China faces a number of important financial-stability risks. A persistent feature of the Chinese banking sector is the rapid formation of non-performing loans (NPLs) during each business cycle. Moreover, lending restrictions and interest-rate caps (financial repression) have, in part, given rise to an ever-expanding shadow-banking sector. The article highlights five cardinal sins within the Chinese financial system: (1) bad lending practices by the regulated sector, (2) lax governance, (3) a shadow-banking system that is dominated by short-Term claims with no liquidity backstop, (4) stark lack of transparency in the shadow sector, and (5) very high levels of interconnectedness between the shadow and the regulated sector. The article suggests that some of these problems will be alleviated through a regulatory big bang that would abolish the current silo approach to financial regulation streamlining financial stability and conduct/consumer-protection supervision. Furthermore, we recommend the introduction of a binding and all-encompassing leverage ratio that will require banks to hold much higher capital buffers as a means to boost bank resilience, reduce NPLs, and battle interconnectedness with the shadow sector. © Cambridge University Press and KoGuan Law School, Shanghai Jiao Tong University.
- financial repression
- financial-stability regulation
- leverage ratio
- non-performing loans
- shadow-banking system