Research on China's Financial System towards Sustainable Growth: The Role of Innovation, Diversity and Financial Regulation

Lead Research Organisation: School of Oriental & African Studies
Department Name: Financial and Management Studies


China withstood the Global Financial Crisis. Hence, at a first glance - if history is a good guide for China's resilience in future - one should not be too concerned about financial stability. Of course, house price inflation might be a source of instability. However, lending criteria seem to be robust with minimum down payments of 20% for first time buyers and 30% for second homes since February 2016. Recent data published by the People's Bank of China (PBoC) show that bank loans grew by 14.07% year-on-year to the end of April 2016, and total credit in the economy expanded by 13.13%. Interestingly, loans seem to grow faster than credit - a particularly curious irregularity that has afflicted the Chinese economy since 2014. As of April 2016, shadow banking accounts for 15.19% of total credit (approximately 50% of GDP). The expansion of shadow banking seems to be a response to disparities in access to finance with large parts of the economy, notably small and medium sized enterprises (SMEs), facing financial constraints. Moreover, recent technological advances and improvements in infrastructure (e.g. high-speed internet access) have helped to make financial innovations available to an increasing number of end-users. Financial technology (fintech) such as crowd-funding and peer-to-peer lending platforms have emerged in China, offering new ways to access financial services. In spite of the considerable potential of newly emerging fintech businesses in China, recent issues, e.g. the collapse of the peer-to-peer lender Ezubao, highlight the need for better regulation of the industry.

Our project aims to answer the overarching research question: how can the Chinese financial system contribute to sustainable economic development? This is further divided into two sub questions: (1) how can financial sector reforms improve financial inclusion, contributing to sustainable growth and development, and (2) how to safeguard financial stability in China? Our proposal will focus on sustainable economic growth, which considers trade-offs between economic, social and environmental targets. Economic growth is only sustainable if growth is inclusive and environmental risks are considered. The project is organised in six work packages (WPs). WP1 will provide an overview and a meta-analysis based on prior research on financial inclusion and risk in China. WP1 will consider fintech businesses in China and their role in promoting inclusive finance as well as their alleged contribution to financial risk. WP2 will model the link between financial development, financial innovations and sustainable growth. Potentially, the most significant contribution of our project is the construction of novel indexes for diversity and resilience in China, which assess three key financial markets: deposits, mortgages and business loans from 2000-2016. WP4 will use these indexes to examine the impact of diversity on financial inclusion and stability. WP5 will explore China's Enterprise Bankruptcy Law and its impact on inclusive finance. Apart from this specific policy change, WP5 will develop advanced quantitative methods to evaluate the impact of policy changes, taking into account causal order. WP6 will assess the extent of compliance in the Chinese financial industry regarding the promotion of green finance. Environmental risk is seen as a material risk to the financial sector, and the financial sector is also the place where the allocation of capital into sustainable or non-sustainable investments is decided. Ma Jun, the PBoC's Chief Economist, has set up large working groups within the central bank, and the Green Finance Committee was set up by the PBoC to develop green finance practices including environmental disclosure, environmental stress testing for the banking sector, and guidelines on greening China's overseas investment. We will assess whether these recent policy changes have triggered a change in lending practices

Planned Impact

Financial sector reforms and sustainable economic development, driven by financial inclusion, are key priorities in the 13th Five Year Plan as mentioned by President Xi, as well as key focus areas for the G20 Agenda chaired by China this year. China recognizes that promoting financial inclusion is the basic premise for sustainable and balanced development. Indeed, the Development Plan for China's Financial Inclusion 2016-2020 was promulgated by the State Council at the beginning of this year. Hence, the critical impact of this research project is to contribute to the financial inclusion and sustainable development road map for China. Overall, there are four main groups of beneficiaries of this project:

(a) Users of diversified financial products in China. This research project is designed to maximise engagement with households and companies in China through, e.g., interviews, focus groups, seminars and workshops. Outputs, influenced by their input to the project, will be geared towards influencing policy decisions, which can maximise financial innovation, financial diversification and inclusive finance for sustained economic growth in China.

(b) Government departments, banks and financial institutions, and other organisations involved in financial sector reforms and promoting sustainable economic development in China. The research project will engage with the People's Bank of China, other government departments, NGOs, banks and financial services organisations by contributing to knowledge on financial sector reforms and sustained economic development in China. We will engage with associations of entrepreneurs, e.g. micro, small and medium companies, to better understand their needs and major obstacles they face in accessing finance, to collect primary data at their level and to gain insight into their perceived view of proposed new financial innovations that are instrumental in sustaining economic development in China.

(c) The broader international community concerned with financial sector reforms and the financing of sustainable economic development in China, including the World Bank, the International Monetary Fund, Asian Development Bank, New Development Bank (previously, BRICS Development Bank), World Trade Organisation, and OECD donors. These institutions' actions can be better informed by new knowledge on financial sector reforms and economic development in China.

(d) The research community in China and globally. These will benefit from new research that will extend existing knowledge on financial reforms and sustainable economic development in China. Specific knowledge products include new journal articles, datasets and research methods.

The research will result in short, medium and long-term outputs for the above four groups.

(a) The short-term positive impact of our research will be felt at the grassroots level by households, companies and NGOs in China, who will benefit from engaging in a knowledge transfer. In turn, the research will enable NGOs and financial institutions to pioneer new and innovative ways of addressing financial inclusion. Being a key player in this high-impact project will enable local collaborators and partners to shape interventions, which will help individuals and communities help themselves. Furthermore, local partners will be a crucial platform for engaging with the community (see Pathways to Impact).

(b) The medium-term positive impact is that research will provide evidence on the nature of the flow of development funds (including the role of government), financial institution and community levels, with respect to guiding strategically Chinese investments nationally and globally.

(c) The long-term policy impact of the research will relate to financial development in China and how this will influence global developments, including implications for the UK. It will be felt in the governmental, non-governmental and international domains within and out of academia.


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Description In the first year of the project we focused mostly on data collection, and in the second year several papers have been completed. Three papers have been published and other papers are in various stages of the publication process.

The paper on the "Development and Transformation of China's Financial System" by Tobin and Volz provides an excellent overview of recent developments in China related to work packages (WP) 1 and WP6. The paper "Industry agglomeration, sub-national institutional constraints and foreign firm performance" by Li, Zhang and Sun explores the role of sub-national institutions in China. The paper entitled "The value of financial constraints" by Kling develops a theoretical model of financial constraints. This model addresses the issue that some firms cannot get access to any debt; hence, their financial leverage is zero. Traditional measure of financial constraints based on leverage and other ratios would not detect that these zero debt firms are constrained. The model, hence, offers a possibility to value financial constraints. There might be a possibility to use the theory as a building block for deriving a model of financial inclusion.

Pesqué-Cela, Tian, Luo, Tobin and Kling wrote the working paper entitled "Do we really know how to define and measure financial inclusion? A systematic review and confirmatory factor analysis", which concludes WP1. The paper notes that there are many ways to define and measure financial inclusion, which as a social construct is latent. This abundance of concepts and measures might serve to stimulate academic debate - but contributes to ambiguity in setting targets for optimal levels of financial inclusion. We conducted a systematic review of definitions, measures and associated data sources highlighting methodological issues and discrepancies. Drawing on methods developed in psychometrics, we apply a meta confirmatory factor analysis to test various measures using cross-country and Chinese data sources. Our contribution is threefold: (1) we integrate Western and Chinese perspectives on financial inclusion, (2) we identify data sources, (3) we derive methods to measure financial inclusion. Our methodology can be applied to different contexts.

In WP3, the diversity index for China based on Michie and Oughton (2011) was constructed as discussed in the paper 'The Evolution of the Financial System in China: A Diversity Index' by Oughton, Pesqué-Cela, and Tobin.

Published papers

• Tobin, Damien and Volz, Ulrich (2018) The Development and Transformation of the Financial System in the People's Republic of China. In: Volz, Ulrich and Morgan, Peter J. and Yoshino, Naoyuki, (eds.), Routledge Handbook of Banking and Finance in Asia. London and New York: Routledge, pp 15-38.
• Li, Xiaoying, Yin-Fang Zhang, and Laixiang Sun. 2018. "Industry agglomeration, sub-national institutions and the profitability of foreign subsidiaries." Management International Review (2017 IF: 2.279). Vol. 58, Issue 6, pp 969-993.
• Ye, Jianliang and Guo, Xiaohan and Luo, Deming and Jin, Xiangrong (2018) The Heterogeneous Tax Burden: Evidence from Firm-Level Data in China, The Singapore Economic Review 63: 1-32.

Working papers

• Kling, G. (2018) The value of financial constraints,
• Oughton, C., Pesqué-Cela, V. and Tobin, D. (2018) The Evolution of the Financial System in China: A Diversity Index
• Pesqué-Cela, V., Tian, L., Luo, D., Tobin, D. and Kling, G. (2018) Do we really know how to define and measure financial inclusion? A systematic review and confirmatory factor analysis
Exploitation Route The theories developed might lead to a general theory of financial inclusion. In addition, the diversity index we constructed can be used as a policy tool to assess the link between the diversity of the Chinese financial system and financial stability.
Sectors Financial Services, and Management Consultancy

Description The project has started two year ago and first outputs have been published related to the project. It is still relatively early to assess the impact of the project at this point. The project team has had already some impact, which could translate into wider societal impact going forward. The project has benefited from the fact that some Co-Is are involved in policy making in China. It is notable that our Co-I Dr Xinxiang Wen, who was the Deputy Director General of the Monetary Policy Department at the People's Bank of China at the time we submitted the bid, has been promoted to the Secretary General of the Monetary Policy Committee of the People's Bank of China. Accordingly, the project team has engaged with current issues such as regulation of internet banking. For instance, Prof Lihui Tian (PI China team) has become a member of the National Committee of Financial Inclusion, and research from our project has been covered by several newspaper articles in China including the People's Daily. Media coverage (selection) People's Daily China Securities Journal To disseminate our research findings, we held a workshop at SOAS University of London in March 2018. In addition, members of the research team presented their papers at conferences (e.g. the paper 'The Evolution of the Financial System in China: A Diversity Index' by Oughton, Pesque-Cela, and Tobin was presented at the EAEPE Conference in September 2018). Co-investigators were invited to give three keynote speeches (e.g. Central University of Finance and Economics, Beijing, in June 2018). The two PI, Prof Lihui Tian and Prof Gerhard Kling, organise a conference at SOAS University of London on 'Financial Inclusion and Fintech'. In addition, the two PIs will be guest editors for a special issue on 'Financial Inclusion and Fintech' published by the European Journal of Finance. We expect between 25 and 30 presenters from universities and international organisations such as the World Bank. ESRC-NSFC grant holders working on financial inclusion were invited to participate in the conference to exchange ideas and share their research findings. Link to the conference:
First Year Of Impact 2017
Sector Financial Services, and Management Consultancy
Impact Types Policy & public services