Session 4a: China's Financial M Arket: Yu Liu Fudan University

Session 4a: China’s Financial M
arket
Yu Liu
Fudan University
SCHOOL OF ECONOMICS FUDAN

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Financial Markets
• China has a bank-based financial system.

• Bond and equity financing only account for about one-fifth of the total
credit to non-financial institutions.
• The financial sector is predominated by state-owned financial instituti
ons.

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Reading
Allen, Franklin, and Jun Qian. "China's financial system and the law." C
ornell Int'l LJ 47 (2014): 499.

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A Brief Review of the History of China’s Fin
ancial System
• China’s financial system was well developed before 1949.
• The development of China’s commerce and financial system as a whole was l
argely outside of the formal legal system.
• Most business-related disputes were resolved through mechanisms outside of
the courts, including guilds (merchant coalitions), families and local notables.
• Between 1950 and 1978, China’s financial system consisted of a single bank -
the People’s Bank of China (PBOC), which is controlled by the Ministry of Fi
nance.
• The PBOC used both a “cash-plan” and a “credit-plan” to control the cash flo
ws in consumer markets and transfer flows between branches.

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ancial System
• During 1978-2984, the PBOC dissociated itself from the Ministry and
became a separate entity (central bank), while state-owned banks took
over some of its commercial banking businesses.
• Bank of China (BOC): foreign trade and investment
• People’s Construction Bank of China (PCBC): fixed investment in manufactur
ing
• Agricultural Bank of China (ABC): business in rural areas
• Industrial and Commercial Bank of China (ICBC): commercial transactions

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ancial System
• During most of the 1980s
• Fast growth of financial intermediaries outside of the “Big Four” banks
• Regional banks were formed in the Special Economic Zones
• Rural Credit Cooperatives (RCCs) were established under the supervision of t
he ABC
• Urban Credit Cooperatives (UCCs) were founded in the urban areas
• Trust and Investment Corporations (TICs) emerged and proliferated

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ancial System
• In the 1990s
• China established the two stock markets (SHSE and SZSE)
• The real estate market paralleled the stock market
• Institutional investors started to emerge in the late 1990s
• In 2003, a few Qualified Foreign Institutional Investors (QFII) entered China’s asset m
anagement industry, operating through forming joint ventures with Chinese companies.
• In 2006, Qualified Domestic Institutional Investors
• Invest in overseas markets
• In 2011, China approved the RMB Qualified Foreign Institutional Investors (RQFII)
• Invest in Chinese stock and bond markets within a predetermined limit

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Bank Size
Tier 1 capital refers to equity capital and In 2007, there were 31 Chinese banks in the global top 1,000
disclosed reserves. It is used to measure the banks. The number increased to 143 in 2020. （ U.S. has
bank's capital adequacy. 184 in 2020.)
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Banks
• Up till February 9, 2018, there are 4,549 banks in China. (As a comparis
on, there are 4,983 banks in the U.S.)
• 1 developmental agency: China Development Bank
• 2 policy banks: The Export-Import Bank of China; Agricultural Development Bank of China.
• 5 state-owned banks: ICBC, CCB, ABC, BOC, BOCOM
• 1 Postal Savings Bank of China (PSBC), or 中国邮政储蓄银行
• 12 Shareholding Commercial Banks
• 4 Asset Management Companies (AMCs)
• 134 Municipal Commercial Banks
• 17 Private Banks
• 1,262 Rural Commercial Banks; 965 Rural Credit Cooperatives; 1,562 Village and Township Ba
nks
• 68 Trusts
• … SCHOOL OF ECONOMICS FUDAN
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Law supporting China’s Financial System
• Legal framework and institutions have been lagging behind that of the
markets
• First bankruptcy law governing SOEs (passed in 1986)
• First company law (became effective in 1999)
• New bankruptcy law (enacted in 2006)

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Structure Indices compare the relative importance of financial markets versus banks, with a lower score
indicating that banks are more important relative to markets.
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Interest-bearing “savings deposits” are by far the most important form of deposits in China,
providing a good source for bank loans and other forms of investment.
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As in other Asian countries, China’s
household savings rates have been
high throughout the reform era.
1. Residents (largest)
2. Enterprises (second largest)

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Although the largest four or five banks (the fifth largest bank is the Bank of
Communications, also state-owned) dominate in every aspect of the banking sector
during the period of 2001– 2012, the role of other banks in the entire banking sector
cannot be ignored.

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Due to the strong demand of
capital by the real economy,
shadow banking— which
includes trust loans, entrusted
loans, loans by small-scale
lending companies, corporate
bonds, and informal finances,
etc.— has been growing rapidly
since 2009.

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Overview of the Stock Market
In the long run, SHSE and SZSE have not done so well. By the end of 2013 it was at about the same level in real
terms as at the start of 1992. The high turnover rate suggests that there is a large amount of speculative trading
especially among small- and medium-cap stocks in the Chinese markets, as these stocks are more easily manipulated
than large cap stocks.
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Overview of the Stock Market
• Despite rapid recent development in China’s stock market, there is evi
dence that the market is still not efficient because prices and investor b
ehavior are not necessarily driven by the fundamental values of listed f
irms.
• Morck et al. find that stock prices are more “synchronous” in the sense
that stock prices move up and down together in emerging countries lik
e China than in developed countries.
• Insider trading; Poor and Ineffective regulation

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Reforms in the Listed Sector
In 2006-2007, China implemented a share

reform ( 股权分置改革 )

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Corporate Governance
• According to the 2005 Company Law, listed firms in China have a tw
o-tier board structure.
• Board of Directors (5-19 members)
• Board of Supervisors (>=3 members): directors and top managers cannot hold
positions as supervisors; representatives of employees must account for at leas
t one third of the board; shareholders, government officials, executives from p
arent companies

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Registration-based IPO system
• In the upcoming year, China will reform its stock market to adopt a co
mprehensive registration-based IPO system
• Shorten the average time between IPO application and registration
• Improve information disclosure system, issuance and underwriting mechanism
s, and delisting channels

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PE/VC
• Allen and Gale (1999, 2000) have suggested that stock market-based e
conomies, such as the U.K. in the 19th century and the U.S. in the 20th
century, have been more successful in developing new industries than i
ntermediary-based economies such as Germany and Japan.
• They argue that markets are better than banks for funding new industri
es, because evaluation of these industries based on experience is diffic
ult, and there is wide diversity of opinion.

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PE/VC
• Stock market-based economies such as the U.S. and U.K. also tend to
have well-developed systems for the acquisition and distribution of inf
ormation, so the cost of information to investors is low.
• A key part of this process is the private equity and venture capital sect
or.
• the existence of an active IPO market is the critical determinant of the importa
nce of venture capital in a country

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Overview of the Bond Market
• Government bond: an annual growth rate of 22.2% during 1990-2012 i
n terms of newly issued bonds.
• Policy financial bonds: the proceeds of bond issuance are invested in g

overnment-run projects and industries.
• Corporate bond: the market is relatively small but has been growing q
uickly in recent years, but still it is the most under-developed compone
nt of China’s financial markets. (Common among Asian countries)
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Standardizing Debt Assets
The commercial draft is a short-term issuance by a bank that guarantees payment at a later time. A firm can use
these drafts to leverage (e.g., pay a deposit of 20% to borrow 100%, which can be cashed in 6 months.

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Session 4b: The Rise of Shadow
Banking
Yu Liu
Fudan University

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Reading
Chen, Zhuo, Zhiguo He, and Chun Liu. "The financing of local
government in China: Stimulus loan wanes and shadow banking w
axes." Journal of Financial Economics 137.1 (2020): 42-71.

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Trust/entrusted Loans and Wealth
Management Products (WMP)

Data source: PBOC and China Banking Wealth Management Registration System UNIVERSITY
New bank loan & GDP
New Bank Loan as a Percentage of 2004 GDP
55.0% 50.0
50.0%
45.0
45.0%
40.0
New Bank Loan/GDP
40.0%
35.0% 35.0
GDP
30.0% 30.0
25.0%
25.0
20.0%
20.0
15.0%
10.0% 15.0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
New Bank Loan/2004 GDP GDP (2004 trillion RMB)
Data source: PBOC and National Bureau of Statistics UNIVERSITY
US-China bond markets
Panel A: 2008-2017 Outstanding Bond Balance in China (in Trillions RMB)
80 Bond/GDP~85%
70
60
50
40
30
20
10
0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
GovernmentOutstanding
Panel B: 2008-2017 Bonds Financial
Bond Bonds Corporate
Balance in US Bonds
(in Trillions $)
35 Bond/GDP~200%
30
25
20
15
10
0
2008 2009 2010 2011 2012 2013 2014 2015
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2016
OF ECONOMICS FUDAN
2017
Government Bonds Financial Bonds Corporate Bonds UNIVERSITY

Summary
CHINA’S LOCAL GOVERNMENT DEBT SHIFTS FROM BANK LOANS IN
2009 TO A SIGNIFICANT FRACTION OF NON-BANK DEBT STARTING
2012
THIS PAPER: THE REAL FORCE BEHIND THE UPSURGE OF SHADOW

BANKING
A universal economic phenomenon/mechanism
WHY DO SHADOW BANKING ACTIVITIES IN CHINA START RAMPANT

GROWTH AROUND 2012-13?
Hangover effect of 2009 stimulus
Time series and cross-section evidence on local government financing and municipal
corporate bonds ( 城投债 )
An angle that helps understand the marketization process of Chinese financial system
starting 2012
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Four-Trillion Stimulus Plan and its financing
FOUR-TRILLION STIMULUS PLAN ( 四万亿刺

激计划 )
 Following 2007/08 global crisis, Premier Wen announced the 4T RMB
stimulus plan on Nov 2008
 Domestic investment (mainly infrastructure) to boost GDP growth
HOW WAS IT IMPLEMENTED AND FINANCED?

 Mostly through local governments (Bai, Hsieh and Song, 2016, Brookings)
 1 trillion from Beijing; the rest through LGFV (Local Government
Financing Vehicles, 政府融资平台 )
 Mostly in the form of bank loans (90% commercial bank loans and 10%
policy bank loans) SCHOOL OF ECONOMICS FUDAN
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Four-Trillion Stimulus Plan and its financing
Transfer of 1
Trillion RMB
Beijing,
central govt Local Government
1994
Budget law Equity holder, by
injecting land
Commercial Local Government

Banking system Financing Vehicle
Loans of 2.7 (Local State-Owned
Trillion RMB Enterprises)
Households
deposits
Loans of 0.3
Policy Trillion RMB
Banks
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Shifting of local government financing (1)
 IN 2010 CHINA REVERTED BACK TO ITS

NORMAL CREDIT POLICY…
 2009 STIMULUS LOAN HANGOVER EFFECT

 Need to rollover/refinance their three- to five-year bank loans
(which are maturing around 2012 to 2014)
 Long-term infrastructure projects need continuing investment
 LGFVS TURN TO NON-BANK SOURCES

 What are they?

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Shifting of local government financing (2)
 FOUR MAJOR DEBT LIABILITIES

 Bank Loans
 Municipal Bonds ( 地方政府债 : pre-2015, issued directly by MoF for qualified local
government; post-2015, issued by local government at the province level )
 Municipal Corporate Bonds ( 城投债 , our focus)
 Corporate bonds issued by LGFVs
 Trust and Entrusted Loans ( 信托贷款和委托贷款 )
 OTHER THREE ARE NON-BANK DEBT; OFTEN WITH IMPLICIT

BAIL-OUT EXPECTATION
 NATIONAL AUDIT OFFICE REPORTS ON LOCAL GOVERNMENT

DEBT, ON DEC 2010 AND JUNE 2013
 Worked hard filling out the rest
 Bank loan wanes, non-bank debt waxes
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Composition change of bank and non-bank debt
financing
Composition of local government debt balance, percentage
100% Bank Loan
Munibond+MCB+Tru
NAO
st
80% MCB
60% NAO
Percentage (%)
40%
20%
0%
1 1 1 0 1 0 1 1 1 1
2 /3 2 /3 2 /3 2 /3 2 /3 6 /3 2 /3 2 /3 2 /3 2 /3
/1 /1 /1 /1 /1 3/ 3/
1
4/
1
5/
1
6/
1
0 8 0 9 1 0 1 1 1 2
2 0 1 1 1 1 1 SCHOOL OF ECONOMICS FUDAN
20 20 20 20 20 20 20 20 20
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Municipal corporate Bond （ MCB, 城投
债）
Newly Issued Municipal Corporate Bonds (MCB)
30.0% 3.5%
25.0% 3.0%
2.5%
New Bank Loan/GDP
20.0%
New MCB/GDP
2.0%
15.0%
1.5%
10.0%
1.0%
5.0% 0.5%
0.0% 0.0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Bankloan/GDP MCB_all/GDP MCB_net/GDP
Data source: PBOC and Wind UNIVERSITY
Cross-sectional analyses: Evidence from MCB
 CORE IDEA
 Areas/provinces with more bank-loan-fueled stimulus in 2009
should have more shadow banking in 2012-2015
 Matters little whether driven by LGFVs (demand) or banks
(supply) in 2009
 Though, we use “late-term officials” as IV (demand shifter) to address
other endogeneity concerns
 WE FOCUS ON MUNICIPAL CORPORATE BONDS

 It is more than data availability issue; source of fund versus use
of fund
 For MCB, we know where the funds go to
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Preliminary Evidence
 ECONOMIC VARIABLES
 Abnormal 2009 Bank loan over GDP at the province level
 (BL/GDP at 2009) – (Average BL/GDP 2004~08)
 Abnormal 201t MCB over GDP for each province over 2012-
2015
 (MCB/GDP at 201t) – (Average MCB/GDP 2004~08)
 WE ALSO LOOK AT REGIONAL AND CITY LEVEL

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Provincial evidence for each year, 2012-2015

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Main empirical tests

 EMPIRICAL SPECIFICATION
 Province FE () and year FE (); from 2004 to 2015

 Time-varying impacts of 2009 abnormal BL on future MCB issuances
 Controls with flexible time coefficients: economic activity at 2007Q4-2008Q3
 Fiscal deficit over GDP, fixed asset investment over GDP; GDP growth, GDP per
capita
 Instrument variable: whether a provincial governor is “late term” (>2 years in
the position) as of 2009
 Stronger promotion incentive for “late-term” governor to react to the stimulus
 More familiar with the local environment, easier to implement the stimulus
 OTHER EVIDENCES
 The effect of longer-term CDB loans, city level results
 Control variables at the same year for omitted variables
 Real effects
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OLS result
• Throughout, standard errors clustered at province-year level SCHOOL OF ECONOMICS FUDAN

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IV result

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MCB issuance purposes
 81% of MCB prospectus reveal its purpose…. but self-reporting
Newly Issued Municipal Corporate Bonds (MCB) by Purposes

30.0% 1.4%
25.0% 1.2%
New Bank Loan/GDP
1.0%
20.0%
New MCB/GDP
0.8%
15.0%
0.6%
10.0%
0.4%
5.0% 0.2%
0.0% 0.0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
New Bank Loan/GDP New MCB_repay/GDP New MCB_inv/GDP
New MCB_other/GDP
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Estimation results
MCB MCB_repay MCB_inv
OLS 2SLS OLS 2SLS OLS 2SLS
2004 -0.007 0.006 -0.001 -0.001 -0.006 0.005
(0.017) (0.038) (0.005) (0.011) (0.009) (0.017)
2005 -0.006 0.006 -0.001 -0.001 -0.006 0.005
(0.017) (0.038) (0.005) (0.011) (0.009) (0.018)
2006 -0.009 0.005 -0.001 -0.001 -0.009 0.005
(0.016) (0.039) (0.005) (0.011) (0.008) (0.018)
2007 -0.001 0.010 -0.001 -0.001 0.003 0.017
(0.014) (0.034) (0.005) (0.011) (0.006) (0.014)
2009 0.036*** 0.093*** 0.002 0.001 0.030*** 0.079***
(0.005) (0.011) (0.004) (0.010) (0.007) (0.022)
2010 0.037** 0.126*** 0.009 0.019*** 0.022* 0.077***
(0.015) (0.027) (0.006) (0.007) (0.013) (0.030)
2011 0.075*** 0.181*** 0.015*** 0.047*** 0.041*** 0.060**
(0.018) (0.037) (0.003) (0.007) (0.007) (0.024)
2012 0.058 0.075 0.020 0.012 0.002 0.065
(0.066) (0.121) (0.019) (0.047) (0.053) (0.077)
2013 0.263*** 0.392* 0.091*** 0.120 0.098*** 0.162***
(0.091) (0.202) (0.034) (0.078) (0.030) (0.054)
2014 0.382** 0.694** 0.12** 0.201* 0.040 0.247***
(0.150) (0.302) (0.049) (0.114) (0.054) (0.087)
2015 0.37** 0.958*** 0.187*** 0.473*** -0.013 0.115
(0.172) (0.317) (0.058) (0.120) (0.057) (0.071)
Province FE Yes Yes Yes Yes Yes Yes
Year FE Yes Yes Yes Yes Yes Yes
Control*Year Yes Yes Yes Yes Yes Yes
Observations 360 360 360 360 360 360
First stage F 3.803 3.803 3.803
Adj R2 0.720 0.695 0.652 0.629 0.671 0.665

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Economic magnitude
 WHAT IS THE LOAN MATURITY IMPLIED BY

ESTIMATED COEFFICIENTS?
 IN AGGREGATE, EACH DOLLAR OF STIMULUS

LOAN NEEDS 1.57/4.7 = 33 CENTS OF REPAYMENT
MCB ISSUANCE
 RMB 4.7 trillion abnormal bank loans extended in 2009
 In total, RMB 1.57 trillion worth of MCB was issued to repay bank loans (the rest
is repaid by trust)
 CROSS-SECTIONAL REGRESSION, HOW MANY YEARS DO WE

NEED TO PAYBACK 33 CENTS?
 Just accumulating the estimated coefficients….
 The IV estimate implied stimulus loan maturity is 3.9 years
 Consistent with other sources (3-5 years in Kroeber, 2016; 4.1 years in Ru, 2018)
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Evidence from CDB Loan
 LOANS FROM CHINA DEVELOPMENT BANK HAVE LONGER
MATURITY
 CDB: policy bank, tends to give longer maturity loans (7.2 years in Ru, 2018)
 ROLLOVER MECHANISM IS CONCENTRATED IN IN LOW-CDB-

LOAN PROVINCES
 Dummy : whether the 2009 CDB loan fraction of a province i is below the median (max 74%, median
16%)
 PREDICTION
 which captures the effect on high CDB-loan province should be insignificant
 The coefficients in front of the interaction term have similar magnitude as the baseline without CDB
interactions
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Evidence from CDB Loan

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Evidence at city level
2004 -0.002 -0.001 0.000 0.000 -0.002 0.000
(0.004) (0.010) (0.000) (0.000) (0.001) (0.005)
2005 -0.001 0.000 0.000 0.000 -0.001 0.000
(0.004) (0.010) (0.000) (0.000) (0.002) (0.005)
2006 -0.002 0.000 0.000 0.000 -0.002 0.001
(0.004) (0.010) (0.000) (0.000) (0.001) (0.005)
2007 0.000 0.004 0.000 0.000 0.000 0.005
(0.004) (0.009) (0.000) (0.000) (0.001) (0.004)
2009 0.005* 0.032*** 0.000 0.000 0.005*** 0.028***
(0.003) (0.003) (0.001) (0.003) (0.002) (0.006)
2010 0.009*** 0.024*** 0.001 0.003 0.007*** 0.009
(0.002) (0.003) (0.001) (0.002) (0.002) (0.010)
2011 0.017*** 0.007 0.004*** 0.011*** 0.0101** -0.009
(0.002) (0.009) (0.001) (0.002) (0.005) (0.011)
2012 0.065** 0.084* 0.020** 0.034*** 0.028*** 0.026
(0.027) (0.046) (0.008) (0.012) (0.005) (0.026)
2013 0.065*** 0.111** 0.022** 0.047*** 0.014** 0.014
(0.017) (0.047) (0.009) (0.014) (0.006) (0.021)
2014 0.142*** 0.303*** 0.061*** 0.112*** 0.025*** 0.191***
(0.034) (0.088) (0.014) (0.033) (0.007) (0.025)
2015 0.091** 0.341*** 0.070*** 0.176*** 0.010*** 0.078***
(0.038) (0.083) (0.012) (0.035) (0.004) (0.018)
City FE Yes Yes Yes Yes Yes Yes
Control*Year Yes Yes Yes Yes Yes Yes
Observations 3,900 3,648 3,900 3,648 3,900 3,648
First-stage 5.426 5.426 5.426
effective F
Adj R2 0.394 0.357 0.346 0.273 0.235 0.235

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Real effects: Investment

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Link to Shadow banking
Local Government Non-Bank Debt over Shadow Banking
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
2008-12- 2009-12- 2010-12- 2011-12- 2012-12- 2013-12- 2014-12- 2015-12- 2016-12-
31 31 31 31 31 31 31 31 31

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Link to shadow banking: entrusted loan growth
Entrusted Loan/GDP_2009 on 2009 Abnormal Bank Loan/GDP
2013 EL/GDP_2009 2014 EL/GDP_2009 2015 EL/GDP_2009
2009 BL/GDP 0.294* 0.473 0.468*** 0.363 -0.0756 0.326
(1.876) (1.436) (2.953) (0.697) (-0.282) (0.856)
Control Yes Yes Yes Yes Yes Yes
Observations 30 30 30 30 30 30
Adj. R2 0.256 0.220 　 0.293 0.284 　 0.219 0.109
• Unfortunately, province-level EL data are only available after 2013
• In 2015, tightening regulation on Trust/Entrusted business in China
Placebo: Abnormal Bank Loan/GDP_2009 on 2009 Abnormal Bank Loan/GDP
2013 Abnormal BL/GDP 2014 Abnormal BL/GDP 2015 Abnormal BL/GDP
2009 BL/GDP -0.0809 -0.338 -0.152 -0.133 -0.284 -0.851
(-0.400) (-0.798) (-0.626) (-0.257) (-0.655) (-1.093)
Observations 30 30 30 30 30
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Adj. R2 0.565 0.553 　 0.644 0.644 　 0.486 0.460
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Link to Shadow banking: Wealth Management Product
7.0
6.0
5.0
61.5%, 4.19
Trillion RMB
4.0
3.0
42.5%, 2.21
38.9%, 1.57
2.0
1.0
0.0
2014/12/31 2015/12/31 2016/12/31
AAA by WMP AA+ by WMP AA by WMP
≤AA- by WMP Total MCB
 Based on annual official reports on WMP; likely underestimate as unclear whether
including certain financial innovation funded through WMP SCHOOL OF ECONOMICS FUDAN
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US Experience in National banking era
 CHINA’S SHADOW BANKING IN TODAY HAS STRIKING
SIMILARITY WITH THE US HISTORY
 NATIONAL BANKING ERA (1863-1912) IN US

 Started with the passage of national banking act (1864) which ended the “free
banking era”
 Tightly regulated nationally chartered banks, segmented
 Frequent banking panics, especially the 1907 panic triggered by a run on Trust
companies, led to Fed as the Central Bank in US
 ECONOMIC BACKGROUND
 Industrial revolution in the Northeast to the settlement of the West; railroad
construction in US is like infrastructure in China today
 A new industry craving for financing, but national banks cannot
 REGULATORY ARBITRAGE (LIKE IN CHINA)

 States in the west started imposing less restrictive regulations, so-called state banks
 Trust companies, which are state-chartered financial institutions SCHOOL OF ECONOMICS FUDAN
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Trust companies in US history
 TRUST COMPANIES ACCORDING TO CAROSSO (1970, P. 99)

Incorporated under liberal state laws, trust companies quickly
extended their activities far beyond those usually associated with
the services of a fiduciary institution. Beginning in the 1890s, trust
companies took on most of the functions of both commercial and
private banks. They accepted deposits; made loans; participated
extensively in reorganizing railroads and consolidating industrial
corporations; acted as trustees, underwriters, and distributors of
new securities; and served as depositories of stocks, bonds, and
titles ..... Very often they also owned and managed real estate.
 THIS IS ESSENTIALLY WHAT CHINA’S TRUST COMPANIES DO

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What do we learn?
NEAL (1971): TRUST COMPANIES IN US HISTORY
 Invested in new industrial securities on the asset side, and issued
deposit to expand the money supply
 Helped establish a financial market to feed real economy
 Form “money trust” with other dominating commercial banks at that
time
IN CHINA, SHADOW BANKING

 Supports infrastructure, real estate, and private firms while generating a
savings vehicle (WMP) for Chinese households
 Accelerates the growth of Chinese corporate bond market at an
astonishing speed (Amsted and He, 2018)
 Relies on the retail network of existing banking branch system; “the
shadow of banks” SCHOOL OF ECONOMICS FUDAN
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Development of the corporate bond market in China

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Conclusion
 A MECHANISM THAT PUTS TOGETHER RECENT VARIOUS ASPECTS OF
CHINA’S FINANCIAL MARKET
 Local government debt; shadow banking; interest rate liberalization
 SHADOW BANKING: UNINTENDED CONSEQUENCE OF FOUR-

TRILLION STIMULUS PLAN
 Good? bad?
 Popular view: hidden risk and leverage, so bad
 BUT IT FOSTERS THE MODERNIZATION OF CHINA’S FINANCIAL

MARKETS
 “Let market be decisive;” interest rate liberalization and deposit insurance
 Rocket-speed of the growth of interbank market in China; less reliance on commercial banks;
richer set of investment products
 Chen, Chen, He, Liu, and Xie (2019) on pledgeability effect
 Households get the return they ought to get (not just house price appreciation)

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HALF OF 2009 ABNORMAL BANK LOANS GO TO LGFV

Data source: Authors’ estimate and Gao et al. (2018)
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PANEL REGRESSIONS WITH SIMULTANEOUS CONTROLS
2004 -0.001 -0.038 0.014 0.013 -0.019*** -0.045*
(0.026) (0.061) (0.011) (0.019) (0.006) (0.023)
2005 0.024 -0.003 0.0194* 0.018 -0.006 -0.027
(0.022) (0.053) (0.010) (0.017) (0.007) (0.021)
2006 0.008 -0.014 0.014 0.012 -0.013** -0.029**
(0.019) (0.039) (0.009) (0.012) (0.005) (0.015)
2007 0.004 -0.005 0.006 0.007 -0.005 -0.014
(0.016) (0.039) (0.007) (0.011) (0.008) (0.018)
2009 -0.006 -0.002 -0.008 -0.008 0.001 -0.007
(0.025) (0.060) (0.009) (0.019) (0.013) (0.027)
2010 -0.039 -0.014 -0.019 -0.023 -0.011 0.004
(0.053) (0.098) (0.022) (0.041) (0.020) (0.038)
2011 0.012 0.040 -0.005 0.002 0.003 -0.009
(0.066) (0.126) (0.030) (0.056) (0.019) (0.039)
2012 0.112 0.284 0.032 0.076 -0.013 0.014
(0.097) (0.177) (0.027) (0.064) (0.033) (0.056)
2013 0.187** 0.191* 0.089*** 0.123** 0.047** 0.019
(0.078) (0.104) (0.031) (0.059) (0.021) (0.034)
2014 0.359*** 0.454*** 0.143*** 0.213*** 0.048 0.133**
(0.101) (0.137) (0.040) (0.075) (0.032) (0.057)
2015 0.252** 0.269 0.134*** 0.139** -0.013 0.044
(0.128) (0.169) (0.052) (0.060) (0.031) (0.043)
Observations 360 360 360 360 360 360
Adj R2 0.743 0.721 0.660 0.635 0.673SCHOOL OF ECONOMICS FUDAN
0.680
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EVIDENCE FROM CDB LOAN
 CDB is a policy bank and thus usually its loan has longer maturity
 Less rollover pressure for provinces with more CDB LGFV loan received in 2009
Low CDB*2004 -0.002 0.007 -0.001 -0.001 -0.002 0.007
(0.015) (0.069) (0.006) (0.020) (0.011) (0.035)
Low CDB*2005 -0.002 0.008 -0.001 -0.001 -0.002 0.009
(0.016) (0.069) (0.006) (0.020) (0.011) (0.035)
Low CDB*2006 -0.003 0.007 -0.001 -0.001 -0.003 0.007
(0.016) (0.069) (0.006) (0.020) (0.011) (0.034)
Low CDB*2007 0.002 0.005 -0.001 -0.001 0.005 0.011
(0.016) (0.072) (0.006) (0.020) (0.011) (0.034)
Low CDB*2009 0.086*** 0.128*** 0.008 0.010 0.065*** 0.101**
(0.017) (0.032) (0.006) (0.016) (0.015) (0.034)
Low CDB*2010 0.099*** 0.204*** 0.020*** 0.025 0.061*** 0.150***
(0.024) (0.045) (0.007) (0.018) (0.018) (0.039)
Low CDB*2011 0.118*** 0.224*** 0.028*** 0.058*** 0.060*** 0.080**
(0.033) (0.058) (0.007) (0.016) (0.018) (0.036)
Low CDB*2012 0.408*** 0.255 0.090 -0.067 0.216*** 0.150
(0.142) (0.382) (0.064) (0.156) (0.075) (0.145)
Low CDB*2013 0.639*** 0.612 0.180*** 0.082 0.274*** 0.205
(0.146) (0.380) (0.066) (0.155) (0.073) (0.139)
Low CDB*2014 0.858*** 1.064** 0.225*** 0.175 0.256*** 0.251
(0.156) (0.456) (0.074) (0.182) (0.078) (0.157)
Low CDB*2015 0.994*** 1.326*** 0.382*** 0.503*** 0.212*** 0.134
(0.154) (0.463) (0.069) (0.172) (0.071) (0.146)
2004-2007 -0.004 -0.003 0.000 -0.001 -0.004 -0.003
(0.013) (0.079) (0.005) (0.024) (0.011) (0.035)
2009-2011 -0.024 -0.038 -0.005 -0.005 -0.014 -0.031
(0.016) (0.034) (0.005) (0.017) (0.015) (0.039)
2012-2015 -0.281** -0.154 -0.065 0.085 -0.146* -0.022
(0.138) (0.454) (0.063) (0.191) (0.075) (0.143)
Low CDB*Year Yes Yes Yes Yes Yes Yes
Control*Year
Observations
Yes
360
Yes
360

Yes
360
Yes
360

Yes
360
Yes
360
Adj R2 0.810 0.725 0.730 0.664 0.711 0.655 UNIVERSITY
REAL EFFECTS OF STIMULUS LOANS
GDP per capita/GDP per capita_2009 FAI/GDP_2009
OLS 2SLS OLS 2SLS
2004 0.087 0.83*** 0.136 0.657
(0.169) (0.195) (0.223) (0.414)
2005 -0.015 0.357* 0.035 0.341
(0.169) (0.208) (0.249) (0.464)
2006 -0.049 0.200 -0.030 0.108
(0.191) (0.204) (0.226) (0.448)
2007 -0.007 0.345 -0.095 0.031
(0.108) (0.246) (0.190) (0.415)
2009 -0.088 0.454*** 0.444** -0.067
(0.057) (0.101) (0.199) (0.347)
2010 0.108 0.599*** 0.776*** 0.437
(0.081) (0.210) (0.227) (0.546)
2011 0.346*** 0.938** 0.817*** 0.040
(0.135) (0.435) (0.317) (0.886)
2012 0.394 1.67** 0.815* 0.164
(0.280) (0.722) (0.460) (1.155)
2013 0.393 2.725** 0.980 -0.205
(0.440) (1.208) (0.635) (1.507)
2014 0.379 3.892** 0.793 0.166
(0.624) (1.716) (0.778) (1.701)
2015 0.397 5.169*** 1.753** 4.596**
(0.724) (1.934) (0.862) (1.849)
Province FE Yes Yes Yes Yes
Year FE Yes Yes Yes Yes
Control*Year Yes Yes Yes Yes
Observations 360 360 360 360
Adj R2 0.979 0.982 0.970 0.970
FAI: fixed asset investment UNIVERSITY
Session 4c: Financial Risks
Yu Liu
Fudan University

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Reading
Song, Zheng (Michael), and Wei Xiong. “Risks in China’s Financial Sys
tem" Working paper, 2017.

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The debt-GDP ratio, which was
slightly above 1.2 in 2008, skyrocketed
to 2.1 in 2015. The high leverage is
associated with enormous appreciation
in housing prices. In 2003–2013,
housing prices in real terms grew at an
annual real rate of 13.1% in the first-tier
cities, 10.5% in the second-tier cities,
and 7.9% in the third-tier cities (Fang,
Gu, Xiong, and Zhou, 2015).
Source: Song and Xiong (2017). Note: The outstanding debt is backed out from
“social financing statistics” provided by NBS, which measures lending from the
financial sector to the non-financial sector (including bank loans, corporate bonds,
and trust and entrusted loans but excluding equity finance). SCHOOL OF ECONOMICS FUDAN
UNIVERSITY
Other concerns
• The 2015 stock market crash wiped out 3 trillion USD in share value. Despite the
government's rescue plan to buy more than one trillion RMB worth of shares, the
market has shown lackluster performance ever since.
• China accumulated almost 4 trillion USD in foreign reserves by 2014. Capital flig
ht has become a serious issue since then. Foreign reserves of 1 trillion USD were l
ost in 2015 and 2016.
• The net capital outflow amounted to 1.5 trillion USD in these two years.

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The investment rate increased to
unprecedented levels above 45%, while
the growth rate fell to 7%. Accordingly,
aggregate TFP growth and returns to
capital dropped dramatically (Bai and
Zhang, 2015).

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Revealing of the Retreat
• An important mission of China’s financial system—it was largely developed to su

pport the dual-track reform.
• China accumulated almost 4 trillion USD in foreign reserves by 2014. Capital flig
ht has become a serious issue since then. Foreign reserves of 1 trillion USD were l
ost in 2015 and 2016.
• The net capital outflow amounted to 1.5 trillion USD in these two years.

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Current Financial Conditions
• China saves about half of its GDP
• High household savings are unlike

ly to change in the near future
• Balance sheet of Chinese househol

ds remains solid (only 30% of ban
k loans are made to households)
• Firms also save a lot. The corpor

ate sector accounts for about hal
f of the nongovernment savings (Y
ang, Zhang, and Zhou, 2011).

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Total Debt-to-GDP ratios (280% in 2020)
For year 2020:
In terms of household debt/GDP ratio, China

(72.5%) surpassed Germany (54.56%) and
Japan (65.26%) and was on par with US
(78%).
In terms of Nonfinancial corporate debt/GDP

ratio, China (161.2%) surpassed all other major
countries. It includes the LGFV debts.
In terms of explicit government debt/GDP

ratio, China (45.7%) has a moderate number.

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Financial risks?
• Many are worried that China might follow in the footsteps of the U.S., which ex
perienced a severe financial crisis initially triggered by the reversal of a dramati
c housing boom in the mid-2000s.
• A debt crisis in the Western world occurs usually when the borrower and the len
ders cannot agree to a mutually acceptable scheme to avoid costly bankruptcy d
ue to all sorts of coordination and hold-up problems.
• This kind of coordination problem underlies the well-known bank-run problem
• As a typical debt contract gives the borrower a limited downside but all the upside, he has t
he natural incentive to seek risk. This conflict would again motivate the lenders to take on a
ll sorts of inefficient decisions to minimize risk, such as premature liquidation of a firm to p
reserve their stake in the firm, or constraining a troubled firm from taking on risky but pro
mising investments.

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Financial crisis are unlikely happening?
• First of all, the Chinese state controls a lot of resources through local governments, the banki
ng system, SOEs, and the connected private firms. Although SOEs remain less efficient than
private firms, the restructuring since the late 1990s has greatly improved the viability of the
state sector, which was on the verge of collapse back then. Some SOEs even became highly
profitable by establishing monopolistic positions in “strategic” industries.
• Second, Chinese households have high saving rates and low leverage levels. The economy r
uns a sizable trade surplus and does not have too much external debt. The financial sector is
dominated by state-owned commercial banks. These provide flexibility for the state to steer t
hrough difficult times.
• Third, the rising leverage is mostly from state-owned banks to local governments, SOEs, and
other connected private firms. This relationship makes it relatively easy for the state to resol
ve the coordination problem between creditors, as well as any externality in restructuring de
bt.
UNIVERSITY
Discussion
Share your thoughts about the financial risks in China?

UNIVERSITY

Session 4a: China's Financial M Arket: Yu Liu Fudan University

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Session 4a: China’s Financial M

SCHOOL OF ECONOMICS FUDAN

• China has a bank-based financial system.

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In 2006-2007, China implemented a share

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• Policy financial bonds: the proceeds of bond issuance are invested in g

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Government Bonds Financial Bonds Corporate Bonds UNIVERSITY

THIS PAPER: THE REAL FORCE BEHIND THE UPSURGE OF SHADOW

WHY DO SHADOW BANKING ACTIVITIES IN CHINA START RAMPANT

FOUR-TRILLION STIMULUS PLAN ( 四万亿刺

HOW WAS IT IMPLEMENTED AND FINANCED?

Commercial Local Government

 IN 2010 CHINA REVERTED BACK TO ITS

 2009 STIMULUS LOAN HANGOVER EFFECT

 LGFVS TURN TO NON-BANK SOURCES

SCHOOL OF ECONOMICS FUDAN

 FOUR MAJOR DEBT LIABILITIES

 OTHER THREE ARE NON-BANK DEBT; OFTEN WITH IMPLICIT

 NATIONAL AUDIT OFFICE REPORTS ON LOCAL GOVERNMENT

 WE FOCUS ON MUNICIPAL CORPORATE BONDS

 WE ALSO LOOK AT REGIONAL AND CITY LEVEL

SCHOOL OF ECONOMICS FUDAN

SCHOOL OF ECONOMICS FUDAN

 Province FE () and year FE (); from 2004 to 2015

• Throughout, standard errors clustered at province-year level SCHOOL OF ECONOMICS FUDAN

SCHOOL OF ECONOMICS FUDAN

Newly Issued Municipal Corporate Bonds (MCB) by Purposes

SCHOOL OF ECONOMICS FUDAN

 WHAT IS THE LOAN MATURITY IMPLIED BY

 IN AGGREGATE, EACH DOLLAR OF STIMULUS

 CROSS-SECTIONAL REGRESSION, HOW MANY YEARS DO WE

 ROLLOVER MECHANISM IS CONCENTRATED IN IN LOW-CDB-

SCHOOL OF ECONOMICS FUDAN

SCHOOL OF ECONOMICS FUDAN

SCHOOL OF ECONOMICS FUDAN

SCHOOL OF ECONOMICS FUDAN

 NATIONAL BANKING ERA (1863-1912) IN US

 REGULATORY ARBITRAGE (LIKE IN CHINA)

 TRUST COMPANIES ACCORDING TO CAROSSO (1970, P. 99)

 THIS IS ESSENTIALLY WHAT CHINA’S TRUST COMPANIES DO

SCHOOL OF ECONOMICS FUDAN

IN CHINA, SHADOW BANKING

SCHOOL OF ECONOMICS FUDAN