Globalization: the Role of Institution Building in the Financial Sector _ The Case Study of China

The role of FDI in institution buildingOver the past 20 years, foreign financial institutions, mainly foreign banks haveplayed an important role in the opening up of Chinese financial in

Globalization: the Role of Institution Building in the Financial Sector

-The Case Study of China

August, 2003

I Introduction

Financial globalization could be described as a process in which global financialactivities get increasingly integrated with the risk creation mechanism Thisdescription emphasizes three points First, financial globalization is not only a process

in which financial activities transcend national borders, but also a process in whichrisks spread across the markets Second, financial globalization is initiated by manymicro-economic entities to seek profits and is driven by the integration of globalfinancial markets Third, it is a gradually deepening process with distinct phases

In general, financial globalization covers five areas: capital flow, monetarysystem, financial markets, financial institution, and financial coordination andsupervision

In China, institution building in the financial sector takes place against thebackdrop of financial globalization It not only shares common features with othercountries’ experience but also has its own characteristics Therefore, it is useful toreview the process of institution building in China, to analyze its effect on theeconomy and prospects under the framework of financial globalization

II Review of Institution Building in the Financial Sector

A Main driving forces of institution building

A review of the developments of China’s financial sector over the past 20 yearsreveals that reform and opening up have been two major forces driving institutionbuilding in the financial sector

Generally speaking, the fundamental reason for financial system reform is toincrease the efficiency of allocating and utilizing financial resources The microeconomic entities in the financial system initiate financial innovation through seekingfor financial resources, resulting in improved efficiency of the whole financial market.The reform is market-oriented and aimed to establish advanced financial system andsound financial order commensurate with the socialist market economy Endogenousinstitutional reform mainly depends on participation of micro entities It coversfinancial incentive, innovation and discipline mechanism, which drive financialdevelopment as a lasting and inherent force

Opening up of the financial industry is an important part of the whole openingstrategy of China Facing financial globalization, it is the rational choice for China tofurther open up its economy and benefit from the strategy called ‘improvementthrough contact’ Full-scale contact with the international markets means that Chinamay gain access to global economic resources in a broader scope and at the same timeexpose the domestic financial market to the impact of the global financial markets,whether positive or negative

B The role of FDI in institution building

Over the past 20 years, foreign financial institutions, mainly foreign banks haveplayed an important role in the opening up of Chinese financial industry In the earlydays of their operation in China, foreign banks’ deposits were generally larger thantheir loan portfolios, and most of the excess funds were either deposited in theiroverseas headquarters or correspondence banks In recent years, the growth of lendinghas accelerated The ratios of loan balance to total capital, total assets and depositbalance have also increased At the end of June 2003, total assets of foreign banksamounted to USD41.25 billion and total loan balance amounted to USD19.86 billion

54 percent of foreign bank loans were granted to support manufacturing industry andhas promoted the development of light industry, chemical industry, and electronicindustry and machinery industry

Foreign banks also bring more overseas customers to the Chinese market, whichhas further promoted the overall increase of foreign direct investment In particular,foreign banks have provided intermediate services such as business consultation andinformation service in the negotiation of international loans, and such servicesconstitute an important part in the process of attracting foreign capital

In addition, foreign banks also play a unique role in institution building in thefinancial sector They help to mitigate financial repression in China, to establish soundfinancial system, to enlarge contribution of the financial sector to economicdevelopment and to realize a virtual cycle of financial deepening and economicdevelopment The role of foreign banks covers the following areas:

1 Competition effect After the entry of foreign banks into the domestic

market, the monopoly of state banks has been broken Competition forces Chinesebanks to reestablish their business strategy and operation

2 Demonstration effect Foreign banks have demonstrated their advanced

technology, equipments, organization and management to domestic banks Theirhigher profitability has stimulated Chinese banks to upgrade technology andequipment while improving management

3 Training effect Foreign banks provide training programs for their Chinese

employees so as to improve their professional skills At the same time, foreignbanks also transfer technology and management skills to their Chinesecounterparts All these have helped to improve the efficiency of Chinese banks.More importantly, foreign banks not only provide an external financing channelfor Chinese enterprises, but also facilitate the development of the domestic capitalmarket while they are engaged in investment and securities business Also, entry offoreign banks urges the Chinese regulatory authorities to comply with internationalstandards and to reduce government intervention In addition, foreign banks have set agood example for Chinese banks on how to do business in the international financialmarkets

For China, the role played by foreign banks is like a double-edged sword Whilepromoting financial deepening in China, expansion of foreign banks’ market sharemight have negative effects on Chinese economy, especially on the financial industry

These negative impact include potential shocks to Chinese banks, strengthenedtransmission of international financial crisis, and reducing capability of the centralbank to exercise macro-economic management using traditional monetary policyinstruments.

C Sequencing of institution building in the financial sector

The sequencing of institution building in the financial sector may differ fromcountry to country However, there are some experiences worth mentioning for adeveloping country like China First, the government should base the contents andspeed of reform on macroeconomic stability Second, the adjustment in financialsector should be consistent with adjustment of the real economy Third, internaladjustment should not lag far behind the process of opening up Fourth, a gradualapproach should be adopted The government should take into account possibleeconomic and social consequences, as well as the time frame required for thedomestic markets to adapt to the new system and the management of enterprises toimprove their professional skills

In view of its overall economy, it is an inevitable choice for China to adopt amodel of ‘limited opening and gradualism’ Most developing countries and a fewdeveloped countries have adopted the model of ‘limited liberalization’ When thesecountries opened their domestic financial markets to foreign competition, theauthorities tend to set various restrictive measures in the areas of market entry andbusiness licensing Therefore, foreign financial institutions, compared with theirdomestic counterparts, face more strict barriers in entering the market, conductingbusiness and complying with regulatory rules Gradualism means that a country opensits financial markets on a gradual basis after certain conditions have been met Therestrictions on market entry and business scope of foreign banks are graduallyloosened and foreign banks will be granted national treatment step by step Thismodel often involves three periods, which starts with strict restriction, then looseningrestriction and ends with full liberalization As Professor Ronald McKinnon pointedout, China should adopt the gradual liberalization approach, rather than the big bangapproach used by the former Soviet Union and some East European countries.According to Professor Tobin, China should gradually integrate with the internationalfinancial market, though it should actively participate in the economic and tradeglobalization This is due to the basic economic situation and the development stage

of Chinese financial market

It has been proved that global financial stability requires effective surveillanceand needs support from the international financial institutions However, sound macroeconomic policy and structural reforms in each country constitute the basis formeeting such a challenge Global financial stability is based on stability of individualcountry’s financial markets Also, the stability of individual country depends not only

on the surveillance, guidance and support of the international financial institutionssuch as the IMF and World Bank, but also more fundamentally on the soundness of itsmonetary and fiscal policy as well as the banking system Apart from the attack of thespeculators, the Asian Financial Crisis was to a larger extent caused by weaknesses inmacro economic policy and the banking system in related countries

D Major Issues in the institution building process of the financial sector

1 The relationship between financial opening and financial security

China’s decision to join the WTO signifies a step forward in the opening offinancial sector to the outside world In the mean time, the era of rigid financialcontrol will come to an end Coupled with the advancement of e-economy, financialopening and liberalization will bring great impact on the existing financial system,and especially on financial regulatory framework This trend also indicates theimportance of financial security As far as China is concerned, financial securityconsists of, inter alias, the soundness of domestic financial sector and stability of theliberalized financial market

2 The disadvantage of domestic banks in competition with foreign banks

Compared with large international banks, domestic banks are generally in anapparently disadvantaged competitive position The restructuring of state-ownedbanks is yet to gain speed despite the significant improvement that has been achieved.After China’s accession to the WTO, increasing number of foreign enterprises choose

to do business with foreign banks as they swarm in Meanwhile, premier domesticenterprises are also shifting to the securities market for financing, which results in theerosion of and more fierce competition in the traditional banking market Theproblems of inadequate innovation, weak competitiveness and the loss of premiercustomers and professional staff will be more salient for state-owned banks Inaddition, high NPL ratio poses a long-lasting difficulty for the state-ownedcommercial banks, which hinders the process of their ownership restructuring

3 Moral hazard

Since 1996, a set of measures has been taken by the government to prevent anddissolve financial risks However, these measures had yet succeeded in addressing theproblem of incomplete contracts, but brought about moral hazard The merging andacquisition are not completely the result of market selection and the government itselftook a leading role The “too big to fail” argument has been under debate in theory allthe times The operation mechanism of those merged and acquired financialinstitutions have not changed fundamentally, however they have increased the number

of branches and staff In China’s case, it is a fact that the bigger the financialinstitutions are, the less possible for them to be closed The government guidedM&As reduces probability to fail, but it does not necessarily mean improvement ofmanagement and assets quality

4 Weak financial infrastructure

Business growth of Chinese banks is constrained by the weak infrastructure inrespect of practice in loan classification, accounting, auditing and payment andsettlement For instance, The NPLs of domestic banks have long been definedfollowing traditional criteria as overdue loans, default loans and bad loans This staticclassification method is quite different from the international accepted methods andunable to reflect the true quality of loans In recent years, the application of the five-category classification method has been advanced thanks to the strong push of thecentral bank and the efforts of commercial banks

5 Slow progress in market-based interest rate reform

Since interest rates are not adequately determined on market basis, their roles assignals to the supply of and demand for fund are not fully effective, and sometimeshave negative influence on pricing and risk management of commercial banks

E Policy measures to promote institutional building

Institution building in financial sector in China has been mainly achieved through

a series of institutional reforms China’s financial institutional reform process could

be divided into the following three stages: (1) preparation and strategy exploration,(2) framework construction, and (3) adjustment and advancement

During the first stage from 1979 to 1984, the financial sector in China began toundergo institutional reform The prominent features of the financial system at thisstage could be summarized as follows:

(1) separation of central banking from commercial banking by establishing a tier banking system,

two-(2) establishment of specialized commercial banks serving different industries;and,

(3) Introduction of deposit based bank growth model

During the second stage from 1985 to 1996, a series of new arrangements and aprimary framework for market-based financial operations were introduced The mainfeatures are as follows:

(1) The legal status of the central bank was established with the promulgation ofthe Central Bank Law and the Regulations on Monetary Policy Committee

(2) The institutional structure diversified, including the development of banking financial institutions, the establishment of several insurance companies, thefast growth of securities industry, the start-up of Shenzhen and Shanghai StockExchanges and the grant of market access to foreign financial institutions

non-(3) Significant progress was made in financial deregulation, including theseparation of commercial banking from policy banking by establishing three policybanks in 1994 and the promulgation of Commercial Banking Law in 1995,encouraging competition among banks, introducing concept of risk, profitability andcost in bank management, improving capital management system, introducingassets/liability ratio regulatory framework, and strengthening internal control

(4) Macro financial management relied more on indirect adjustment than ondirect control, with extensive application of monetary policy instruments such asinterest rate, reserve requirement and open market operations, while focus ofsupervision of commercial banks shifted from credit ceiling to a comprehensive set ofprudential ratios

(5) Remarkable progress was achieved in institutional innovation of the financialmarket Stock exchanges, inter-bank market and bills market began to operate

During the third stage from 1997 till now, the development of a buyer’s marketentailed adjustment and consolidation in the process of financial institution building.The main features were as follows:

(1) Transferring the non-performing assets of commercial banks to the newlyestablished AMCs;

(2) Improving the segregated financial supervisory system by establishingSecurities Regulatory Commission, Insurance Regulatory Commission and BankingRegulatory Commission, and replacing 32 provincial branches with nine regionalbranches of the central bank;

(3) Accelerating capital market development by improving its functions andexpanding market capitalization;

(4) Accelerating restructuring of the state-owned commercial banks and puttingproperty right reform on the agenda;

(5) Rectifying financial order to prevent financial risks;

(6) Stimulating domestic demand and combating deflation by implementing asound monetary policy;

(7) Expanding the scope of financial service and initiating consumer creditmarket; and

(8) The emergence of extensive cooperation among banking, insurance andsecurities industries has created the conditions for providing universal-bankingservices in the future

To sum up, China’s financial system reform in the past two decades has beencharacterized by institutional innovation, namely the change from planned financialsystem to market-oriented financial system and the change from one-tier bankingsystem to two-tier banking system

First, the direct policy instruments for macro-economic management has givenway to indirect to market instruments The central bank shifted its reliance on directcontrol of credit ceilings and currency issuance to market instruments such as reserverequirement, interest rate, central bank lending and open market operations in recentyears to adjust money supply During this process, the channel for base money supplyhas been evolving from through central bank lending to purchasing foreign assets andopen market operations

At the same time, the spectrum of institutions has become more diversified withthe establishment of 10 joint stock commercial banks, 100 city commercial banks,large number of urban credit cooperatives, trust and investment companies togetherwith finance companies, financial leasing companies and fund managementcompanies

F Role of the government, central bank and international financial institution in institution building

1 Role of the government

As an indispensable part of the financial system, supervision and regulation of thegovernment have strong influence on the behavior of microeconomic entities Aiming

at mitigating risk and encouraging competition, the supervisory authorities adjustfinancial framework and promulgate supervisory regulations The regulations mayhave impediments on banks’ activities However, banks may also initiate some newfinancial activities in order to enhance their profitability Also they may create somenew operating models, such as new organizational structure or new financial products,which go beyond the existing supervision boundary Nevertheless, the authorities mayregard these initiatives as evasion of financial supervision and therefore, work outnew regulatory measures to follow such development

Nonetheless, a neutral solution would be finally found to balance the cost andbenefits for various sides as the pressures increasingly mount on the authorities.Lastly, financial innovation and the economic environment tend to be mutually re-enforcing

When reviewing the whole process of financial restructuring in China, it is notdifficult to find the pervasive role played by the government Intervention by thegovernment in different ways and of different purposes has different effect on thearrangement of reform An exogenous intervention of the authorities on the financialindustry would cultivate the exogenous features of the institutional reform, whichwould constitute external pressure on the financial institutions Therefore, such areform would be less forceful in improving microeconomic performance

2 Role of the central bank

The central bank has played a role of policy designing and implementation in theprocess of institution building in the financial sector The promulgation of The CentralBank Law in March 1995 has legally confirmed the status and responsibility of thePeople’s Bank of China (PBC) as the central bank With dual responsibilities onmonetary policy and financial supervision, the PBC has designed and implemented aserious of financial reform programs under the leadership of the State Council andwith collaboration of relevant government ministries In the process of designingreform programs, the PBC has learnt from valuable experiences of the developedeconomies and followed the principles of market economy at the same time

For instance, after learning from experiences of several countries, theorganization of the PBC has undergone a break-through reform in 1998, with therestructuring of 32 provisional branches into 9 regional branches By doing so, thePBC has accomplished a historical transition in its administrative regime by replacingits provincial branch network with regional branches set up in accordance withregional economic development As a result, the independence of the central bank inimplementing monetary policy and financial supervision has been strengthened While learning experiences from other countries in the restructuring process, thePBC has never neglected the specific situation in China For instance, China has

enjoyed strong balance of payments position after achieving current accountconvertibility of the Chinese currency in December 1996, resulting in a stableexchange rate and a sustained growth of its foreign exchange reserves.

As international experience shows, capital account convertibility requires stablemacroeconomic environment, a healthy financial system, effective financialsupervisory framework and enduring national strength

While some emerging economies in Asia such as Thailand, Malaysia and Koreahave abolished control on capital account transactions and realized full convertibility

of their currencies; China still sticks to the ‘gradualism approach’ in promoting capitalaccount convertibility The existing deficiencies in the economic fundamentals call forprudent liberalization

It was such an arrangement that has put China in a better position to confront thechallenge arising from the Asian Financial Crises At the same time, we havesuccessfully prevented the negative impact of the confidence crisis on Chineseeconomy and competitive currency depreciation, which have in turn contributed to thefinancial stability not only in Asia but also in the whole world

3 Role of the international financial institutions ( IFIs )

The IFIs have played an active role in financial restructuring in China byintroducing international standards and good practice and providing policy advice andpersonnel training in specific areas For instance, China has established its externaldebt surveillance system with the assistance of the Bank for International Settlements.Also, technical assistance from the World Bank has contributed to the establishmentand application of the five-category loan classification system in Chinese bankingindustry Actually, all domestic commercial banks adopted the five-category loanclassification system in early 2002 The idea of setting-up four AMCs to dispose jofnon-performing loans of the state-owned banks and the practice thereafter have alsobenefited from technical assistance of the World Bank

China has taken active measures to increase its transparency and meet relevantinternational standards and guidance since its WTO accession Efforts have beenmade to further increase the transparency of macroeconomic statistics, fiscal policy,monetary policy, banking information disclosure, as well as the securities andinsurance industries New improvements have been made in promotion of goodgovernance structure as well as implementation of international accounting standards

In general, these measures have gained wide international acclaim

G The role of new technology in institution building

With fast development of modern information technology and financialengineering in recent years, the tendency of providing financial services through theInternet has become increasingly clear Though threat from e-commerce on thetraditional commercial services have been somewhat limited due to inconvenience ofgoods distribution, challenges of on-line financial services to the traditional bankingservices would go beyond any technical barriers, because the nature of on-linefinancial service is the processing of information

The fast development of the Internet technology has influenced substantially theeconomic and financial behavior, and it indicates the arrival of the era of competitionfor on-line financial transactions, and it may also bring about a huge shock to thetraditional business of the financial industry Foreign banks stationed in China will benational treatment of foreign banks are being phased in line with China’s WTOcommitment, and the original geographic and customer restrictions on foreign banksregarding their foreign exchange and RMB business will also be phased out.

With strong portfolio and rich experience, foreign banks could expand quicklytheir market shares through on-line banking and overcome their limited businessnetwork and outlets On the contrary, the original strength possessed by domesticbanks in terms of geographic distribution would be weakened, which may havenegative impact on domestic banks

At the moment, corresponding regulations on on-line banking service are yet to

be put in place, the same situation may also apply to those regulations regarding thesecurity certification system as well as the modernized payment system We haverealized that a considerable gap does exist between China and the developed countrieseither in the area of information technology and quality control on credit assets or infinancial risk prevention

In light of this situation, commercial banks in China need to strengthendevelopment of information technology by cooperating with each other andmobilizing the best resources among themselves, so as to reduce the cost ofmanagement and business development

By large, domestic financial institutions should not only focus their attention oninnovation of financial products, but also make due efforts in the application ofinformation technology, in exploring on-line banking business as well as in promotingnon-bank financial institutions Efforts should be made in upgrading financialoperations and financial services, and in conducting systematic study on bankingbusiness development, its security system, risk prevention as well as supervision.Formulation of relevant policy and regulations should aim to promote healthydevelopment of on-line banking services in China

The substantial changes in financial system and technology mentioned abovehave posted great challenges to China’s financial and supervisory system Fromtechnical point of view, non-bank financial institutions or even non-financialinstitutions are able to evade supervisions due to swift development of on-linefinancial services Therefore, either opening of financial markets or development ofinternet-based financial services will constitute big challenges to both the monetaryauthority and the financial supervisory authorities

III Institution Building of the Chinese Bond Market

A Current stage of the Chinese bond market

Prior to 1997, China’s bond market mainly comprised exchange-based bondtransactions and over-the-counter (OTC) transactions of bearer’s treasury bonds atbanks Due to the different trading terms issued in these two markets, transactionsbetween them could not be fulfilled Volatility of the stock markets has significant

negative implications for the price of government bonds traded on the stockexchanges.

In accordance with the request from the central bank in 1997, commercial banksretreated from the exchanges The government bonds entrusted by the commercialbanks at the exchanges were transferred completely to China Government SecuritiesDepository Trust & Clearing Co (CGSDTC), and the outright and repurchasetransactions of securities were executed by using government bonds, central bank’sfinancial bills and policy financial bonds China’s bond market has been reshaped toconsist of inter-bank market, exchange market and an OTC market The features ofthe markets are as follows:

1 Inter-bank bond market

The inter-bank bond market is also an OTC market where the institutionalinvestors trade bonds on a wholesale basis A majority of book-entry treasury bondsand all policy financial bonds are issued and traded on this market The trading ininter-bank market is quote driven and executed case by case at negotiated price Thetrade of inter-bank bond market relies on the securities booking system of the

system of the national inter-bank lending centre provides pricing information, settlethe bond transaction and handle the bond registration and settlement through theCGSDTC As of end-June, 2003, the outstanding balance of bonds traded in inter-bank market was RMB2740 billion yuan, in which RMB1480 billion yuan weretreasury bonds, RMB1030 billion yuan were policy financial bonds, and RMB240billion yuan were central bank bills

2 Bond Exchange market

The exchange market is the marketplace where both institutional and individualinvestors’ trade bonds Trading on exchanges is order-driven, and executed atmatched price Bonds listed on the exchange include treasury bonds, corporate bondsand convertible bonds As of end-June, 2003, the outstanding balance of bonds traded

at exchanges was RMB363.5 billion yuan, in which RMB330.8 billion yuan weretreasury bonds, and RMB32.7 billion yuan were corporate bonds

3 OTC market

The OTC market comprises two segments One is for the Ministry of Finance toissue bearer treasury bonds to individuals and enterprises The other is both for theMinistry of Finance to issue and for individuals and enterprises to trade book-entrytreasury bonds In the case of the latter, commercial banks trade with investors at theprices they offer through their outlets, and provide depositing and clearing services tothe investors

B Roles of the government and the central bank in bond market development

The government and the central bank played significant roles in establishing anddeveloping bond market in China

Since 1998, inter-bank bond market has become the major bond market in China.China’s government and the central bank played important roles in facilitating

development of this market and construction of the market mechanism by adoptingeffective measures.

First, the central bank acted as the designer and promoter of the OTC market inChina The inter-bank bond market was actually organized and established by thecentral bank Marco-economic policy measures taken by the government since 1997have also contributed to the rapid development of the inter-bank market In April

1998, in order to support the reform on commercial bank’s required reserves; theMinistry of Finance (MOF) issued RMB270 billion yuan of book entry treasury bonds

to the state-owned commercial banks, and RMB42.3 billion yuan special treasurybonds to other commercial banks Since 1998, while Chinese government adoptedproactive fiscal policy to boost domestic demand, the MOF and policy banks haveissued large amount of treasury bonds and policy financial bonds, which resulted insubstantial increase of outstanding bond balance in the inter-bank market Since 1998,the central bank has gradually relied its monetary policy operations mainly on openmarket operations (OMOs), while at the same time the inter-bank market has becomethe major market place for the OMOs and its liquidity has seen continuous increase.Second, the central bank encouraged market-based bond issuance, drawing ongood international practice Before 1998, treasury bonds were mainly issued in theform of bearer certificate and purchased by all types of investors, while policyfinancial bonds were issued by compulsory allocation Those issuance practicesundermined financial institution’s asset management capability and also harmedoperation and development of the inter-bank market In 1998, the central bankpromoted the market-based bond issuance of policy financial bonds and finally madepossible the bidding-based issuance of treasury bonds in 1999

Moreover, the central bank has made continuous efforts to enhance theconstruction of market infrastructure Under the instruction of the central bank, theCGSDTC developed and improved the bond depository and clearing system,strengthening risk prevention capability of the market The central bank also guidedChina inter-bank funding center and the CGSDTC to computerize their tradingsystem, centralized book-entry system, bond issuance system and OMOs system, andupgrade these systems in accordance with the changing market demands from time totime It organized the CGSDTC and commercial banks to develop the second-tierdepository system supporting transactions of book-entry treasury bonds throughoutlets of commercial banks, establishing a mechanism for depositors, traders andclearing clients to supervise each other, which ensured the sound operation of thebond market

C Positive implications of bond market development

Development of bond market in China provided important market conditions andmarket mechanism for macroeconomic management and financial institutions’operations

First, it supported the implementation of proactive fiscal policy and facilitated theissuance of treasury bonds and policy financial bonds From 1998-2002, treasurybonds issued by the MOF totaled RMB2158.6 billion yuan, financial bonds issued bythe policy banks totaled RMB929 billion yuan The bond market has played animportant role in government’s efforts to boost domestic demand and stimulate

economic growth.

Second, bond market provided a solid foundation for the central bank to exerciseindirect financial management Since 1998, OMOs has become the most importantinstrument for the central bank’s day-to-day monetary policy operations As a matter

of fact, the effectiveness of OMOs depends on precise comprehension of centralbank’s policy stance by participants of the inter-bank market Thanks to marketparticipants’ sensitivity to its policy signals, the central bank is able to transmitmonetary policy through the inter-bank bond market on a timely basis, and thusensure the effectiveness of its policy Development of bond market is also conducive

to the advancement of the market-based interest rate reform After the establishment

of inter-bank bond market, repo rates were completely determined by both tradingparties, while the issuance rate was determined through public bidding The centralbank’s successful deregulation of interest rates in the inter-bank market has provideduseful experience for further steps of interest rate reform

In addition, bond market development also made financial institutions’ portfolioadjustment much easier Previously, China’s commercial banks had rather simplebalance sheets, which only consisted of loans on the asset side and deposits on theliability side Such a structure constituted a constraint on commercial banks’ businessdevelopment Along with the bond market development, such a simple structure wasessentially improved Bond holdings accounted for an increasing proportion ofcommercial banks’ total assets, which to some extent contained the rising riskoriginated from dominance of loans in the total assets and helped to improve the assetquality Besides, active trading on the bond market has facilitated the improvement ofcommercial banks’ liquidity management

D Blueprint for the construction of China’s bond market

In comparison with developed market economies, there is still much room forChina’s bond market development The advance of China’s economic and financialreform also entails the rapid development of bond market

With regard to the financing system, intermediate financing, particularlyfinancing through the banking system, still takes a dominant position, while directfinancing only accounts for a rather small portion Firms’ over-reliance onintermediate financing, mainly banking loans, has become one of the major problemsyet to be addressed

With regard to macro-economic management, bond market is the connectingpoint for monetary policy and fiscal policy Given that household savings andcorporate deposits still account for a significant component of overall financial assets,commercial banks will be the major buyer of treasury bonds and consequentlyimportant supporters of the proactive fiscal policy in the future While ensuring theissuance of treasury bonds to raise funds for capital replenishment, the central bankshould inject liquidity to the inter-bank bond market through OMOs and providesufficient funding sources for private investment, so as to avoid the “crowding out”effect of the fiscal policy

Additionally, coordination between policies for domestic currency and foreigncurrencies also entails the support of bond market development In the past several