Editorial: China Must Continue to Open Up State-Owned Financial Institutions

China’s State Council recently published a guidance document introducing new management measures for state-owned financial capital. The document explicitly stated, for the first time, that the State Council and local governments will authorize the central Ministry of Finance and local finance bureaus respectively to perform investor functions for state-owned financial capital.

The dispute over the powers of various government departments, which has raged for many years, has finally been resolved. The public has focused on this point. However, another point in the guidance document should not be ignored: Policymakers have made arrangements for optimizing the allocation of state-owned financial capital, emphasizing that the country’s state-owned financial institutions will “advance in some areas and retreat from others, take action for some things, and refrain from taking action for some others.” This shows that, even as the financial sector takes big steps in opening up to the rest of the world, domestic opening-up has returned to the agenda.

“Advancing in some areas while retreating from others” is an important step toward enhancing the competitiveness of state-owned financial institutions. At a time when the opening-up of the financial industry is rapidly gaining momentum, the Chinese government must urgently tackle the issue of how to improve the competitiveness of state-owned financial institutions and the country’s financial industry as a whole. The recently released guidance document called for management of state-owned financial capital to be “focused on improving the efficiency of state-owned financial capital, and increasing the vitality, competitiveness, and sustainability of state-owned financial institutions.” The market is the only place where the competitiveness of businesses can be tested. All other tasks, whether self-assigned or assigned by others, are secondary to improving competitiveness. This is also a necessary condition of “letting the market play a decisive role in resource allocation” — a frequently reiterated goal in China’s policy documents.

Competition is the fundamental driver of the market economy. Only through market competition can prices be discovered, incentives formed and optimal resource allocation achieved. Competition pushes businesses to constantly increase their competitiveness. Hence, the implementation of the recent guidance document should keep in mind competition policy from start to end. The government should effectively guarantee fair competition between various market players to truly ensure the survival of the fittest.

Property-rights reform is the basis for increasing the vitality and competitiveness of state-owned financial institutions. The document reflects the idea of “diversified management” for state-owned financial institutions, which vary in nature and functions. The guidance document offers different measures for policy banks, industry-related financial institutions, and those that are involved in maintaining national financial security, for instance. State-owned financial institutions involved in competitive areas should actively introduce various forms of capital, and state-owned financial capital can have holdings in these institutions, ranging from minority stakes to controlling ones, the document stipulates. The document also calls for China to “continue following the principle of marketization and steadily promote mixed-ownership reform of state-owned financial institutions.” Experience has shown that, when controlled by state-owned capital, financial institutions can grow large but cannot achieve strength, and they have difficulty establishing modern corporate governance structures and cultures. Paternalistic thinking, lack of respect for budget constraints, and insider control are problems that frequently plague these institutions. Serious research needs to be conducted on what the optimal maximum involvement of state-owned capital is, for institutions in competitive fields.

China’s crisis-prevention measures after the global financial crisis have contributed to the rapid expansion of the country’s financial industry. At the same time, the industry has increasingly displayed the characteristics of being “large but not strong,” “deviating from the real economy,” high leverage, increased risks, and other problematic traits. China’s policymakers have in recent years deepened financial reform and strengthened financial supervision, making some progress in deleveraging and risk prevention. However, it is still worth pondering the extent to which the competitiveness of state-owned financial enterprises has grown since the financial crisis. As the country increases its openness to the outside world, this question is attracting more and more attention. The optimistic view is that state-owned financial institutions have the advantages of dominant market share, and a better understanding of local customers’ needs. The pessimistic view is that there have been no substantial improvements in pricing power, risk control, and corporate governance, and that the industry has actually experienced a “lost decade.” Both views have their merits, but the latter seems rooted in more-fundamental issues. There is no doubt that, faced with an uncertain future, China’s state-owned financial institutions will always be in the process of increasing their competitiveness.

At the same time, China’s financial industry is clearly lagging behind when it comes to opening up to domestic private capital. The initiative to open up state-owned financial institutions to private capital has been going on for a while now, and multiple projects have been launched to address the issue. However, there are many roadblocks, and there has been no marked progress so far. This issue is closely related to the problem of small and midsize enterprises finding it difficult and expensive to obtain financing. This is due to the vested interests of state-owned financial institutions, as well as regulatory agencies’ past fears about private capital causing financial disorder. Now, with financial supervision reform achieving obvious progress, the establishment of a deposit insurance system, and continuously increasing openness to the outside world, domestic opening-up should not progress haltingly, and should certainly not regress.

The recently issued guidance document has put forward many targeted measures for standardizing the operation of state-owned financial institutions and enhancing their competitiveness. For instance, it calls for state-owned financial institutions to disclose the state of their operations and improve their transparency in a timely, accurate and legal manner. It also calls for these financial institutions to publicize their capital status and accept public supervision, among other requirements. These are necessary measures. But the current priority should be to establish the basis of a financial competition policy, in accordance with competition regulations issued by the State Council two years ago. The Chinese government must create a system for reviewing fair competition, and prevent the introduction of new policies that limit or eliminate competition. It must also gradually clear existing regulations and policies that go against the principle of fair competition. These efforts should especially focus on state-owned financial institutions with significant influence in their industries.

True competition between financial institutions will happen only after interest-rate marketization and exchange-rate liberalization are truly achieved. The recent guidance document emphasizes the competitiveness of state-owned financial institutions, as well as the idea that of advancements coupled with retreat. These can be seen as precautionary measures that complement each other. In order to achieve true competition in competitive fields, Chinese policymakers must ask themselves this question: Which areas should state-owned financial institutions advance into, and which should they retreat from?

Translated by Teng Jing Xuan (jingxuanteng@caixin.com)