The Need for Modern Financial Governance
Financial governance is a long-term effort. It requires the construction of an institutional framework that is law-based，market-oriented and integrated with global infrastructure. Last year was a critical window for pushing ahead with this important agenda and there will be profound challenges in the remainder of 2020 and beyond. Innovative ideas are imperative. In the following article the author examines China's system of financial governance and efforts to modernize it.
The core of marketization is to advance reforms that promote a market-based allocation of the factors of production and a market-oriented development of institutions. That entails reforms that make interest rates more market-based. There is a need for promoting the market-oriented benchmark interest rate in order to facilitate the pricing of existing floating-rate loans. This must be accompanied by maintaining the basic stability of the renminbi exchange rate at a reasonable and balanced level while we adjust the relationship between the government and the market. At the same time，we need to vigorously develop direct financing，particularly equity financing，and speed up the development of the bond market. Similarly，there is a need for an increase in the supply of effective financial services，and the construction of a multi-tiered financial market system with diversified structures，comprehensive functions，and well-developed systems to better serve the development of the real economy.
The essence of a law-based system is the adherence to the spirit of contracts and the rule of law in a market economy. Administrative rules need to be clarified and kept in line with the law，while we strictly carry out our administrative responsibilities. China's financial sector has been developing at a rapid pace with numerous financial innovations. Traditional boundaries between finance and the real economy are being broken while barriers between online and offline services are being whittled away. The domestic and overseas market are becoming more integrated，while distinctions between banks，securities firms and insurance operations have largely been eliminated. Financial asset allocation has thereby become more effective. But there are continuing problems such as financial and regulatory arbitrage，as well as regulatory gaps，inter-market arbitrage，and the diversion of funds away from the real economy. There are continued difficulties with debt defaults，hazardous derivatives，and a shortage of affordable financing. In the future，we need to enhance our legislative standards through the Law of the People's Bank of China，the Commercial Bank Law，the Deposit Insurance Ordinance and the Regulations on Local Supervision and Administration，to promote and guarantee the high-quality development of the financial sector.
At its core，internationalization is aimed at opening up China’s economy to a higher degree. It entails removing systemic and other obstructions that hold back the free flow of financial resources to optimize the use of domestic and international markets. In recent years，China has made sustained efforts in achieving a two-way opening up of the financial sector. It has followed a regulatory management system that combines what is called "pre-establishment national treatment" and a "negative list" policy that opens up more of the economy by lowering entry barriers to foreign-funded financial institutions. That also facilitates global resource allocation on behalf of China's capital market.
We have steadily promoted the internationalization of the renminbi and its convertibility under the capital account. We have worked hard to streamline the government，delegating power and improving government services，as we facilitate trade and investment. China is also trying to reduce the transaction costs of real economy. By advancing these policies，we can hedge against the rising transaction costs caused by populism and the anti-globalization movement. Ultimately，we want to promote the healthy development of the global economy while maintaining China's global competitiveness. Additionally，China has actively participated in international cooperation，promoted the reform of international financial institutions such as the International Monetary Fund and the World Bank，and facilitated the construction of a new beneficial global governance pattern that is effective and based on equality. It has also contributed Chinese solutions to international financial governance.
A Window of Opportunity
Promoting the modernization of a national governance system and governance capabilities is a major reform set at the fourth plenary session of the 19th Cntral Committee of the Chinese Communist Party. Micro and structural issues in the financial sector have been sorted out after years of efforts，and as a result，the resilience of the financial system has been significantly improved. Governance shall be the last major step in the face of various systemic challenges. Financial institutions and market systems are able to play their roles in resource allocation and risk management only when a well-developed modern financial governance system is in place.
China-US trade friction was a significant external shock in 2019. That was followed by Covid-19，which resulted in global financial turmoil and economic recession. But under the strong leadership of the Communist Party's Central Committee and the State Council，the financial sector has made progress in building a market-oriented，law-based and internationalized financial governance system. Basic construction of the capital market is proceeding in an orderly manner. The science and technology innovation board and the pilot registration system for stock offers have been launched successfully. Meanwhile，structural deleveraging is progressing on schedule，new asset management regulations have been implemented，financial upheavals in key areas have been dealt with effectively，major risks have been successfully forestalled and defused，and the financial market opening has been advancing quickly and steadily. There have been major policy measures on lifting restrictions on foreign ownership of banks，securities and insurance firms. Additionally，we have seen the integrated development of the Shanghai International Financial Center and the Yangtze River Delta，the construction of the Guangdong-Hong Kong-Macao Greater Bay Area and the Hainan Pilot Free Trade Zone. These policies have all been promoted in a coordinated manner and thereby helping the opening up of the financial system.
Challenges Ahead
From the perspective of the current global economic and financial market situation，there will be profound changes in the global economy in the years ahead. We may see the most significant shock to global demand since the 1930s. This year will be a watershed during which Covid-19 delivers a short-term shock to China's demand and supply and in turn causes a global demand shock.
As for the financial impact，markets respond significantly faster than the real economy. Financial markets of various countries have gradually rebounded from the initial turmoil as governments put remedial policies in place. This quick recovery reflects the fact that financial indicators respond to adjustments in liquidity as well as developments in the real economy and policy actions.
The biggest risk to China and the global economy comes from the demand side. The pandemic has shifted consumer preferences in terms of luxury goods and necessities as well as services. The modes of production and factor inputs have also changed，including the trend towards onshoring and local procurement. In view of this，there will be adjustments to supply chains. This is also why many economists see the global economy absorbing the biggest blow since the Great Depression.
It is therefore necessary to fully understand the importance of the remarks of Secretary General Xi Jinping made at a meeting of the Standing Committee of the Political Bureau of the Communist Party's Central Committee，where he reiterated the need to "stay alert to potential risks and be prepared，both in thinking and action，and respond to long-term changes in the external environment." The global financial system will be up against a more complicated environment after 2020，the world economy will most probably be highly polarized and the global supply chain will be reorganized. On the positive side，what China did in 2019 on its financial governance system construction has built an institutional foundation that can respond to the uncertainties of 2020 and beyond. We have strong faith in China's financial market development，the performance of our own financial market and a stable renminbi exchange rate. These have already had practical benefits. However，we still need to remain clear-eyed about two important things: first，the construction of a financial governance system is not simply a goal，but a guarantee for the stable operation of a financial system in a new era. Second，the market-oriented，law-based and internationalized governance system is not a template to maximize the benefits of the financial market，but it can minimize the transactional costs of resource allocation and risk management under the current information and knowledge structure.
In addition，we are delighted to see that in March the Chinese Communist Party's Central Committee and the State Council jointly issued the Opinions on Improving the Systems and Mechanisms for Market-based Allocation of Factors of Production，which clarified the current and future deployments and requirements for the marketization，legalization and internationalization of financial governance. This focused on four aspects: improving the fundamental institutional arrangement for the stock market，accelerating the development of the bond market，increasing effective supply of financial services，and the expansion of the opening of the financial sector.
New Ideas
While many parts of the global economy are in lockdown due to Covid-19，financial markets are highly integrated and interacting without interruption. The International Monetary Fund describes the current situation of the global economy as "The Great Lockdown." Trade，logistics，and people are trapped within their own country or region due to the pandemic，whereas information and financial investments are still flowing freely around the world with the help of modern information technologies. Moreover，at least 15 central banks from different countries and regions have adopted "normalized" quantitative easing policies，creating spillover effects on a global scale. We believe that for the near future at least，financial theories and policies will experience new controversies as well as innovation. We need to be aware of the following:
First，a new consensus needs to be reached on the rules and discipline for currency issuance. Currency supply may be treated as the main valve affecting systemic risk. We need to ensure effective adjustments of this valve. Lessons learned from currency crises of the past tell us that we need to adhere to the two key components of monetary policy and macro-prudential management. The former addresses the needs of the real economy and the latter attends to the need for systemic financial stability.
Second，financial supervision should help us achieve a balance of investor protection，financial innovation，and the stable operation of financial institutions. This issue has long been the biggest challenge for governance capability since the introduction of new asset regulation rules. Since we have not yet achieved in-depth market-oriented and law-based financial governance，this issue has resulted in many problems. Market-based financial governance must rely on proper management of investors and licensed market participants，while law-based finance requires participants to adhere to the letter and spirit of contracts. We have made gains in this area over the past year，but there is much that remains to be done.
Third，we need to optimize the combination of our fiscal and monetary policy tools. After years of experimentation，China has completed an important and innovative policy design. Instead of monetizing fiscal deficits，it has achieved the "financialization" of fiscal functions. In so doing，the financial sector has been able to achieve the allocation of resources through a market mechanism while maintaining money supply discipline. For example，while supporting micro，small and medium-sized enterprises，financing goals have been achieved with "increased volume，expanded scale and reduced cost." According to the Monetary Policy Implementation Report for the First Quarter of 2020，in order to enhance inclusive financial support for micro，small and medium-sized enterprises，the People's Bank of China raised the relending amount to small and medium-sized banks on January 13，February 26 and April 30，with a rediscount quota of 300 billion，500 billion and 1 trillion yuan，respectively. As of the end of March，smaller local banks had issued loans with preferential interest rates (including discounting) of 276.8 billion yuan，supporting 351,400 enterprises (including farm households). Among them，agriculture-related loans reached 55.2 billion yuan，carrying a weighted average interest rate of 4.38%. Loans for micro and small enterprises were 155.6 billion yuan，with a weighted average interest rate of 4.41% while discounted bills were 66.1 billion yuan，with a weighted average interest of only 3.08%. The interest on all of these credits was below 4.55%，the highest level permitted by the State Council. China continues to focus on providing financial support for the national economy and people's livelihoods. At the same time，it maintains a stable currency and appropriate monetary policies. It can be said that China has maintained a mature and balanced policy framework.
The author is SAFE's deputy administrator