C&B Notes

Wen Appeals to Shake Up Bank System

As the end of his leadership reign nears, Premier Wen Jiabao has made an appeal for reform of China’s banking system.  In particular, he argues that private investors should be allowed to enter the formal banking market (there is already a huge informal lending market to fund local business projects outside the state-controlled system) and that capital controls should be loosened, which will promote easier foreign investment in domestic businesses.  Of course, it isn’t as simple as just allowing private investment in financial services businesses.  A big part of the banking problem in China is that most people do not have assets to borrow against due to murky property rights and the propensity of the powerful to steal valuable land and other assets.  Real property rights are a necessary condition for a normal banking system.

The country’s economic expansion is set to slow in coming years after racing ahead at a torrid pace over the past decade, raising questions over whether China can switch from a model based on exports and investment to one that relies more on a rising consumer culture.  That has led to a nationwide conversation over China’s tight grip on its financial system, which favors big state-owned firms but has been criticized by economists and even some reformers in China for impeding more balanced growth.


To realize the economic transformation, “private companies should be encouraged to get into the financial-services industry,” said Fang Xinghai, director-general of Shanghai Municipal Financial Services Office and a former World Bank economist, in an interview at China’s Boao Forum for Asia this week.

For decades, China’s economic growth has relied to a large extent on the captive savings of ordinary Chinese moved at cheap rates to state-owned enterprises.  The system penalizes savers and rewards borrowers, perpetuating an economic imbalance marked by high rates of investment and suppressed consumption.

That model is increasingly seen as unsustainable.  To lift the economy, many economists believe China must now transfer more money to consumers and aid its service sector, which is based on private enterprise.

Some economists argue that low interest rates are partly a consequence of China’s efforts to keep its currency undervalued.  The central bank fears that higher rates would attract speculative capital, fueling inflation.

There is plenty of skepticism about when/if any of this reform may happen at real scale:

“The Chinese government has said similar things for many, many years and I have yet to see drastic, concrete action,” said Victor Shih, an associate professor at Northwestern University.

Gary Hufbauer, a former senior U.S. Treasury official now at the Peterson Institute for International Economics, said if Beijing follows through with Mr. Wen’s pronouncements, “It would be a dramatic step towards a true market economy.”

But, he added, “Whether this will materialize, one has to take these statements with a grain of salt.”

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