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Financial market needs right tools

By Hong Liang (China Daily)
Updated: 2008-09-23 14:46

While the international capital markets were gripped by a sense of doom last week, a senior Chinese legislator heroically declared at a public forum that "it is time" to speed up the process of market deregulation in China to improve capital efficiency.

On first hearing, these words sounded brash at a time when excessive deregulation was blamed, at least partly, for the outbreak of the US credit crisis that sent the world capital markets into total disarray before a massive rescue operation was mounted last Thursday by the US government and central banks of numerous other countries and economies.

On second thoughts, maybe she was right. The Chinese capital market is too tightly regulated to allow room for financial intermediaries to effectively and efficiently match the respective needs and risk profiles of borrowers and lenders. And limited sources of funding are seen as a major constraint on the growth of a private sector comprising mainly of small- and medium-sized enterprises.

This problem has become increasingly pressing as the government pursues a tightening monetary policy to combat inflation. As bank landings dried up, thousands of factories in the light industrial centers of the Pearl River Delta region were closed down. There is certainly a need to promote what Wu Xiaoling, vice-chairwoman of the Financial and Economic Committee of the National People's Congress, described at the forum as "private sector financing" as opposed to bank loans.

Deregulation to facilitate private sector financing will invariably breed innovation as financial intermediaries are freed to create products that can best match borrowers' and lenders' requirements. But striking a balance between innovation and market risks is a duty that regulatory agencies tend to overlook from time to time.

As Joseph Yam, chief executive of the Hong Kong Monetary Authority, wrote: "It is important to remember that the financial system exists to serve the public interest in effective financial intermediation, not the private interests of the financial intermediaries."

When they were first introduced, subprime mortgage bonds seemed to be a prime innovative product that matched the needs of investors and fund raisers, who, in this case, were the hundreds of thousands of home buyers whose credit records would not have otherwise qualified them for loans.

The easy-credit induced buying spree pushed up property prices, which helped boost the value of the underlying assets of those bonds that had a relatively higher coupon rate. The high credit ratings of those bonds enhanced their appeal to investors, including some of the world's most venerable financial institutions.

The reasons behind the outbreak of the subprime mortgage crisis have been well documented. The sustainability of the scheme was brought into question when predatory lending tactics were employed by some lenders to rope in more homebuyers.

As has been disclosed, the total exposure of Chinese banks to the US subprime credit crisis is limited. And Chinese investors can take comfort in the fact that a debacle of such a scale can never happen in China's tightly regulated financial market.

The devastating force of the crisis that shook markets around the world has the potential to strengthen arguments for pulling back the pace of financial reform in China. And that is what many proponents of deregulation are worrying about.

China is facing challenges of an entirely different nature to those of the US, said Fan Gang, director of National Economic Research Institute. Speaking at the same forum, Fan said: "The Chinese financial market lacks effective financial tools, which has hampered the sustainable development of the (capital) market."