Urbanization needs further financial reforms

2. Suggestions

To resolve financial repression, finance deepening and gradual deregulation of the financial market are much needed. In China, the diversity of financial institutions and monetary deepening are critical to the development of finance. Only market and competition can most effectively and efficiently allocate economic resources.

First, releasing unnecessary restraints on financing activities is essential. There are several ways to do this: diminish deposit reserve ratio; increase loan-deposit ratio; further the liberalization of interest rate. The recent targeted reserve requirement ratio cuts have already functioned to release liquidity into the banking system. But loan-deposit ratio alone is rarely an effective indicator of a healthy financial market. According to the Basel Accords Ⅲ, a volunteer global stress-testing standard, Liquidity Covered Ratio (LCR) and Net Steady Finance Ratio (NSFR) are more reasonable than merely the loan-deposit ratio. Internationally speaking, the normal deposit-reserve ratio is between 8 percent and 10 percent while China’s has long been around 20 percent. The high ratio aggravates the disequilibrium between supply and demand.

Furthermore, policy banks also need to play a bigger role in urbanization. They usually focus on long term investment and massive construction. So, urbanization needs policy banks to support infrastructure construction, public services and social improvements. They can try allocating more than 50 percent of new loans to buttress urbanization.

Government ownership or government control of domestic banks and of financial institutions usually put barriers that obstruct other institutions seeking to enter the market. Urbanization needs more private capital to enter the market, such as private trust funds and mutual funds. By combining the force of private financial institutions can the capital needs be met.

A fair system is essential to the survival and even prosperity of small financial institutions. Private financial institutions of small or medium sizes are an indispensable part of a robust financial industry. There are a series of methods to establish a supportive atmosphere for private and small financial institutions: lower the standard for market entry; more favorable policies for small institutions to operate; encourage private capital to take part in traditional financing.

The government needs to continue its support for the financing of urbanization, help improve credit availability and reduce financing costs for specific sectors in the real economy. None of the transformation can be done without government’s continuous reform of the financial sector.

The author is with the New York University School of Law