Feb 13, 2018 06:58 PM

Editorial: Regulators Must Identify the Source of Financial Risks

Recent sharp declines in U.S. stock prices have triggered strong shake-ups in global equities markets. The Chinese stock market also has seen effects.

Thanks to good economic fundamentals at home and abroad, domestic investors have not panicked. But some commentators are concerned that the current policy of controlling financial risks will exacerbate the market volatility. Others directly blame financial deleveraging for plunges in the Chinese stock market. This view has missed the key point and presented a distorted view of reality.

Authorities’ determination to prevent risks should not waver, and measures to tighten the oversight should not stop. In the meantime, the financial system should shut the “back door” while keeping the “front door” open to create a fair playing field for all.

The U.S. stock market emerged relatively quickly from the subprime mortgage crisis of 2007-10. Despite several swings in the past decade, the stock indexes have continued to rise overall.

There are many explanations for the latest slump, such as concerns about the pace of interest rate hikes following the change of the U.S. Federal Reserve chairperson, the technical panic triggered by the expansion of cryptocurrency trading, and the correction of the market, which had been rising for a while.

These explanations have hit some meaningful points, but the basic consensus is that the U.S. stock market has yet to slip into a “crisis mode.”

The stock market correction has prompted a deep reflection about the real risks in the Chinese stock market and financial markets, as the country’s economy has been going through a transition from one of speedy growth to quality, and authorities have been trying to remove financial risks. China’s risks are clearly rooted in the deeper problems of the country and its economy. While China’s stock market has become more international, the external impact is not decisive. So even if the stock market falls further, using government resources to stabilize the market is not a way out.

Preventing financial risks is a major goal of Chinese authorities, and there is no turning back from the rectifying campaigns that have already begun. Only by deepening the reform of the financial regulatory system, regulating and developing the financial market system and improving the adaptability of the financial structure while optimizing the economic structure can China guarantee the smooth and healthy operation of its financial market.

For a long time, insufficient and unbalanced financial development coexisted with the relatively high financial risks. Central authorities’ key Central Economic Work Conference, held at the end of last year, decided that the main tasks for the next three years will be to fight three major battles, with “preventing major risks,” especially financial risks, topping the list. It’s a strategically important judgment that hits the mark.

In recent years, shadow banking and local government debt have become outstanding problems. Corporate leverage ratios remain high. The level of leverage ratios among individuals has risen significantly. More worrying is the local-government debt problem, which is still severe even after a period of being addressed. The central government recently shut down a number of large local infrastructure projects that are closely related to the debt issue. More importantly, scarce financial resources are not serving the real economy in accordance with market rules, and a significant amount of money circulates within the financial system, with risks accumulating. Some of the money is at the mercy of government will, with cash being allocated to some money-losing “zombie enterprises.”

Take a closer look of the financial mess, and you may find it easier to see where China’s financial risks lie. Bond market defaults have been occurring one after another recently. Bank employees were found to be faking documents for loans. The information of large-scale asset-management products is seriously opaque, while multiple layers of borrowing and lending are entangled.

There has been a wide range of financial cases involving illegal fundraising, some of which are obvious Ponzi schemes. While the risks of internet finance are not confined to one place when they are born, many of the above-mentioned irregularities have been kept off the regulatory radar, and even sheltered by local governments. Some businesses have been taking advantage of the loopholes between different regulators. In the stock market, the old problems of insider trading and market manipulation have kept coming back despite crackdowns, and have become the transmission channel of new risks. As the size of China’s financial system has become so huge today, if the risks get out of hand, the consequences can be disastrous.

To prevent financial risks, the central government has launched a number of initiatives. The Financial Stability and Development Committee of the State Council has been established, and the regulatory system is expected to be gradually optimized. The macro-prudential regulatory framework has gradually taking shape. The new rules on asset management products have been addressing stubborn ills such as “guaranteed repayment” that only magnifies financial risks. It is no surprise that where there is reform, there will be resistance. Reformers must remain focused and not be distracted by complaints.

Of course, staying committed to reform does not mean ignoring reality and acting blindly. The financial system is closely linked with the development of enterprises and the interests of the people. Reform in this area must be careful. Reform needs thorough research, rational policymaking and determined implementation. The reformers should keep a watchful eye on the new problems that the new policy may cause.

At present, extra attention should be paid to closing the “back door” and opening the “front door” of the financial system, which means the authorities should ensure fair play of all businesses. The decision-makers vowed to standardize the issuing of local debts. Although the effect is not obvious, the direction is undoubtedly correct.

The same applies to financial risk management. While cracking down on illegal financial activities, new financial products that meet the needs of the real economic sector need to be launched as soon as possible.

Meeting the capital crunch of small and midsize enterprises and improving the income of residents are closely related to the government’s goals of upgrading economic drivers and realizing the goal of to ensure all people are well-off. These can be the benefit of the battle against financial risks.

Paying attention to the internal causes of financial risks does not mean ignoring external risks. The central government has recently repeatedly stressed the need to further open up the financial sector to the outside world. China’s financial ties with the world are becoming closer, and the risks can easily spread. China has to be ready to deal with external risks as soon as possible. There is no shortcut to dealing with external risks. Financial institutions need to improve their internal governance and keep pace with world standards. Regulators need to improve their ability to do their job and not panic. As the lifeblood of the modern economy, finance cannot prosper without the support of a strong economic body. Only a sound market economy mechanism, standard property right protection system and macro management that fits with the modern economic rules can provide a reliable foundation to deal with financial risks. And only in this way can the economy move forward.

China is moving from high-speed growth to high-quality development. This shift calls for a healthy financial system that will also underpin the long-term development of the financial system. It is not the intention of policymakers to keep financial markets in check. Quite the contrary, after three years of hard work, the risks have been effectively contained and the financial markets are becoming vibrant. The financial markets will provide a strong heart to pump up China’s sustainable economic development.

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