By Chen Daofu, Research Institute of Finance, the Development Research Center of the State Council (DRC)

Report No 72, 2014 (Total No 4571)

Summary:

China's capital market has been a bit chaotic this year, reflecting the economic transformation is taking place, with financial risks appearing. The market is sending abnormal signals because of the government's and banks' supposed guarantee. In addition, there is no difference between the non-risk and risk capital market, and the capital market's screening function gets weaker. This could result in a "crowding-out effect" or "over-expansion", or "bad money driving out good" and a failure of reaching for space with time.

Financial system risks are, to a large extent, a reflection of risks in the real economy's transition, with discordances in the reforms exacerbating the fragility of the financial system. An unreliable loss-bearing mechanism is the basic reason leading for the increase in risks.

China needs a clear solution to the non-marketization of local governments and to work out real estate policies and needs to remove people's expectation of rigid repayment of trust products. It also needs a stable mechanism so that market order can play a larger role.