Historical Overview Of Chinese Financial Sector

Prior to 1949, the financial system of China was very well developed. The earliest form of capitalism can be seen at the times of the late Ming Dynasty (17th century), when commerce was initiated in the Zhejiang-Jiangsu area and further developed during the Qing Dynasty (17th century to early 20th century). Late Qing China had a highly commercialized society with detailed regulations of guilds (merchant coalitions), where the key role was played by family traditions and customs. In Section IV below, it will be shown that modern equivalents of these mechanisms were behind the success of Hybrid Sector firms in the same areas in the 1980s and 1990s.

The development of China”‘””s financial system from the late nineteenth century to the early twentieth century was highlighted by the emergence of Shanghai as the financial center of China and Asia. During this period, Shanghai transformed from an agricultural-based trading hub for surrounding areas into an industrialized center linked to international goods and financial markets. With thriving entrepreneurial and trading activities, various financial institutions were given life. For example, five of China”‘””s first modern banks were founded between 1897 and 1908; and by 1936, there were 28 major foreign banks that had set up branches in Shanghai.

After the foundation of the People”‘””s Republic of China in 1949, all of the pre-1949 capitalist companies and institutions were nationalized. Between 1950 and 1978, China”‘””s financial system consisted of a single bank the People”‘””s Bank of China (PBOC), a central government owned and controlled bank under the Ministry of Finance, which served as both the central bank and a commercial bank, controlling about 93% of the total financial assets of the country and handling almost all financial transactions. With its main role to finance the physical production plans, PBOC used both a cash-plan”‘ and a credit-plan”‘ to control the cash flows in consumer markets and transfer flows from branches of the bank.

The first main structural change began in 1978 and ended in 1984. By the end of 1979, the PBOC departed the Ministry and became a separate entity, while three state-owned banks took over some of its commercial banking businesses: The Bank of China (BOC) was given the mandate to specialize in transactions related to foreign trade and investment; the People”‘””s Construction Bank of China (PCBC), originally formed in 1954, was set up to handle transactions related to fixed investment (in manufacturing); the Agriculture Bank of China (ABC) was set up (in 1979) to deal with all banking business in rural areas; and, the PBOC was formally established as China”‘””s central bank and a two-tier banking system was formed. Finally, the fourth state-owned commercial bank, the Industrial and Commercial Bank of China (ICBC) was formed in 1984, and took over the rest of the commercial transactions of the PBOC.

For most of the 1980s, the development of the financial system can be characterized by the fast growth of financial intermediaries outside of the Big Four”‘ state-owned banks mentioned above. For example, regional banks (partially owned by local governments) were formed in the Special Economic Zones in the coastal areas; in rural sectors, a network of Rural Credit Cooperatives (RCCs; similar to credit unions in the U.S.) was setup under the supervision of the ABC, while Urban Credit Cooperatives (UCCs), counterparts of the RCCs in the urban areas, were also set up. Non-bank financial intermediaries, such as the Trust and Investment Corporations (TICs; operating in selected banking services and non-banking services with restrictions on both the sources of deposits and loans made), emerged and proliferated in this period.

In 1985, the government legalized the status of foreign banks”‘”” branches and their operations in the Zones. The financial reforms slowed down during 1988-1991 to control inflation, during which considerable (government-run) consolidation took place. For instance, many TICs were merged and were increasingly regulated by the PBOC.

In 1992, the famous Southern Tour”‘ by then Chinese leader Deng Xiaoping marked the beginning of another economic boom. In the financial system, this period witnessed a sharp increase in foreign direct investment (FDI), a deregulation of the banking sector characterized by the emergence of many new state/local government owned commercial banks, and the re-emergence of Shanghai as the financial center of China.

In 1994, three policy banks”‘ were established to take over policy”‘ related lending in underdeveloped areas, export and import, and rural areas, while the four largest state-owned banks further developed into regular commercial banks, with profit maximization becoming an increasingly more important goal. Along with the growth of banks and financial intermediaries, inter-bank lending (1994) and bond (1997) markets were established, and the bank debit/credit cards market expanded rapidly. During the same period, the central bank (PBOC) increasingly used interest rates and reserves to manage the liquidity of the banking sector. For example, the PBOC sets lower and upper bounds on deposits and loans, while commercial banks can decide the actual rates within the bounds. The inter-bank lending rates were converted toward a uniform system in 1996.

The most significant event for China”‘””s financial system in the 1990s was the inception and growth of China”‘””s stock market. Two domestic stock exchanges, the Shanghai Stock Exchange (SHSE) and the Shenzhen Stock Exchange (SZSE), were established in 1990, and have experienced remarkable growth since then.

Following the Asian Financial Crisis in 1997, financial sector reform has focused on state-owned banks and especially the problem of nonperforming loans (NPLs). Finally, China”‘””s entry into the WTO in December 2001 marked the beginning of a new era. Since the eventual opening of the capital account and adopting a floating exchange rate are required by the WTO, one should expect to see increasing competition from foreign financial institutions and frequent and large scale capital flows. Perhaps we can even some witness dramatic changes and intriguing events within China”‘””s financial system shortly after December 2006 (the end of the five-year transition period after joining the WTO).