China has much to gain from accelerating reform of its capital market

Developing a multi-tier capital market system wherein different parts complement each other is high on the agenda for China's financial reforms. As capital markets can be a significant factor for economic growth, China has much to gain from fostering further development of its capital markets. However, progress in China's capital market reform has been less than satisfactory.

To promote the sound development of China's capital markets, it is critical to adjust the structure of the stock market, improve the bond market, greatly develop the wealth management market and give full play to the role of financial institutions.

The US stock market is dominated by large companies and high-tech firms while companies listed in China's stock market are limited in size and are mainly from traditional industries.

The difference is clear. The stock market in the United States has gathered the most outstanding companies in the nation or even in the world that are representative of the future, making the market capable of responding quickly to any changes in the broader economy and playing a prominent role in leading economic growth. As far as the Chinese stock market is concerned, listed companies are mainly those in traditional industries and traditional financial sectors, whose combined market capitalization accounts for 75 percent of the total, meaning that the market does not act as a barometer of the broader economy, not to mention guiding the economy toward better quality and higher efficiency.

The construction of an optimization mechanism for listed companies should be accelerated, among which the quick expansion of the registration system to encompass all initial public offerings should be deemed the bellwether of the broader capital market revamp. The still prevalent approval-based IPO system is in dire need of reform as its nature is assessing a company's assets and earnings in the past, instead of a company's growth potential, making it incompatible with investors' market selection.

Steadily enhancing the proportion of safe assets is another major task. At the end of 2019, sovereign bonds, local government bonds, financial bonds, corporate bonds, negotiable certificates of deposit and securities accounted for 16.3 percent, 22.3 percent, 23.4 percent, 22.8 percent, 9.8 percent and 0.3 percent respectively, of the total value of the Chinese bond market. An evident flaw is the too low portion of safe assets represented by government bonds. Safe assets are the main vehicles of financial institutions' liquidity management and open market operations by the central bank. This market determines the benchmark of the interest rate system, the risk-free rate of return and the efficiency of macro control policies in the financial sector. In an open economy, the market also plays a critical role in the renminbi's internationalization.

The structural distortion in the Chinese bond market is a mirror of similar distortion in the financial institution system, which has been plagued by the too high proportion of indirect financing as the assets of traditional commercial banks account for the bulk of the total. Over the past few years, however, a new risk has been emerging-long-term low interest rates or even a negative interest rate. With super-low interest rates or even a negative interest rate likely to be the new normal for quite a long period of time. In that case, financial activities and institutions that depend on interest rate spreads will find it more difficult to stay viable.

Many foreign non-banking financial institutions or commercial banks manage to survive low or negative interest rates as their business models do not rely on interest rate spreads, but rather on providing professional financial services. In light of this, it's urgent to nurture insurance firms and pension funds, as well as other non-banking financial institutions. For commercial banks, it's also a pressing task to transform to being a professional financial service provider.

Furthermore, we should carefully summarize institutional arrangements that have proven effective in practice in China and incorporate them into the development strategy of China's capital markets. China should attach importance to the development of the wealth management market.

Statistics show that indirect financing accounted for over 80 percent of the total for many years in a row until 2012, when the wealth management product industry started to flourish. The proportion of indirect financing has been on the decline since then, hitting a record low of less than 60 percent around 2015.However, following a nationwide crackdown on misconduct in the wealth management industry in the second half of 2015, the proportion of indirect financing has rebounded to over 80 percent. Such fluctuations show that, in practice, developing the wealth management market could be a viable way to increase the proportion of direct financing.

According to traditional financial theory, capital markets should be the main fund raising venue for companies. However, China's capital markets have not fulfilled such function. Commercial banks have undertaken the task by providing medium and long-term loans on a large scale, becoming a major tool for capital formation in China.

Medium and long-term loans accounted for 62.2 percent of the total in China at the end of July, compared with 30 percent in the US. Deducting housing mortgage loans, medium and long-term loans accounted for 36.3 percent of the total, compared with a meager 2 percent in the US. Such a comparison clearly shows that the capital needed by high-speed growth in China has been provided by Chinese commercial banks. China should abandon the "either this or that" approach toward direct and indirect financing. Instead, China should carefully study how banking institutions can effectively participate in the process of capital formation and assume part of the responsibilities of capital markets.

The author is the chairman of the National Institution for Finance & Development, one of 25 China top thing tanks, and an academic member at the Chinese Academy of Social Sciences.