China’s Financial Sector Opening UpInsights SRD/New York Research Center
At the end of China’s 13th Five-Year Plan, China has decided to further accelerate the opening up of its financial sector as part of China’s 14th Five-Year Plan.
History and Overview
After four decades of reform and development, China has established a comprehensive financial system, where state-owned commercial banks and other commercial banks, policy banks, non-bank financial institutions, and foreign-funded financial institutions coexist and complement each other.
The overall history of China’s opening up of its financial sector can be divided into three stages.
The first stage is from 1979, the start year of China’s economic reform and opening up, to 1993. During this time, China saw the establishment of its first fully foreign-funded bank, Nam Tung Bank (Macao) in 1984, and the first joint venture bank, Xiamen International Bank in 1985.
The second stage was from 1994 to 2001, when China saw the unification of the dual foreign exchange rates of the yuan and the yuan becoming fully convertible under the current account. In 1994, China set out its first law to regulate foreign financial institutions, the "Regulations on the Administration of Foreign Financial Institutions in China." By 1999, foreign securities companies, fund management companies, and insurance companies began to be able to participate in China’s interbank market.
The next stage started in 2001, marked by China joining the WTO. In the 30 years after that, China has seen the come and go of the QFII regime, the 811 RMB exchange rate reform in 2015, the yuan joining SDR in 2016, the creation of the Stock Connect and Bond Connect, and the Belt & Road initiatives and the establishment of the Asian Infrastructure Investment Bank.
In recent years, China has already become a big country with regard to its financial sector in terms of absolute scale. Today, China has over US$45 trillion worth of total financial assets, the largest banks in the world, and the world’s second-largest bond and securities market in size. Since 2018, China introduced over 50 measures to open up its financial sector, such as lifting foreign ownership caps on various financial institutions in fields including banks, securities, funds, futures and insurance. At the beginning of this year, the new PRC Foreign Investment Law, as well as its Implementing Regulations took effect, providing greater promotion and protection of foreign investment as well as enhanced regulatory transparency. With a substantially shorter negative list for foreign investment in general, the financial sector now has a zero negative list since September this year. As a result, there have been 30 new foreign-controlled financial institutions added to China’s capital market since 2018. Besides, we now see that all three major global credit rating agencies have presences in China, and A-share and RMB bonds are now included in more main international indexes. China has launched Shanghai-Hong Kong, Shenzhen-Hong Kong, Shanghai-London stock connect programs, as well as the Bond Connect program.
Risks and Benefits
Given such rapid development of the financial opening-up, some were concerned and were crying the wolf’s coming as they worry that the fast-paced open-up will bring more risks than China is ready for. It is true that people should not overlook the many potential risks that come with financial opening up, including market risks, foreign exchange risks, product risks, supervision risks, potential brain drain, and also possible shocks to China’s financial system. Some believe that expanding the open-up of the financial sector does more harm than good, but in fact, such a view does not conform to the law of development of the financial industry. However, as said by Dr. Xu Zhong, Director General of the Research Bureau of the People’s Bank of China, “In fact, opening to the outside world itself is not the source of financial risks. On the contrary, expanding opening to the outside world can help enhance the competitiveness of financial institutions, fundamentally prevent and defuse financial risks, and safeguard national financial security and stability.”
China is deeply engaged with the global economy through trade links, but far less integrated with cross-border capital flows. China’s financial market opening lags behind its hunger for capital. In particular, under the guidance of the new “dual circulation strategy,” promoting reform and development through opening up is not only an inherent requirement for the sustainable development of China’s financial industry, but also an inevitable choice to proactively prevent and resolve systemic financial risks, while also fulfilling China’s commitments when joining WTO. It is also a way of reflecting China’s confidence in its economic and financial strengths. In the meanwhile, it helps to strengthen China’s overall planning and coordination of supervision.
What benefits can China gain in the process? First of all, foreign financial institutions as new players may bring a “catfish effect” to the Chinese financial institutions to promote innovation and optimization, as well as by bringing their advanced management experience. Foreign financial institutions will serve as an external stimulus for technological improvement, talent development, product innovation, and management optimization of China’s domestic companies. It also conforms with the economic rule for optimized capital allocation among locations and industries, and will help to promote China’s supply-side reform. In addition, it will help China’s financial sector improve its management and supervision capabilities, and strengthen its ability of risk control and governance. Last but not least, it will also aid China to gain more international influence, with increased presence and voice in the global financial system.
Accelerated Opening Up
China has envisioned the 14th Five-Year Plan (2021-2025), including the goal to further open up China’s financial sector. Specifically, the priorities and focuses of the new plan will be around the following areas:
- The “Pre-establishment National Treatment” and the “Negative List Management” system, and to streamline the operational process for foreign financial institutions to enter China’s market;
- The RMB exchange rate formation mechanism reform and RMB internationalization, so as to enhance the flexibility of the RMB exchange rate and to reduce restrictions on the cross-border use of the yuan;
- The bond market and credit rating are expected to be the next hot spots for further open-up; and
- Risk prevention and management should never be neglected while accelerating opening up, to strengthen macro-prudential management, improve the professionalism and effectiveness of financial supervision, and improve the ability to prevent and resolve major risks.
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