[Chinese] financial system that is growing increasingly fragile

“The government, not a financial market, also decides both lending and deposit interest rates and broadly instructs the banks to lend to favored sectors. In short, banks are passive entities that absorb all the credit, interest and market risk involved in the government’s policy decisions. If, for example, inflation were to grow rapidly, the value of existing bank assets would be decreased. In a closed financial system like China’s, banks must inevitably be the institutions at risk. Although the banks are government-backed, we have seen elsewhere that in certain circumstances that are almost always unforeseeable, such support may mean little.”

“The easiest thing the government could do would be to significantly open its financial system to foreign participation. At present, foreign financial institutions hold less than 2 percent of all domestic financial assets. A recent study has shown that in 150 emerging financial markets, foreign financial institutions hold upwards of 37 percent. Greater foreign involvement would create more competition for Chinese banks, a good thing, and would also, from the government’s perspective, diversify systemic risk”