very little to with the economy: the stock market crash does not signal a recession any more than the previous boom in the stock market signaled a booming economy It is unlikely that the crash will cause unmanageable financial distress While margin balances were very high, indicating that some investors had borrowed money to invest, stocks remain a small part of household wealth (around 10 %), limiting the effects of the crash Some firms may also have borrowed money to invest in the stock market, but such activities are unlikely to be large enough to affect the economy as a whole More important than the direct economic or financial effects has been the poor performance of policymakers during the bubble Government support for the bull market inflated the bubble, from which a crash was inevitable 258 P Armstrong-Taylor The intervention to halt the decline in prices, while partially successful, came at enormous cost to the long-term prospects for the stock market and the credibility of government promises to allow market forces greater freedom Beyond the stock market, several reforms have been postponed in an apparent attempt to ensure financial stability and maintain economic growth.3 Such backtracking is concerning because reform will necessarily involve slower growth and some instability (as we will see in the next section) If the government is unwilling to accept this, the risk of stalling reforms increases Short-Term Risks, Long-Term Benefits While I think the pessimism about China has been overblown, that does not mean that its transition does not involve real risks However, failure to transition, while possibly safer in the short run, would be far costlier in the long run Viewed in this light, volatility is to be expected and, to the extent that it reflects the implementation of reforms, a positive sign This book has analyzed many of these risks in detail; here I want to highlight the main theme that can be used to understand China’s reforms China’s growth since 2009 has been maintained by increasingly inefficient investment funded by rapid increases in debt This is unsustainable It must be slowed and eventually replaced with other sources of growth Financial reforms can play a role in this  – in particular by forcing borrowers to pay market interest rates and by removing government guarantees of debt The combination of these policies will be to reduce borrowing and investment and, hence, growth In the short run, risk will increase; higher interest rates, slower growth, and the withdrawal of government guarantees will increase the risk that indebted firms will go bankrupt Therefore, slower growth, increased financial distress, and financial volatility are a necessary part of the transition process The alternative is a major financial crisis or long-term suffocation by debt (as happened in Japan) Although the short-term risks of reform are great, so too are its long-term benefits Growth may be slower, but it will be less dependent on increases in debt and, therefore, more sustainable China’s workforce will shrink in the coming decades, so future growth will require increased productivity This will require a market-based system that can allocate capital efficiently and in particular increase resources available to the more productive private sector This, together with continued urbanization and improved education, should allow China to continue to grow for decades to come Wei (2015) 21 The Future 259 In summary, China's financial system faces a challenging and risky transformation, but there is no reason it cannot succeed and play its part in helping China follow its East Asian neighbors to become a developed economy References Kaminska, I (2013, August 12) The great Chinese collateral trade, illustrated FT Alphaville Retrieved from http://ftalphaville.ft.com/2013/08/12/1599272/thegreat-chinese-collateral-trade-illustrated/ Tang, K., & Zhu, H (2015) Commodities as collateral Working Paper Retrieved September 8, 2015, from http://www.bus.umich.edu/ConferenceFiles/2015-MitsuiFinance-Symposium/files/Zhu_Commodities_as_Collateral.pdf Wei, L (2015, November 6) China delays economic liberalization Wall Street Journal Retrieved November 14, 2015, from http://www.wsj.com/articles/ china-delays-economic-liberalization-1446865113 Appendix: Financial Decision Making in the Chinese Government In this book, I have deliberately avoided getting bogged down in the institutional details of the Chinese government I prefer to focus on the key underlying forces at work rather than the particular institutions through which those forces act However, there may be some places in the book where I refer to a particular institution but not take the time to explain what it is For those who find this frustrating, this appendix can serve as a reference The Chinese Communist Party (CCP) and the Chinese central government are formally distinct The CCP is senior to the government and the General Secretary of the CCP is senior to the Premier of the government Figure A.1 shows the relationships among various parts of the CCP and the central government Formal relationships can be misleading, however, as the source of real decision-making power is not always clear Although the State Council is formally the senior policymaking body, under Xi Jinping, some of that power appears to have shifted to some central leading groups (also known as leading small groups) Nevertheless, Fig. A.1 should help clarify the major relationships In what follows, we will briefly describe each of the institutions and their role in economic and financial decision making Major Central Government Institutions Chinese Communist Party The CCP is the sole governing party of the People’s Republic of China and its General Secretary, currently Xi Jinping, is China’s most senior leader Formally, the most senior body within the CCP is the National Congress, © The Author(s) 2016 P Armstrong-Taylor, Debt and Distortion, DOI 10.1057/978-1-137-53401-9 261 262 Chinese Communist Party Appendix: Financial Decision Making in the Chinese Government Ministry of Finance China Central Huijin Company People's Bank of China State Administration of Foreign Exchange Financial Regulatory Commissions CCP body National Development and Reform Council Government body Central Leading Groups State Council Central Discipline Inspection Committee Fig A.1 Principal CCP and government agencies related to finance which elects senior leaders and can revise the policies and constitution of the party In practice, however, the National Congress approves decisions made by senior leaders within the Politburo or its Standing Committee (both of which are headed by the General Secretary) The CCP influence on the economy goes well beyond that of parties in most Western democracies It not only sets macroeconomic policy and creates legislation but also influences the leadership and major decisions of many nonpolitical organizations such as state-owned firms and banks State Council The State Council is the major policymaking body of the central government of China It is led by the Premier, currently Li Keqiang, and includes the heads of the major government departments and agencies It is roughly equivalent to the cabinets of the UK or US governments From a financial point of view, it directs or delegates all central government involvement in the financial system, including administration of governmentowned or controlled entities, appointment of key personnel, formulation and implementation of financial laws and regulations, and the setting of monetary and exchange rate policies Central Leading Groups Central leading groups provide guidance to government departments on the direction of policy, particularly in areas that span the domains of multiple government departments The purpose of these groups is to accelerate the Appendix: Financial Decision Making in the Chinese Government 263 formulation and implementation of such policies by cutting through government bureaucracy and interdepartmental disagreement In some areas, these groups have become the dominant source of new policy, supplanting the State Council The most important of such groups for economic and financial reform are the Central Leading Group for Comprehensively Deepening Reform and the Central Leading Group for Financial and Economic Affairs Both of these are headed by Xi Jinping, with Li Keqiang as deputy leader, and so serve to centralize economic policy within the senior leadership Central Discipline Inspection Committee The Central Discipline Inspection Committee, headed by Wang Qishan, was set up to implement Xi Jinping’s anticorruption campaign Although it has no direct input on economic policymaking, it may be important in weakening resistance to reform from political opponents of Xi or from vested interests who stand to lose from reform Ministry of Finance The Ministry of Finance answers to the State Council It effectively controls the largest banks in China This control is exercised partly through direct shareholdings and partly through its effective control of the China Central Huijin Company (Huijin), which also has substantial ownership stakes in these banks Through these direct and indirect ownership stakes, the Ministry of Finance controls all four of the major state-owned commercial banks (Industrial and Commercial Bank of China, Construction Bank of China, Agricultural Bank of China, and Bank of China), as well as China Development Bank, Bank of Communications, and China Everbright Bank This gives it control over most of China’s banking system and around half of the total financial assets The Ministry of Finance also has a strong influence over the China Investment Corporation (CIC), which is a sovereign wealth fund that manages around $650 billion of China’s foreign exchange reserves Huijin is a subsidiary of CIC. Formally, CIC answers directly to the State Council, but senior personnel frequently rotate between CIC and the Ministry of Finance For example, the current minister of finance, Lou Jiwei, is a former chairman of CIC (and chairman of Huijin) and before that was a vice minister of finance 264 Appendix: Financial Decision Making in the Chinese Government The Ministry of Finance has several other roles with less connection to the financial system Principal among these are managing tax revenue, government expenditure, and public debt People’s Bank of China The People’s Bank of China (PBoC) is China’s central bank and answers to the State Council It is in charge of domestic monetary policy – such as the setting of interest rates and the reserve ratios for banks – and the exchange rate It also controls the State Administration of Foreign Exchange (SAFE), which manages China’s foreign exchange reserves It has some financial regulatory functions, particularly in relation to controlling systematic risk Along with the regulatory commissions, it has some influence over the appointment of senior management with major banks and other institutions It serves as the lender of last resort to the banking system and is often active in adding or removing liquidity from the financial system There is believed to be some rivalry between the PBoC and the Ministry of Finance The PBoC is generally seen to be pro-reform while the Ministry of Finance is more conservative Previously, the PBoC controlled Huijin through SAFE, but in 2007, Huijin was transferred to CIC. This was seen as being symbolic of the declining power of the PBoC relative to the Ministry of Finance and, hence, a setback for the prospects for financial reform Financial Regulatory Commissions Three major financial regulatory commissions answer directly to the State Council Their main role is to draft and enforce laws They also have a role in the appointment of senior management to organizations within their jurisdiction The China Banking Regulatory Commission is the primary regulator of the banking system Its main responsibilities are to draft and oversee the enforcement of banking laws; to grant, amend, or terminate banking licenses; and to oversee the management and supervisory boards of the major stateowned banks The China Securities Regulatory Commission regulates securities and futures issuance and trading It oversees securities firms, investment banks, investment funds, futures firms, qualified domestic and foreign institutional investors, stock exchanges, and futures exchanges Appendix: Financial Decision Making in the Chinese Government 265 The China Insurance Regulatory Commission regulates the insurance industry, including all insurance holding companies, insurance asset management firms, and insurance agencies or brokers National Development and Reform Council The National Development and Reform Council (NDRC), currently chaired by Xu Shaoshi, is responsible for formulating policies for economic and social development and managing economic restructuring It formulates China’s 5-year plans, which serve as guidelines to policy priorities over the relevant period It also oversees major government projects, including those in infrastructure and energy The NDRC has its roots in the planned economy, and its role is dependent on a strong government influence on the economy; thus, it is unlikely to support market reforms since they would lessen the role of the government Index A anti-corruption drive, 214–17 Asian Infrastructure Investment Bank, 197–202 asset prices excessive, 29–30 B banking, 65–76 competition, 68–70 interest rate liberalization, 67 officials' incentives, 71–73 risk-management, 73–76 bond markets, 32, 115–21 benefits, 115 local government debt, 127 reforms, 120–1 risks, 119–20 C capital account liberalization (see capital account liberalization) restrictions, 56–9 capital account liberalization, 183–95 benefits, 186–7 risks, 184–5 capital controls, 56–9 effect on stock markets, 105–6 Chinese Communist Party (CCP) conflicts, 207–9 consumption, 26 corporate governance, 102–5 risks, 239–40 corruption, 214–17 D debt foreign, 227–30 -funded investment, 4, risks, 227–33 role in crisis, 18 domestic reforms, 63–154 E exchange rate, 159–65 liberalization, 159–65 valuation, 164 exports, 2, © The Author(s) 2016 P Armstrong-Taylor, Debt and Distortion: Risks and Reforms in the Chinese Financial System, DOI 10.1057/978-1-137-53401-9 267 268 Index F financial links transmission of crisis, 250–2 financial repression, 23–37 free trade zones, 193–5 G global financial crisis, 16–19 government ability to contain crisis, 245–6 ability to manage risk, 242–6 ability to prevent crisis, 243–5 government guarantees, 39–51 moral hazard, 43–4 growth model, 1–7 existing, 20–23 unsustainability, 4, 5, I inefficiency, 28–9 informal lending, 86–92 reforms, 90–2 interest rates liberalization, 33–37 repression of, 23–37 international consequences of economic transition, 248–9 distortions, 53–9 impact of China crisis, 250–2 investment, 33 reforms, 159–202 investment debt-funded, 4, 5, declining returns, 261–66 excessive, 26–7, 40 J Japan financial crisis, 19–22 L liquidity risks, 47–9, 237–8 loan guarantee firms, 92–5 purpose, 92–3 reforms, 95 risks, 93–4 local government debt, 123–40 bond market, 135–8 characteristics, 127–9 links to financial system, 131 links to real estate market, 131–3 reasons for growth, 123–9 reforms, 133–40 M Minsky, 11 theory of financial crises, 12–13 moral hazard government guarantees, 43–44 N New Silk Road, 197–202 P politics, 207–20 anti-corruption drive, 214–17 centralization of power, 217–20 conflicts, 207–11 overcoming opposition to reform, 213–20 R real estate, 32–3, 143–54 risks, 148–54 real estate market bubble in, 143–6 reforms, 170–4 reforms Index benefits, 85 local government debt, 133–40 overcoming opposition to, 213–20 stock markets, 109–112 winners and losers, 209–11 regulation risks, 240–2 renminbi exchange rate (see exchange rate) internationalization (see renminbi internationalization) renminbi internationalization, 167–82 effects, 176, 178, 181, 182 risk-management banking, 73–6 in financial system, 40–3 risks, 11–22, 33–7, 225–46 asset-liability mismatches, 236–9 corporate governance, 239–42 debt levels, 227–33 declining investment returns, 233 domestic, 225–46 foreign debt, 227–30 government's ability to manage, 242–6 international, 247–52 liquidity, 47–9, 237–8 loan guarantee firms, 93–4 of trusts and wealth management products, 83–4 real estate, 148–54 regulation, 240–2 solvency, 45–7 systematic, 49–51 S shadow banking, 30–1, 79–95 benefits, 84–5 characteristics, 79–80 informal lending, 86–92 loan guarantee firms, 92–5 reasons for growth, 83, 84 269 reforms, 85–6, 90–2 risks, 80, 83–4, 89, 93–4 trusts and wealth management products, 83–6, 90 Shanghai Free Trade Zone See free trade zones Shanghai-Hong Kong Stock Connect, 105, 113 solvency risks, 45–7 stock market volatility, 99–102 stock markets, 97–113 benefits of developing, 97–9 classes of shares, 105 effect of capital controls, 105–6 government intervention, 106–7 importance of individual investors, 100 problems with, 102 reforms, 109–12 volatility, 99–102 subprime crisis, 34–37 systematic risks, 49–51 T trade transmission of crisis, 250–1 trust companies, 82–6 reforms, 85–6 U United States subprime crisis, 16–9 V variable interest entity, 189–90 VIE See variable interest entity 270 Index W wealth management products, 82–6 reforms, 85–6 Wenzhou reforms, 90–2 Wenzhou model, 87–92 financial crisis, 87–8 lessons, 89–90 .. .Debt and Distortion Paul Armstrong-Taylor Debt and Distortion Risks and Reforms in the Chinese Financial System Paul Armstrong-Taylor Nanjing University Nanjing, China Debt and Distortion... crisis On the other hand, limited opening is possible and may be helpful in increasing the pressure for reform in domestic sectors An understanding of the Chinese financial system and reforms helps... analyzing the financial system for three reasons First, the financial system evolved to support the economic system that brought this growth, and it is impossible to understand the financial system