Lou Jiwei on China's banking, PE/VC, IPOs, and Big Tech's role in lending
The former Finance Minister calls on local govt-backed PE/VC funds to partner with finance professionals and urges the relaxation of IPOs in China.
Lou Jiwei, China’s former Finance Minister, gave a speech on December 21 at the 2024 annual conference of China Wealth Management 50 Forum (CWM50), which describes itself as “a non-government and non-profit academic think tank” on September 12th, 2012. CWM50 says it is committed to building a premium platform for professionals interested in China's financial and wealth management industry and aims to facilitate the exchanges of theories, thoughts, innovations, and experiences.
In line with his straight-talking style, Lou gave accessible background and comments on China’s banking sector, private equity, venture capital, and the stock market, and how internet platforms could leverage their technology to assist bank lending but should also have skin in the game.
The speech was originally published in the WeChat blog of the Global Asset Management Forum (GAMF), a self-described “non-governmental global think tank” founded by the School of Economics and Management, Tsinghua University, Sun Yefang Economic Science Foundation, and CWM50.
高质量发展的实现路径与金融支持
Paths to Achieving High-Quality Development and Financial Support
The 19th National Congress of the Communist Party of China (CPC) in 2017 first proposed the concept of high-quality development, signaling a shift in China's economy from a phase of rapid growth to one focused on high-quality development. Since then, through continuous practical and theoretical innovation, the pathways to achieving high-quality development have become increasingly diverse. These include: driving technological innovation, optimizing and upgrading industrial structures, promoting green and sustainable development, coordinated regional development, ensuring and improving people's livelihoods, deepening reform and opening up, and other aspects. High-quality development requires multi-party collaboration, with various pathways interlinked and mutually reinforcing, driving the economy and society toward high-quality, sustainable development.
Having worked in [China’s] Treasury for a long time, while finance is not my area of expertise, I have had many interactions with the financial industry. Here, I would like to briefly discuss the role finance can play in promoting high-quality economic development. The financial sector has its distinct characteristics, including both strengths and weaknesses. To support high-quality economic development, it is necessary to address the weaknesses of the financial sector through fiscal and monetary policies, as well as enhanced regulation.
The financial sector has the following key characteristics:
The primary focus of financial institutions is the management of monetary funds and various financial assets, such as loans, stocks, bonds, and futures contracts. Financial institutions achieve business development by managing the flow and allocation of monetary funds and financial assets. For example, banks accept deposits from customers and then lend these funds to enterprises or individuals with funding needs, completing the circulation and allocation of funds.
The financial sector involves high risks, such as credit risk, market risk, and liquidity risk. Financial transactions often use leverage to amplify returns. Given the high risks in the financial sector and its significant impact on the broader economy and society, strict regulatory measures are needed.
Due to the unique characteristics of the financial sector, it is not well-suited for public welfare sectors such as "coordinated regional development" or "ensuring and improving people's livelihoods." These areas require more reliance on fiscal policy tools. However, in areas such as "driving technological innovation" and "optimizing and upgrading industrial structures," the financial sector can play a more supportive role.
In terms of supporting technological innovation, one key measure is for banks to increase the proportion of medium- and long-term loans to support technological upgrades of enterprises. During economic downturns, when credit risk rises, banks tend to reduce the proportion of medium- and long-term loans. Policy tools are needed to alleviate this issue. For instance, fiscal loan guarantee funds can help reduce the credit risk for banks, while central bank loans for technological upgrades can lower the cost of bank loans. More importantly, addressing the difficulties faced by private enterprises in obtaining affordable loans is crucial. For many years, 70% of technological innovations in China have come from private enterprises, but banks tend to apply higher-risk pricing to loans for private enterprises. A key reason for this is the stricter accountability that arises when risks occur. This systemic issue requires the government’s accountability mechanisms to treat both state-owned and private enterprises equally.
Another effective financial product for innovation-driven growth is venture capital (VC) and private equity (PE) funds. In recent years, VC/PE funds have faced difficulties at every stage of the investment process—raising funds, managing investments, and exiting investments. The biggest challenges are in the fundraising and exit phases. As regulatory measures on the stock market become more stringent, it becomes harder for VC/PE funds to exit their investments. Many local governments have set up numerous venture capital funds, often requiring high investment return ratios, and these funds are also tasked with attracting investment. These government-led funds are guided by the dual but sometimes conflicting goals of seeking returns and attracting investment, managed by local state-owned enterprises, which lack sufficient market-based operations and management capacity, resulting in performance often falling short of expectations.
One of the reasons for the underperformance of government-backed venture capital funds is the lack of tolerance for failure in performance assessments. Typically, VC/PE investments target early-stage tech companies, which have immature technologies and management models, and thus a higher likelihood of failure—usually over 50%. However, the returns from successful projects can be high enough to make up for the losses. If every failed project is held accountable, fund managers will be hesitant to invest. In the current environment, the market is lacking in “patient capital,” and the focus should be on how government-backed venture funds can transition to a more market-driven model.
In 2016, the Treasury/Ministry of Finance pledged 9 billion yuan, taking a 22.5% share, to establish a national technology venture capital fund, with a target of 40 billion yuan. Through a market-based bidding process, CICC Capital was chosen as the manager, and the fund was named CICC Qiyuan Fund. The management approach is a "penetrating management" model, where fund managers oversee not only the sub-funds but also the specific projects. Since its inception, the fund has delivered strong returns and has consistently ranked first in the industry for investment returns and risk control. It has now completed its second phase of fundraising and is mainly cooperating with regional venture capital funds, with CICC Capital continuing as the fund manager. This model has provided a valuable example for the market-driven transformation of local venture capital funds.
On December 16, the State Council's executive meeting reviewed policies to promote the high-quality development of government investment funds. It emphasized building a scientific and efficient management system, operating government investment funds according to market-based, rule-of-law, and professional principles, and better serve the country's overall development. The meeting also stressed the need to strengthen long-term and “patient capital,” improve differentiated management mechanisms for different types of funds, and establish a responsibility mechanism that aligns authority and accountability, encouraging innovation and tolerating failure. I hope relevant departments and local governments to really implement these policies.
The healthy development of the stock market is essential for the functioning of VC/PE funds. Controlling the pace of initial public offerings(IPOs) and exits by listed companies does not reduce stock market volatility; it actually weakens the innovation-driven mechanisms of enterprises. A better approach would be to implement a strict information disclosure system, with severe penalties for companies that fail to disclose accurate information or engage in fraudulent reporting, as well as for investment banks and accounting firms. Investors should have access to real and timely information to make informed decisions about the value of stocks. Approval of listings by regulatory bodies or exchanges cannot guarantee the quality of listed companies and may lead to rent-seeking mechanisms that foster corruption.
Regarding low-carbon and sustainable development, financial institutions have already played an important role. Many banks have issued green bonds to raise funds for low-carbon projects, such as subways and high-speed rail, which are considered low-carbon infrastructure. Currently, relevant government departments list low-carbon projects, and financial institutions select projects from the list for investment. Moving forward, it is essential to focus on developing carbon markets based on carbon measurement, with financial institutions able to obtain carbon credits from these markets when investing in low-carbon projects, helping accelerate the transition to a low-carbon economy and society.
Inclusive finance is an important aspect of supporting small and micro enterprises. Many large banks are developing fintech and big data models to more accurately assess customer risks, allowing more small and micro enterprises to become clients. In practice, small and medium-sized banks are closer to small and micro enterprises and are more suitable for providing inclusive finance services, but they lack strong fintech capabilities and have limited ability to identify credit risks. A better approach is for small and medium-sized banks to collaborate with Internet platforms that possess large amounts of data and robust algorithmic models to help identify credit risks, which will aid in the development of inclusive finance. However, small and micro enterprises have the highest credit risks, and if the Internet platforms’ lending businesses reach trillions of yuan, any mistakes in risk identification could lead to systemic risk. Therefore, Internet platforms should not only engage in assisting lending but should also co-lend a certain proportion of the loan, such as 10%-15%, to share the risks.
The reason for the 2008 U.S. financial crisis was that banks issued mortgage loans without requiring a down payment ratio, and banks did not retain any risk on the mortgage loans, directly converting them into asset-backed securities for market trading. Eventually, the underlying assets encountered credit risk, which quickly spread to the entire capital market, causing the financial crisis. Ultimately, after much reflection, the U.S. amended its regulatory laws. It required that mortgage loans must have a down payment ratio of no less than 10%, and when mortgage loans are securitized, banks must retain at least 10% of the risk. These lessons should be learned, but we must not go to extremes. If Internet platforms are required to co-lend 30% or more, it would occupy a large amount of capital, and their most important and beneficial function - assistance in lending by technology - that promotes inclusive finance would be strangled. Therefore, a balance must be struck between improving efficiency and preventing risks.
China has entered a moderately aging society, and ageing finance [Note: the sum of financial activities around various elderly needs of the members in society in order to handle the challenges of ageing and composed of pension finance, elderly service finance, and elderly industry finance] has great potential. The 个人养老金 personal pension system has unique advantages. China’s Pension scheme consists of three pillars: the first pillar includes 企业职工基本养老保险 basic pension insurance for urban employees and 城乡居民养老保险 rural residents, with the government providing some subsidies to the latter; the second pillar includes 企业年金 enterprise annuities, contributed by both employers and employees; the third pillar, personal pensions, is especially suited to individual businesses and flexible workers who do not have access to enterprise annuities. The personal pension system offers tax incentives. Personal contributions to pension accounts are tax-deductible up to a limit of 12,000 yuan per year, and investment income is not taxed until withdrawal. Upon withdrawal, the pension is subject to a 3% tax rate, separate from other income. The system allows individuals to invest in a range of financial products to preserve and grow their funds. The personal pension system is being rolled out nationwide starting December 15, opening new opportunities for developing ageing finance.
The personal pension system initially faced challenges when piloted in Shanghai, Fujian, and Suzhou in 2018. It was modeled after the U.S. tax-deferred individual retirement accounts. However, in China, the main source of retirement income, the basic pension, is tax-free, and there are several tax deductions in individual income tax, making tax deferral less effective. After four years of piloting, contributions totaled only 300 million yuan. The system has now been revised to allow for a tax deduction of up to 12,000 yuan per year during the contribution phase, and a 3% tax on withdrawals. This policy is more suitable for China's national conditions. Starting in November 2022, the new system has been piloted in 36 cities, with contributions reaching 28 billion yuan by the end of 2023 and over 60 million participants by June 2024. With time, I expect pension finance to grow on a large scale.
The financial sector is high-risk, highly leveraged, and technically complex, making it difficult for investors to identify risks. Strict regulation is necessary to prevent systemic risks. Prior to 2017, high-risk products like P2P (peer-to-peer lending) and Ponzi schemes, masquerading as Internet-based financial products, caused significant losses and potential systemic risks. The introduction of the asset management regulations in April 2018 was aimed at eliminating these risks. After a three-year transition period, the aforementioned financial activities that could lead to systemic risks have essentially been eradicated. However, the issue of how to handle small and medium-sized banks that have been hollowed out remains unresolved.
The Communist Party of China’s 20th Central Committee's third plenary session laid out several key policies for the financial sector, including serving the real economy, deepening capital market reforms, strengthening financial regulation, and promoting high-level opening-up. Among these, serving the real economy is seen as the most important. My speech today mainly focuses on financial services for the real economy and offers some basic insights. I hope it can provide some inspiration.
Other speeches from Lou Jiwei this year
