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Activating Private Capital
Cover Stories Series 2012> Activating Private Capital
UPDATED: May 7, 2012 NO. 19 MAY 10, 2012
Breaking Up Banking Monopolies
China needs to revitalize the real economy and free up capital for small businesses
By Lan Xinzhen


The Central Government is obviously discontent with the state monopoly in the financial sector. It has already issued several documents supporting the non-public economy's entry into the financial sector, encouraging private capital to establish banks in the country's vast rural areas. However, because of various "glass doors," it is difficult for private capital to enter the financial system. To date, none of the government's measures has been effective at weakening the state banks' monopoly. The biggest ill for state monopolies in the financial sector is that bank credit is typically given to large state-owned enterprises, leaving small and medium-sized enterprises (SMEs), especially private businesses, to fend for themselves.

Most Chinese media think among the 12 tasks for the comprehensive financial reform set by the State Council for Wenzhou, the most important is to encourage and support private capital's participation in reforming local financial institutions and establishing village banks, loan companies, rural financial cooperatives and other new-type financial organizations in accordance with the law.

This means that private capital can establish real "privately owned banks," with their management personnel selected by shareholders, instead of being appointed by the government.

Pan Zhengyan, Deputy Director of the Financial Research Center of the Shanghai Academy of Social Sciences, said breaking the state's monopoly on banks has been society's wish for some time, and bigger strategic reform of the banking sector is unavoidable. But only financial reform processed with market-oriented measures will be able to break the state monopoly.

Pan said the first thing that needs to be done is to enhance competition in the financial market by extending market access to the financial sector. An important goal of the pilot project is to set up a reasonable and multiple financial system instead of one dominated by state-owned financial institutions. This calls for the practice of allowing private capital to fully integrate into the financial system. Incorporating private capital into the financial sector will not only enhance market forces, but also expand the sector's market capacity.

According to Pan, to thoroughly break the state monopoly in the financial sector, the government should also change the rules of market competition. Non-market formation of interest rates is a special mechanism in the Chinese banking sector. That is to say, prices of bank capital (interest rates) are decided by the "authority," instead of the market. The price mechanism does not play a decisive role to either the suppliers (banks) or the buyers (enterprises). It is difficult for privately owned SMEs to get loans at reasonable prices.

Hence there is conflict in the Chinese financial industry: On the one hand, SMEs, particularly privately owned ones, can only depend on financing means with high interest rates and high risk such as usurious loans or illegal financing, with interest rates higher than the social average. On the other hand, under the protection of a special pricing mechanism, banks of various sizes are enjoying bonus from policies and gaining profits from actual "negative interest rates" caused by inflation. Such a price formation mechanism for bank capital is beneficial to the banking sector and directly leads to monopoly profits in the banking sector and actual monopoly in the financial industry.

"The key point to change the unreasonable allocation of social resources is to change the present market rules. Otherwise, it is hard to realize justice and rationality in competition of the financial industry and to really break the monopoly in the banking sector," Pan said.

Legalizing private lending

Liu Yuanchun, Deputy Director of the School of Economics of Renmin University of China, said an important part of the financial reform scheme in Wenzhou is to regulate private lending and facilitate private capital entry into the financial sector.

Private lending, especially in large sums, is illegal in China. In Zhejiang Province, where the private economy is more developed than in other regions, many people have already been sued for private lending. Figures showed that in 2008 there were nearly 200 cases involving illegal deposits and more than 40 cases involving fundraising fraud. The recent Wu Ying case has aroused wide public condemnation against ruling private lending as illegal.

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