How the financial industry can serve the supply-side reform

Over the past three decades, China's economic development has relied on the three major dividends of reform and opening up, accession to the WTO, and labor force to maintain sustained and rapid economic development. However, China's economy has recently entered a new normal period in which it has shifted from high-speed growth to medium-high speed growth, economic structure adjustment tends to be optimized, and the old and new driving forces are transformed. In the past, the demand-side "troika" of consumption, investment, and export has become increasingly weak in pulling the economy forward, and structural mismatches between supply and demand have become more serious, which urgently calls for alleviating the imbalance of the existing economic structure through supply-side structural reform. Structural supply-side reform is urgently needed to alleviate the existing structural imbalance in the economy. Financial resources are the core resources of a modern economy, and the function of finance is to serve the development of the real economy, with the two promoting each other***. If the real economy is the muscle, capital is the blood, the financial system is the blood vessels. The financial industry must help supply-side reform and will benefit from it. By promoting the marketization of interest rates, improving the structure of financing and sounding the structure of the banking industry, the financial industry will liberate the financial constraints and provide stronger financial support for the supply-side reform. Supply-side reform is also an enabler for the transformation and development of the financial industry. By transforming business concepts and reforming institutional mechanisms, financial institutions will allocate and utilize financial resources more efficiently, and improve the service quality and efficiency of the financial supply system.

I. Serving supply-side reform with targeted financial reform

The Central Economic Work Conference at the end of 2015 clearly emphasized the need to focus on strengthening structural reform, moderately expanding aggregate demand while removing production capacity, removing inventories, removing leverage, lowering costs, and replenishing short boards, improving total factor productivity, and better adapting the supply system to the changes in the demand structure. An important aspect of supply-side reform lies in the financial side, and the key is the institutional reform of finance, with the core focus on reducing enterprise costs, deleveraging financing and improving capital efficiency. Deepening the marketization of interest rates, improving and optimizing the financing structure and perfecting the banking structure are the important contents of the financial supply-side reform in the current and future period.

After more than 20 years of steady progress, China's interest rate marketization reform has made a major breakthrough, with financial institutions having the power to independently decide on interest rate fluctuations. Giving full play to the role of the market in the process of price formation and change is conducive to better guiding the allocation of financial resources, continuously improving the direct financing mechanism for stocks, bonds and other direct financing transactions, and promoting the diversification of social financing; it is conducive to dispersing financial risks and reducing the indebtedness rate of enterprises and financing costs; it is conducive to promoting the growth of residents' wealth and guiding residents to rational changes in their financial management and consumption behaviors; and it is conducive to the flow of funds to new industries with high yields, high technology and good prospects. It is also conducive to the flow of capital to new industries and start-ups with high returns, high technology and good prospects, creating favorable conditions for China's economic rebalancing and industrial structural adjustment; and it is conducive to promoting China's economy to shift from an externally-expanded growth mode to an internally-intensive growth mode, thus truly realizing the goal of supply-side reform. At the same time, the marketization of interest rates also poses challenges to banks and other financial institutions in terms of pricing, structure and risk. In terms of product pricing, the marketization of interest rates has led to oscillations in short-term spreads and declines in medium-term spreads, and financial institutions need to continuously improve their product risk pricing capabilities. In terms of product structure, to reduce the negative impact of narrowing spreads, financial institutions need to adjust their product structure, i.e., expanding non-interest income through integrated management, which will increase the proportion of high-risk and high-yield assets. From the perspective of risk management, increased volatility due to interest rate shocks and the entry of private capital into the banking industry, with its strong profit-seeking motives, may also lead to a tendency to minimize risks, which puts higher demands on the risk management capabilities of financial institutions. Although the interest rate marketization reform has made decisive progress, there are still three tasks that need to be continued in the future. First, the central bank-led benchmark interest rate system for commercial banks should be withdrawn as soon as possible, and the corresponding market-led interest rate system for financial institutions should be established gradually, so as to ultimately realize the marketization of interest rates. Second, the market-oriented pricing ability of financial institutions should be strengthened, and their reliance on the central bank's benchmark deposit and lending rates should be gradually weakened. Thirdly, the interest rate transmission mechanism should be further unblocked, so that changes in short-term interest rates can effectively affect deposit and loan rates, bond yields and other market interest rates.

The results of the supply-side reform are reflected in the capital market, which has been activated to create more diversified financing channels and lower-cost financing methods for enterprises. At present, the financing structure of Chinese enterprises is still dominated by indirect financing, and in 2015, new direct financing accounted for only 23.2% of the increase in the scale of social financing, up 6.03 percentage points from 2014, but still at a relatively low level. There is no absolute difference between direct financing and indirect financing, but the low proportion of direct financing in China has led to an over-reliance on indirect financing, resulting in problems such as high leverage, over-concentration of financial risks, and difficulties in financing for small and medium-sized enterprises (SMEs). Accelerating the construction of the capital market and improving the capital market, which is multi-level, diversified, complementary, functional and resilient, will help increase the proportion of direct financing and better meet the diversified financing needs of the real economy under the innovative growth model. Direct financing, which does not require the intervention of financial intermediaries, can help revitalize the stock of assets, reduce the reliance of enterprises on indirect financing methods such as bank credit, and lower the financial risks during the stage of economic transformation and adjustment; raising the ratio of direct financing can help avoid the phenomenon of unsustainable non-financial sector finances due to the reliance on bank credit to increase leverage, and can help enterprises to reduce costs, deleverage, and promote the healthy development of the real economy.

In order to effectively promote the supply-side reform, commercial banks should make good use of the increased volume and revitalize the stock through four initiatives, including investment and loan linkage, optimization of credit investment, improvement of the banking structure and innovation of the rural credit system, so as to build up a well-governed, reasonably-structured, dynamic and creative banking institution system, and to provide strong financial support for the promotion of the transformation and upgrading of the economy and the structural reform of the supply-side. Firstly, we will actively promote investment and lending, so as to make "dual-creation" a new impetus for development. In the past, commercial banks only provided credit support to their clients, while PE/VC enterprises provided equity financing services. Banks are permitted to invest through their subsidiaries and provide effective financing for small and micro enterprises, especially science and technology enterprises, during the start-up period in the mode of "equity + debt". Investment and loan linkage can effectively combine the advantages of commercial banks in terms of capital, clients, brands and channels with the advantages of risk institutions in terms of risk control and investment capacity, so as to effectively support mass entrepreneurship and innovation. Secondly, commercial banks should accurately grasp the requirements of supply-side structural reform, and do a good job of "addition and subtraction" of credit investment. On the one hand, they should "add" credit investment in science and technology industries, emerging industries and small and micro enterprises. We will closely follow the national economic development and structural adjustment policies, and increase credit support for strategic emerging industries such as "Made in China 2025" and "One Belt, One Road"; on the other hand, we will "subtract" from the credit investment in overcapacity industries, monopolized industries, and backward enterprises. "On the other hand, credit investment in surplus industries, monopolized industries and backward enterprises will be reduced. On the other hand, we will make greater efforts to revitalize the credit stock, promote the clearing of non-performing loans of "zombie enterprises" and problematic enterprises, push forward the dissolution and disposal of non-performing loans, and strictly limit the amount and scale of credit for the "two high and one leftover" industries. Third, it is stepping up efforts to promote the establishment of small banks by private capital, building a team of small urban commercial banks to provide financing services to small and microenterprises on a door-to-door basis, strengthening and enriching the "capillaries" of the financial system, and targeting and improving the efficiency of the allocation of financial resources. Fourth, innovating the rural credit system and developing inclusive finance. Recently, the Interim Measures for Pilot Mortgage Loans for the Operating Rights of Contracted Land in Rural Areas and the Interim Measures for Pilot Mortgage Loans for the Property Rights of Farmers' Housing have been issued, and local government departments are being encouraged to set up a mechanism for compensating for and mitigating the risks of loans through such means as subsidized interest rates, risk-compensation funds, and guarantees by guarantee companies. Banks should determine the loan collateral rate, amount, term and interest rate on a reasonable and independent basis, simplify the loan procedures, solve the problem of farmers' financing difficulties, revitalize the assets of rural land, increase land circulation, help farmers increase their income and become rich, and accelerate the pace of agricultural modernization and urbanization.

II. Promoting banks' own supply-side reforms through institutional mechanism innovations

One of the main goals of supply-side reforms is to promote the efficiency of economic operations by increasing total factor productivity. Improving the quality and efficiency of the bank-led financial supply system and allocating and utilizing financial resources more efficiently through institutional reform is not only a requirement of supply-side reform, but also a necessity for banks to push forward their own reform and transformation. It is all the more necessary for commercial banks to accelerate their own supply-side reforms, starting from the reform of institutional mechanisms and the transformation of business concepts, in order to adapt to the requirements of the new environment, effectively support the supply-side reforms being carried out by the economy, and better serve the real economy. The supply-side reform of commercial banks mainly involves the following three areas.

Through deepening the reform of institutions and mechanisms, optimizing the corporate governance mechanism and improving the efficiency of operation and decision-making. The company has further improved its corporate governance mechanism with Chinese characteristics, laying the governance foundation for effectively serving the real economy. We will give full play to the roles of the Party Committee, the Board of Directors, the Supervisory Committee and the management, and explore new ways and means of effectively combining the leadership of the Party Committee and modern corporate governance. Promoting the reform of internal management mechanism and fully mobilizing the enthusiasm of the bank's management staff to serve the real economy. Through the implementation of the reform of the employment and remuneration mechanism, the implementation of professional managers and the system of all-employee, all-product pricing assessment, etc., we have truly broken the "big pot of rice" and pushed the bank employees to take the initiative to improve their service consciousness and service efficiency.

Establishing a diversified and capital-light business model to improve the efficiency of resource utilization. Commercial banks should continuously increase the adjustment of their asset structure, liability structure, and on- and off-balance-sheet business structure, and strive to build a "lightweight bank". In terms of asset business, they should comply with the requirements of the capital market and direct financing development, focus on non-credit business such as interbank business and bond investment, and reduce the proportion of credit assets. In the liabilities business, we should change the traditional concept of setting loans by deposits, create an asset-driven liabilities business mindset, and further improve the initiative of liabilities. By vigorously developing new businesses such as investment banking, asset custody, wealth management, cash management, transaction banking and off-balance-sheet businesses, we will reduce the weight of risks, so that the growth rate of risk-weighted assets will be lower than the growth rate of total assets, and that the growth rate of assets under management will be higher than the growth rate of asset size. To truly realize low capital consumption and low-cost expansion by improving operational efficiency, and to drive relatively large financial resources with relatively small capital investment, so as to better serve the development of the real economy. Construct market-oriented, refined and professional business management mechanism to improve management efficiency. It is necessary to break the shackles of the traditional management system, explore in-depth the business unit system and the subsidiary system, promote the change of the operation and management mode from block-oriented to block-combined, effectively enhance the professional operation and management capability, and let professionals do professional work. Further responding to the requirements of interest rate and exchange rate marketization, changes in the structure of assets and liabilities, as well as changes in the internal and external structures, we will continue to push forward the transformation and innovation of asset and liability management, promote the transformation of asset and liability allocation and management from passive, single-side and on-balance-sheet to active, multi-dimensional and full-balance-sheet management, and place more emphasis on the dynamic, combined and forward-looking management of all assets and liabilities. Through the construction of internalized and refined management mechanism, we can serve the real economy more effectively.