ROLE OF THE MARKET IN MAINTAINING FINANCIAL SYSTEM STABILITY

 

 

Theoretically speaking, financial market development may not aid in the stability of a financial system. However, as a financing channel differing from the indirect financing of institutions, the financial market is likely to play a positive role in stabilizing financial operations. First, the financial system, although enjoying economies of scale, is dominated by indirect financing from banks, a system that embodies uncertainties in its asset-liabilities structure. A deteriorating balance sheet originating from bad loans has always been the direct cause for bank runs, the traditional root of a financial crisis. This type of situation generally would not occur in a financial market where both the deposit supply and investment demand corresponded with each other. Secondly, financial institution financing is the result of collective decision-making and action, thus there is a time lag for risks exposure, and risks are highly concentrated. While contrarily, financial market features decentralized decision-making and action, which can both quickly reveal risk and disperse such risk over a large area.  Finally, the long-term economic recession in Japan as well as the financial crisis in Southeastern Asia has helped more people realize that a higher dependence upon internal funds and financing from the financial market helps create a more stable and ideal capital structure for enterprise.

The following passages will be devoted to China’s interbank bond market and its effect on financial stability, from the angle of perfecting adjustment mechanism of monetary policies through market forces.

Officially launched in June 1997, the interbank bond market witnessed two years of stagnancy. In 1998, the interbank bond market found its ground from the adjustment of required reserves and the lift of long-running control on loan scale, for a developed interbank bond market is essential for either commercial banks in enlarging the scope for their asset utilization or the monetary authorities to shift direct adjustment into indirect one. In 1999, the interbank bond market came into its full swing. Divergent financial institutions entered the market; various types of treasury bonds and policy bonds were introduced gradually; repo and cash bond were both developed. It is worth mentioning that this market served as a breakthrough of the interest rate liberalization reform. The turnover in the market soared to 4.097 trillion yuan in 2001, hit 10.63 trillion yuan in 2002, and is estimated to set a record high of 15 trillion yuan in 2003.

Currently, the interbank bond market constitutes the major component part of China’s money market. The money market development can promote the central bank’s shift of monetary adjustment mechanism in two aspects. One is to make the central bank adopt an adjustment mechanism through market forces; the other lies in the fact that the money market provides prerequisites for the central bank’s conducting monetary policy through markets. One way in which money market influences monetary policy is the impact upon commercial bank’ s required reserves. Since 1998, the monetary authorities have lifted the control on loan scale and have turned to the money supply adjustment. Its open market operations have imposed an increasing effect on commercial bank’ s reserves and then on the total supply of base money. Another way in which money market affects monetary policy is to influence the central bank’s base money supply through assets. From the forex regime reform in 1994 to 1997, the RMB counterpart of foreign exchange reserves has been the main channel for injecting base money. From 1998 on, China’s forex income growth leveled off, while loans with the central bank kept climbing. To prevent base money from skyrocketing, the central bank has offset the base money through open market operations. Since the second half of 2002, the RMB counterpart of foreign exchange reserves has been increasing remarkably. To solve the problem of limited offsetting means, the monetary authorities adopted many measures, including the newly emerged central bank papers. The third way to influence monetary policy is the interest rate mechanism. The interest rates of repo, cash bond and funding in the interbank bond market are the rates most close to those determined by market forces in China's financial system. These rates offer increasingly significant benchmark prices for the allocation of financial resources, and serve as a more real reference system for the monetary authorities to judge the supply and demand of funds in the market.

To further develop the money market, endeavors should be made in four aspects: to enrich trading varieties and enlarge the money market scale, to perfect the infrastructure of the interbank bond market, to unify trading markets and to develop market maker system.