China's financial system: Now and in 20 years
Vincent Cheng

In the past few years I have been spending nearly half of my time expanding Hang Seng Bank's business in the Chinese mainland market, and through that process I have accumulated some experience.

A modernized banking structure is now taking shape in China, though at this stage the industry is still dominated by State-owned banks. At present, the big-four State-owned commercial banks have a market share of about 60 per cent in terms of deposits and loans. Ten years ago their share was 90 per cent. A new generation of commercial banks has been established, some of which are funded privately and are listed on the mainland bourses.

Today, there are about 70 foreign banks with over 150 branches in China providing domestic and foreign currency business. Compare it with 1993 when the figures were 27 and 58 respectively.

On the capital market, as of 2003, the two stock exchanges had 1,285 listed companies with a total capitalization of US$510 billion. Since 1990, the mainland's stock market has grown to be the third largest in Asia, after Japan and Hong Kong, in terms of market capitalization. In mid-2004, the number of stockbroking firms totalled 170, and the number of offices in which they operated throughout the country exceeded 2,000.

However, the majority of the listed companies are still State-owned enterprises, and the majority of their share capital is held by various State or provincial entities. The listed portion of those shares accounts for less than one-third of the total market capitalization.

What's more, foreign investors and investment banks have only limited access to China's stock market, which still has characteristics typical of emerging markets, including low transparency, the prevalence of connected party transactions and speculative trading.

In terms of currency, the renminbi is still not fully convertible, which restricts capital flows, especially outflows of funds. But this should not blind us to the achievements that China has made. Over the past 10 years, China has unified its currency by abolishing the Foreign Exchange Certificate designated for use by foreigners in the mainland. It also unified the renminbi exchange rate by scrapping the foreign exchange swap centre in 1994. During this period, China has accumulated the world's second largest foreign currency reserves totalling over US$400 billion.

Looking ahead

In 20 years, the renminbi will hopefully become a fully convertible currency. First, it would mean that by then China would have a very robust banking and financial system to handle the volatility of the international financial flows in and out of China. Second, it means that the economy can function more efficiently.

It will also be highly likely that, by that time, the renminbi will have become one of the three major international currencies in the world, along with the US dollar and the euro. Renminbi will be a currency for international payments and a store of value in the form of a reserve currency held by many central banks.

At that time, China's banking system will be characterized by the presence of more private commercial banks, complemented by special-purpose State-owned banks. The ownership restructuring currently taking shape will go on.

A clear delineation of the shareholder-management structure will be in place, thus making the management accountable to the shareholders and holding them responsible for their business decisions. Foreign banks, which lately have been increasingly active in seeking strategic partners in the mainland market, will be much more active.

In 20 years China's SOE reforms will be largely completed, and those listed companies will no longer have separate classes of unlisted state shares. There will be no separation for "A" shares and "B" shares for different kinds of investors. The QFII scheme will be a matter of history because foreign investors will be able to participate freely in China's stock market.

The financial industry will see the emergence of a larger number of indigenous financial institutions: stockbroking firms, fund and asset management companies and investment banks. Institutional investors, from insurance companies to corporations, will be active players.

This is happening right now, but in 20 years some of the indigenous players might have grown to a scale comparable to their international counterparts from the US and Europe, thanks to the huge domestic household savings and the abiding desire of Chinese people to invest their money.

There will be an active bond market both for government securities and private sector corporate bonds. The financial infrastructure will be complemented by markets for financial derivatives such as futures and options, in interest rates, renminbi or an equity index. Over time most of the concerns about the substantial volatility and risk of these markets will no longer be an issue as they increase in sophistication.

 

 
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