In an article that discussed China's financial asset structure and policies, the Governor of the People's Bank of China, Yi Gang, analyzed the changes in China's financial asset structure from the perspective of risk-taking. Yi Gang believes that diversifying, managing, and allocating risks are the most basic functions of finance. The main characteristic of the market economy is that the economic subjects decentralize decision-making and bear their own risks. Such characteristics are helpful in diversifying risks and incentivizes economic entities to obtain corresponding returns by taking risks. Meanwhile, the government's responsibility is to protect property and other related rights, so that the social-economic subjects would be willing to take risks and obtain returns, utilizing the market to its fullest. It is more efficient for decentralized economic entities to make decisions and truly take risk. Likewise, the financial system will be more stable too.
From the perspective of risk taking, the risks of financial assets are not held by those who holds it. Some assets are low risk for holders, like savings deposits and deposit insurance systems. These risks are generally borne by the financial sector, though the main portion of it is ultimately borne by the government. Some assets' risk can be transferred, for instance through mortgage loans where banks can transfer parts of the risk. Some asset risks bear different names from the actual bearers. For example, a lot of unregulated financial products are products entrusted by clients for financial management, and clients would have to bear the risks. In reality however, banks and other financial institutions are the ones bearing investors' risks.
Based on the actual attribution of the main financial assets held by various departments, Yi Gang's research calculated the risk of residents, enterprises, governments, financial institutions and foreign departments bearing financial assets. He arrived at the conclusion that in recent years, banks and other financial institutions have been seeing a concentrated amount of financial asset risks, and a considerable portion of them were borne by the government. By 2018 year-end, the scale of financial assets undertaken by financial institutions and government departments was RMB 365.9 trillion and RMB 118.7 trillion respectively, 5.85 times and 2.60 times greater than the end of 2007. Additionally, the assets account for 54.5% and 17.7% of all financial risk assets. This adds to 72.2%, 2.6 percentage points higher compared to 2007. The trend of concentrated risks in financial institutions is clear. The proportion of risk borne by financial institutions has increased 14.2 percentage points compared to the end of 2007. Meanwhile, other units such as residents, enterprises and foreign departments all accounted for 9.4%, 13.8% and 4.6% of the risks by the end of 2018 respectively.
Considering the current conditions in the market economy, Yi Gang believes that the risks should be dispersed and shared throughout the market, though this has not been the case. It's been more than a decade since the international financial crisis has happened, and there is a high concentration of Chinese financial assets risks in the banking sector and debt financing. That leaves us with two reasons to explain the current phenomenon:
First, direct financing, especially stock financing, has grown slowly. Direct financing involves direct transactions between non-bank economic entities and has higher requirements for the rule of law and credit environment. Stock financing however, has a relatively low growth rate, and real economy financing is still dominated by indirect financing and debt financing, which has led to a significant increase in the proportion of bank loans among various financings. Currently, among the market's financial tools, the bond market is more constrained than bank loan financing. Meanwhile, the equity market is more constrained than the bond market. The concentration of risks in financial institutions, especially banks, is likely to affect the incentive and constraint mechanism, disrupt the efficiency in allocating financial resources, and distort risk pricing. This will in turn cause the excessive rapid expansion of financial assets and a decline in some assets' quality, which magnifies financial risks.
Second, the macroeconomic operation has had an important impact on the financial structure. From 2003 to 2008, before the international financial crisis took place, China's economy was steadily growing, and its internal growth momentum was strong. During this period, the country's high savings supported domestic investment, though it also formed a current account surplus. The high economic growth also attracted large external investments, thereby reducing the business dependency on credit and other debt financing. As economic growth exceeded credit and other debt growth, the macro leverage ratio declined steadily too. After the international financial crisis broke out, as a result of hedging downward pressure on the economy and expanding domestic demand, the bank debt financing grew rapidly. Not only did loans grow faster, but banks also derived money through interbank, equity and other investments to provide some off-balance sheet and shadow banking business financing, most which are considered debt financing. Debt financing has risen significantly, coupled with a decline in nominal GDP growth, this has led to a substantial increase in macro leverage.
In China, any research concerning financial assets always looks into real estates too. A survey conducted by the Statistics Department of the People's Bank of China showed housing assets accounted for nearly 70% of urban residents' household assets in 2019, exceeding the financial assets held by residents. There is a dual relationship between real estate and financial assets:
(1) Real estate is an important asset for residents and enterprises. Residents and enterprises constitute liabilities to banks through real estate financing, and the banks' financial asset correspond to real estate in the hands of residents and enterprises.
(2) Many loans are placed with real estate as collateral. The rise in real estate prices will funnel more loans through the collateral channel, and the two will strengthen one other. Since loans are highly dependent on collateral, the distribution of collateral has become an important factor in influencing bank capital flow and capital allocation. In truth, this isn't conducive to cultivating the bank 's credit loan culture, and does not bode well with the bank's role as a financial intermediary to identify entrepreneurs and support innovative development features. In recent years, the proportion of new real estate loans in new RMB loans has increased from 25.4% in 2010 to 41.5% in 2017.
In the past decade, the proportion of China's bank loans in various financing has increased significantly. After the international financial crisis, domestic demand has played a role in economic growth. The demand for loan financing has become higher, and a certain increase in debt leverage is unavoidable. However, the rapid expansion of credit with government credit support and real estate as collateral will lead to the concentration of financial risks in banks and governments, and it is easy to form a self-reinforcing mechanism to accumulate excess capacity, real estate bubbles and debt leverage risks. International empirical researches show there is an obvious inverted U-shaped relationship between government debt and economic growth. Once the government debt ratio exceeds the threshold, it may have a negative impact on long-term economic growth by reducing growth.
Based on findings which has shown that the economic growth model driven by excessive debt expansion is unsustainable, policy makers are calling for a no-strong stimulus movement. While stability in total demand needs to be maintained, supply-side structural reforms are the focus here so as to promote economic structural adjustment and reform to achieve high-quality economic development. In recent years, the problem of domestic overcapacity has been significantly alleviated, the overall supply and demand have become more balanced, at the same time the comprehensive economic resilience has increased. From 2007 to 2015, China's GDP growth rate fell from 14.2% to 7%, a decline of 7.2 percentage points in 9 years, from 2016 to 2019 it was 6.8% to 6.1%, a decline of 0.7 percentage points in 4 years. The overall downward adjustment is converging. Meanwhile, the excessively rapid increase in macro leverage ratio has also been curbed, with a cumulative increase of 2.8 percentage points from 2017 to 2019, far below the average annual increase of more than 10 percentage points from 2008 to 2016, which has remained pretty much stable, of which corporate leverage has fallen.
ANBOUND's researchers believe that Yi Gang's ten-year comparative analysis of China's financial asset structure has provided the country with a breakdown of the financial industry from the angle of asset structure. It observes and notes the changes in financial risk based on the "static results" of financial assets at different periods. From the perspective of research ideas, the quantitative analysis does not analyze the causes of financial risks, the dynamic mechanism, nor the development logic in risk formation. However, it is consistent with macro observations and judgments. China's trend of financial risks is clear and obvious. It is heavily located in the banks and government and correlates significantly with real estate. The pandemic that is creeping across the globe has brought new challenges to China in solving its financial risks. In his studies on the relationship between urbanization and credit expansion, excess capital, financial risks as well as crises, ANBOUND's chief researcher Chan Kung has long pointed out that excess capital caused by excessive urbanization is the biggest feature of the current global market. The triangular relationship of crisis formed through the "urbanization - excess capital - economy and financial crisis" process is an important reason in affecting or even controlling economic pulse. (Crisis Triangle, Chan Kung, September 2015). Based on this understanding alone, one should realize that alleviating China's financial risks in a systematic way is not something that can be achieved by merely treating the symptoms; instead it involves a systematic solution too.
Final analysis conclusion:
The Chinese central bank's empirical research shows China's financial risks are concentrated in the banks and government, and it correlates significantly with real estate. There is no fast solution to mitigate China's financial risks; rather a systematic approach is required to tackle the problem.
