O'Melveny & Myers LLP and Promontory Financial Group have co-authored the first detailed analysis of China's financial system undertaken in the wake of the global financial crisis. The study has important implications for the international financial community and policymakers in China, Asia, the US, and elsewhere.
The paper, "The Financial System in China: Risks and Opportunities Following the Global Financial Crisis," is co-written by Susan Krause Bell, a partner at leading financial services industry consultancy Promontory Financial Group, and Howard Chao, Asia Practice Group Chair and partner at the international law firm O'Melveny & Myers LLP. It examines the unique characteristics of the Chinese banking system and the government's role in both supervising the banks and managing systemic risk. It also compares the supervision of Chinese banks to that of other global banks and considers what the major risks and opportunities are going forward for the rapidly evolving Chinese financial sector.
The paper notes that:
- Though China's financial sector was relatively unscathed by the global financial crisis, the system faces serious short- and long-term challenges. The inconvertibility of the RMB, protection from foreign competition within China, conservative regulation, and the overall growth of the Chinese economy shielded it from many of the problems other countries encountered. Nonetheless, in the short term, the surge in bank lending as part of the fiscal stimulus program will likely generate new non-performing loans and weaken bank balance sheets. Moreover, rapid change in the form of further financial liberalization, internationalization of Chinese banks, and the eventual convertibility of the RMB will bring new risks into the system.
- For the foreseeable future Chinese financial institutions will continue to dominate the domestic Chinese financial markets; but profitable niches will exist for opportunistic international financial firms. Coming out of the Crisis, international banks will have fewer resources to compete head to head in the Chinese domestic market against the large state-controlled Chinese financial institutions. However, international banks will fare better in areas where they can offer more innovative and tailored financial services to Chinese customers. They also may find new opportunities assisting Chinese corporates as they pursue international expansion plans.
- Chinese financial institutions increasingly will become formidable competitors in international financial markets. Although they are quite new to the international marketplace, they have two advantages: (i) strong relationships with their traditional Chinese customers, and (ii) strong Chinese government backing. To compete effectively with them, institutions outside China will have to develop strategies that emphasize the advantages they hold, including risk-management expertise, international presence and business connections, and more experience with innovative, customer-responsive product development.
- Ultimately, the predictability of the Chinese government may be the most important, yet most elusive, aspect of evaluating the risk of doing business in Chinese financial markets. The Chinese financial sector will have a better chance of weathering current and future risks and becoming more competitive on a global scale if supervisors and firms place more emphasis on developing sound, market-based practices and the State moderates its role in controlling innovation and decision-making. For non-Chinese financial institutions, therefore, the most important thing is to understand the Chinese system, the role of the State in the system, and how the State's role could change.
This paper will have relevance to anyone interested in the future of the Chinese financial system, including foreign firms operating, or considering operating, in China, potential investors in the Chinese financial system, and counterparties to Chinese financial firms. It should also help Chinese policymakers and financial firms understand some of the perspectives of the international financial community.
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