Financial Risk Awareness Needs to Be Guided by a Better System
On March 24, thousands of depositors rushed to line up at a bank in Sheyang, east China's Jiangsu Province, after rumors took off that the bank would be closed. This incident shows the public are highly wary of financial risks. In sharp contrast, some people have blindly chosen high-yield wealth management products regardless of risks in years past, reflecting a lack of sound financial risk awareness.
To that end, a fundamental system for China's financial markets should be established to guard against risks, including a deposit insurance system. Such a fundamental system needs to be constantly improved so as to give the general public reasonable and stable market anticipation and to maintain financial stability.
Very few individual investors are aware of risks of the shadow banking financial products in which they invest. Nor do they care about the profitability of the projects that the funds they purchased flow to. This is in sharp contrast with the level of risk awareness of individual investors in China's stock market, where even some unprofessional investors are able to elaborate on the profitability prospects and risks of listed companies.
In theory, the risks attached to financial products in the shadow banking system are greater than those associated with the fluctuation of stock prices. Thus, it follows that shadow banking investors should pay more attention to risks and should be more cautious than stock market participants. However, some investors don't rely on financial risks to make investment decisions. When facing investment failures, some of them may even be engaged in irrational activities in order to claim their rights, as represented by the chaotic bank run in Jiangsu.
The key reason lies in the lack of a fundamental financial system. A lack of risk governance and arrangement system has forced China's financial markets to shoulder more risks than it should have undertaken. The lack of a deposit insurance system has forced the country to use its sovereign credit to vouch for all of the deposits. The imperfect exit mechanism of financial institutions has left the central bank to deal with management failure risks of those financial institutions. This has, to a certain extent, implicitly encouraged those institutions to be bolder when making decisions. China's multi-trillion-yuan shadow banking system was formed on this basis.
Widespread public education on the risks of the shadow banking system has also yet to kick off, a major reason for the rapidly growing popularity of high-risk products.
A lesson can be learned from China's securities market. Starting from scratch, the stock market experienced irrational reactions from investors who suffered from investment failures. But China didn't compromise for the sake of these investors and insisted they should shoulder the responsibilities of their own investment decisions. Right now, investors in the stock market are quite mature and are willing to stomach failed investment all by themselves, following long-term financial risk education.
However, several redemption crises which have occurred in financial products belonging to the shadow banking system ended up with all investors receiving their principal and interest. This has, to a degree, encouraged their future adventurous investment decisions.
This year's government work report pledged to establish a deposit insurance system and improve financial institutions' ability to deal with risks. It's widely anticipated that China will make substantial steps in strengthening fundamental systematic construction in the financial markets. With downward pressure on the country's economy, the management risks of the real economy can be filtered through the financial markets. During the process, a well-established fundamental system in the financial markets can serve as a basic guarantee.
Taking the deposit insurance system for instance, if China had such a system, incidences such as the bank run in Jiangsu wouldn't happen. And there would be no room for any rumors on bank closures.
An improved mechanism for financial institutions to better deal with risks will give the market reasonable anticipation of any management failures on behalf of these institutions and make it less likely for those risks to scatter to other parts of the market.
Once such a fundamental system is announced, short-term market turbulence is bound to occur. To cushion the short-term turmoil caused by policy changes, an observation period should be set up after the announcement.
In a nutshell, conditions are ripe to establish a fundamental system in China's financial markets, with the deposit insurance system being one concrete example. Such a fundamental system can help knit a safety net for China's financial markets, effectively guide investors to make cautious decisions and maintain financial stability, which is also the most effective way to cope with rising financial risks in a time when the macroeconomy faces downward pressure.
This is an edited excerpt of an article by Xiang Zheng, a financial commentator, published in Securities Times
Depreciation rate of the yuan against the U.S. dollar in the first quarter of 2014
588.09 bln yuan
China's new bond offerings in February, a year-on-year increase of 15.7 percent
66.84 mln tons
Crude oil produced by China National Offshore Oil Corp. in 2013
The number of complaints received by Chinese authorities on food, pharmaceuticals, cosmetics and medical equipment in 2013
62.3 bln yuan
Net profits of Bank of Communications in 2013, a year-on-year increase of 6.73 percent
215.12 bln yuan
Net profits of China Construction Bank in 2013, a year-on-year increase of 11.12 percent
12.06 bln yuan
Net profits of The People's Insurance Co. (Group) of China Ltd. in 2013, up 18.8 percent from the previous year
Email us at: email@example.com