The speech that rocked China's financial industry, from fmr Finance Minister Lou Jiwei

If your job involves China's finance, you should read it in full.

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Highlights:

China’s former Finance Minister Lou Jiwei made eight points in an explosive speech on China’s finance on Sunday, Dec. 20, 2020:

1. Significant financial chaos threatened China’s economy in a few years before 2016;

2. What Beijing did to resolve the chaos;

3. Beijing should continue to lower leverage and resolve financial chaos;

4. China should return to separate operation instead of continuing the journey of mixed operation in finance, namely limiting financial conglomerates;

5. Significant structural problems persist in China’s bond markets and China’s central bank shares at least partial responsibility;

6. Systemic risks exist with Alibaba-controlled Ant (Financial) Group growing exponentially; govt should intervene before it’s too big to fail; govt shall facilitate competition with Ant

7. China’s systemic flaw in identifying systemic financial risks calls for a Chinese version of the Financial Stability Oversight Council at the Treasury

8. China’s central bank failed in macro-prudential supervision; the state bailout of Baoshang and Hefeng banks is flawed in not sufficiently taking care of taxpayers’ interest.

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Lou Jiwei, the former Chinese Minister of Finance and before that inaugural Chairman of the state sovereign wealth fund China Investment Corporation, ignited a fierce debate across the Chinese financial world with a public speech on Sunday.

Lou gave an extraordinarily candid reality check of China’s financial industry, from the early 2010s to now. Lou did not mince his words. In addition to criticizing what happened and still happens, he even called out China’s central bank and other regulators by name.

China’s economy and finance in itself already deserves big attention. Adding to that is Beijing’s recent opening up of finance to foreigners (ENG, Refinitiv). Wall Street, dubbed by as one powerful friend left in the U.S. of China (ENG, WSJ), rushed in taking majority/entire control (ENG, Bloomberg) of their once joint ventures.

Due to the explosiveness and depth of his speech, your Pekingnologist feels obligated to do a full translation. It’s a sharp, inside, and critical look at China’s finance industry from a high-level official. And English-language reports of this are meager. As far as your Pekingnologist is concerned, only three major media outlets - Bloomberg, Reuters, and South China Morning Post, and those were quite brief.

This is going to be a lengthy newsletter filled with jargon in finance. The subject here is highly technical and this one-man shop is certain to make mistakes. Suggestions for corrections are very welcomed.

Caixin, China’s leading financial news outlet published Lou’s speech (CHN) with a note that says 经本人审定 Lou himself reviewed the published version. That’s the Chinese source quoted below. All links, brackets (), and highlights are mine.

Notable pushback, including articles and experts apparently associated with the central bank, has also emerged. But this particular newsletter does NOT cover that - because this is already too lengthy.

One of the phrases Lou repeatedly used was 双循环 dual circulation and 内循环 domestic circulation. It will take pages to put that into perspective, but for the sake of simplification, just understand - in abstract - dual circulation as the entire Chinese economy, where there is one part that is externally linked, and the other part - domestic circulation - as the internal part of the Chinese economy that has few direct links with outside China.

***

今年9月1日，习近平总书记主持中央深改委第十五次会议，提出：“加快形成以国内大循环为主体、国内国际双循环相互促进的新发展格局。”十九届五中全会进一步将双循环新发展格局列为“十四五”规划和2035远景目标的重点内容之一。提出需要推动更深层次改革，实行更高水平开放，并兼顾发展与安全，为构建新发展格局提供强大动力。4月9日，党中央国务院发布《关于构建更加完善的要素市场化配置体制机制的意见》，是推动更深层次改革的纲领性文件。资本在五大要素之中，就此我谈几点意见，或者说是体会。

On September 1 this year, General Secretary Xi Jinping presided over the 15th meeting of the central committee for deepening overall reform, proposing to "accelerating the establishment of a new development pattern featuring dual circulation, which takes the domestic market as the mainstay while letting domestic and foreign markets boost each other." The Fifth Plenary Session of the 19th Central Committee further listed the new development pattern characterized by dual circulation as one of the key elements of the 14th Five-Year Plan and 2035 Objectives. On April 9, the Central Committee and the State Council issued the guideline on improving the market-based allocation mechanism of production factors, a programmatic document to promote deeper reforms. Capital is among the five production factors, and on this I will share a few comments - or my experience.

NOTES:

这里讲的资本市场是广义市场，不仅包括股票、债券、信贷，还包括监管、金融基础设施及财金关系。

The capital market here means a broad market, including not only stocks, bonds, bank credit/loans, but also regulation, financial infrastructure and the relationship between the treasury and finance.

NOTE: Throughout the following paragraphs, please remember the capital market is defined as a very broad one.

第一，金融乱象对国内大循环的危害。

2016年前短短数年，我国资本市场发生了严重的混乱。大型商业银行均控有保险公司，也纷纷开办证券公司，办有理财业务，并利用网点优势销售关联甚至其他机构的保险和资管产品，还入局PE和VC行业；保险公司热衷于控制商业银行，某些治理结构不良的保险公司更是借此，为其循环注资、庞氏融资提供便利。商业银行绕过拨备覆盖率、风险准备计提以及存贷比、资本充足率等监管，将大量资金出表，开展委外业务，通过“通道”、“资金池”的方式形成“银行的影子”，进一步放大了相关行业杠杆水平，积聚了风险；P2P泛滥，风险事件频发。银行同业拆借早已不是头寸调剂，拆借的范围也超出了同业。实体经济没有足够的收益，资金被抽入金融行业，高杠杆、高风险、高利润运营，金融行业的利润，比其他所有行业的利润总合都多，带动实体经济利率大幅抬升，企业融资难，融资贵，严重影响双循环发展，特别是国内大循环。

First, the danger of financial chaos to the domestic circulation.

In just a few years before 2016, serious chaos occurred in China's capital market. Large commercial banks all controlled insurance companies, opened stock brokerages, and, taking advantage of their advantages of (wide-spread) physical sites, sold insurance policies and wealth management products from affiliated and even other (unaffiliated) institutions, and stepped into PEs (private equity) and VCs (venture capital).

Insurance companies were keen to control commercial banks, and certain insurance companies with poor governance structures used this to facilitate their circular financing and Ponzi-scheme-like financing.

Banks bypassed the regulation of provision coverage ratio, risk provisioning, deposit-to-loan ratio and capital adequacy ratio, and moved a large amount of funds out of the balance sheet to carry out entrusted investment, creating shadow banking through "channels" and "pools of funds,” further raising the leverages of the relevant industries and accumulating risks.

Internet-based peer-to-peer lending was proliferating and risk events were frequent.

Interbank lending was not about smoothing through temporary liquidity shortages, and the scope of lending was beyond the banks.

The real economy did not have enough revenue, funds were pumped into the financial sector. It was a high leverage, high risk, high profit operation. The profits of the financial sector exceeded the combined profits of all other sectors of the economy, driving the real economy interest rates up significantly, leading to difficult and expensive corporate financing, , seriously affecting the development of the dual circulation, especially the domestic circulation.

NOTES:

1) The insurance company Lou referred to is of course Anbang headed by now-imprisoned Wu Xiaohui.

2) Like many in China, Lou uses the term “real economy” which is overwhelmingly considered in Chinese mainstream view as the most important part of the economy.

第二，金融回归本源，为实体经济服务。

2015年底中央经济工作会议提出“去杠杆”，2017年中央金融工作会议，习近平总书记进一步提出“金融要回归本源，为实体经济服务”。在此之后，开始治理金融乱象。首先是加强风险隔离，清理证券公司“资金池”业务；银行理财业务子公司化，银行资金不得再做股权投资；保险公司“保险姓保”， 压缩“万能险”业务，对控制银行做循环注资行为进行清理；证券公司以经纪和投行业务为主业，对所办的基金公司风险隔离；证券基金管理不同类型基金，要严格风险和利益隔离，严禁高利刚兑性债权类资产；PE和VC公司管理的基金开始备案，并同“资金池”切断，防止在所管理的基金之间操纵收益，这有助于投资人识别关联风险；P2P已全部清零，宏观杠杆率高位趋稳，市场利率稳中有降。变化是可喜的。

Second, the return of finance to its origin - serve the real economy.

At the end of 2015, the Central Economic Work Conference proposed "deleveraging." In the Central Financial Work Conference of 2017, General Secretary Xi Jinping further proposed that "finance should return to its origin and serve the real economy." After this, the financial chaos began to be tackled.

The first is to strengthen risk segregation, clean up the securities brokerages’ "pool of funds" . Bank-based asset management, which dominated China's asset management market, entered the era of independent subsidiary operation (ENG, Deloitte), and funds from banks were no longer allowed to go to equity investment.

Insurance companies "returned to insurance businesses", and their universal life insurance businesses were cracked down on.

Cleaning-up work on insurance companies’ circular financing through control of banks began. Securities brokerages were asked to focus on stockbroking and investment banking as the main business, and they were asked to isolate themselves from the “pool of funds” they used to run; securities investment fund companies were asked to strictly separate the different types of funds they ran and build a firewall in between, promises to bail out high-interest credit assets were forbidden.

Funds set up by PE and VC began to register, and they were ordered to be isolate from the “pool of funds”, to stop cross-fund manipulation for profits. Based on these moves, investors can better identify the risks associated with the funds.

Peer to peer lending has all been phased out. Macro leverage has stabilized at a high level, and market interest rates have stabilized with declines. The changes are welcome.

NOTE: Too technical for your Pekingnologist, who can barely get the translation correct.

第三，去杠杆，治理乱象的方向不能动摇。

今年以来，宏观杠杆率再次提高，大约比去年底提高了20个百分点，达到260%以上，这是特殊时期的特殊变化。今年百年不遇的新冠疫情突然爆发，我国和世界经济都陷入严重的衰退。作为应对措施，我国和世界各国都采取了扩张性的财政货币政策，导致阶段性的杠杆率高企。目前我国控制疫情和恢复经济取得令人瞩目的成绩，成为全球唯一实现经济正增长的主要经济体，非常时期的财政货币政策正在考虑有序退出。宏观杠杆率应稳住，并逐步下降。一是，治理金融乱象虽取得重大成果，但远未成功，“资金池”清理、资产净值化、取消刚兑、高风险机构的排查清理、金融基础设施紊乱等现象，还要继续整治。二是，美国、欧洲等主要国家宏观政策的外溢性明显，全球金融市场波动的风险加大，而我国正加大金融开放，需要“保持战略定力，办好自己的事”。

Third, we can not waver in the direction of deleveraging and resolving (financial) chaos.

Since this year, the macro leverage ratio has increased again, about 20 percentage points higher than the end of last year, reaching more than 260%, which is a special change in a special period. The sudden outbreak of the coronavirus, unseen in a century, plunged both our country and the world economy into a deep recession. As a response, both China and the world adopted expansionary fiscal and monetary policies, leading to high leverages in the period. Now that China has made impressive achievements in controlling the pandemic and relaunching the economy, becoming the only major economy in the world to achieve positive economic growth. An orderly exit from the extraordinary fiscal and monetary policies is being considered. The macro leverage ratio should be stabilized and made to decline gradually.

First, although significant accomplishment has been achieved in the fight against financial chaos, it is far from successful. The cleanup of "pools of funds", the regulatory requirement that management of trust assets on the basis of their net value, so that the value of the trust product directly reflects the value of its underlying assets , the elimination of the presumption that local governments will always bail out state-linked borrowers, identification and cleanup of high-risk institutions, and disruption of financial infrastructure needs to be continued.

Second, macro policy spillover from the United States, Europe and other major countries is obvious, increasing the risk of global financial market volatility; while China is increasing financial openness, we need to "maintain strategic stability, do their own business".

NOTES:

1) Despite the world-wide recession where stimulus is the go-to option for China and other governments, Lou insists Beijing should continue deleveraging and an orderly exit from the extraordinary fiscal and monetary policies is being considered.

2) Resolving China’s financial chaos is far from over, in his opinion.

第四，混业经营不是方向，要向分业转型。

与分业经营相比，直观上混业经营有利于节约经营成本，但也更容易蕴藏和传递风险，导致金融风险问题愈演愈烈，对国民经济带来了较大系统性风险。同时，混业经营要真正控制住风险传染，要求金融监管从分业监管转为精细的网格化管控，进行更为严格的合规监管，不仅难度较大，甚至需要深入到金融业经营的内部，大幅增加金融机构的合规成本。综合考虑，混业经营规范运行之后，从金融机构微观角度看并不一定节约经营成本。从治理乱象所采取的措施看，是在削弱混业，要进一步向分业转型。从国民经济整体角度看，金融业分业经营，能够更好的服务实体经济的发展。

Fourth, the mixed operation of the financial industry should NOT be our direction, (we need) to change to separate operation (in finance).

Compared with the separate operation in finance, mixed operation appears to save operating costs, but it also more easily harbors and transfers risks, resulting in intensifying financial risks, bringing greater systemic risk to the national economy.

Meanwhile, for regulators to really control the risks associated with mixed operations, it requires the regulatory regime to go from separate supervision of separate financial licenses to fine-tuned grid supervision and engage in more stringent supervision.

This is not only difficult, but also (requires regulators) to go deep into the operations of the financial industry, and significantly increases the compliance costs of financial institutions. Looking at the issue comprehensively, if mixed operation really goes fully compliant, the financial institutions’ compliance cost may not be low from their own micro-level perspective.

From the measures (we’ve) taken to resolve the chaos, (we have in fact) weakened the model of mixed operation, and have been transitioning to separate operation. From the perspective of the national economy as a whole, the separate operation of the financial industry can better serve the development of the real economy.

NOTES: To put Lou’s words into a context that may be more familiar with English speakers, think along the lines of Glass–Steagall Act of the 1933 Banking Act and more recently Dodd-Frank.

At the risk of oversimplification, Lou champions a financial industry where banks be just banks (mainly just taking deposits and lending), securities brokerage be just securities brokerage, insurance companies be insurance companies, etc., and that regulators should NOT give too many various licenses to one financial conglomerate.

The significance of Lou’s words is that for years China’s finance industry has been effectively gearing toward mixed operation, but he thinks this direction is WRONG.

第五，相对于股票市场，债券市场是短板。

2015年股票市场经历了大股灾，在此之后，股票市场的改革加快。科创板注册制、净值型证券基金、强化退市制度、规范证券公司融资融券业务、加大股票欺诈处罚力度等措施相继出台，当然需要改革的内容还有很多。相比较而言，债券市场改革已经落后。今年以来，债券违约事件频频发生，特别是大型国企违约事件更是影响相关地区国企和政府的公信力。存在的问题，首先是市场分割，发行和监管不统一。发行的审查有证监会、人民银行、发改委，多头管理。特别是银行间市场早已不是银行间融通资金的定位，非银行金融机构、非金融企业都可以在银行间市场发行、上市债券，包括中期票据。其次，交易所市场和银行间市场交易分割，同债不同价。这种分割状态，会导致为争取市场份额而放松标准。7月份，央行和证监会决定同意两个市场间基础设施互联互通合作，这是可喜的变化，建议尽快落地。还有，银行间市场债券多为银行大量持有，商业银行既承销又持有，市场流通性差，一旦出现债务违约，商业银行受损。债券市场的问题还有很多，解决的基础性条件是发行标准、交易流通、监管机制的统一。按照《证券法》，市场应是交易所市场，监管机构应是证监会。银行间市场回归同业拆借市场的本位，信用债应全部退出，利率债（国债和政策性金融债）可在两个市场同时交易，结算要打通，既方便银行间抵押融资，又促成两个市场同债同价。基础性的问题解决后，债券市场改革的内容还有很多，要问题和目标导向加快推进，不然会是下一个风险集中爆发点。

Fifth, the bond market now has more defects compared to the stock market.

China’s stock market experienced a major crash in 2015, after which the reform of the stock market was accelerated. There have been measures such as the introduction of registration-based (compared with administrative approvals) IPO system in the Shanghai Stock Exchange STAR Board, the introduction of net value-based securities investment funds, the simplification of delisting stocks, regulation of margin trade and short selling, and increasing the punishment for stock fraud, but of course there are many more reforms needed.

In comparison, bond market reform has lagged behind. Since the beginning of this year, bond defaults have occurred frequently, especially defaults of large state-owned enterprises, which have affected the credibility of state-owned enterprises and governments in the relevant regions.

The problems are, first of all, market fragmentation and lack of uniformity in issuance and regulation. There are three regualtors that can greenlight bond issuance: China Securities Regulatory Commission (CSRC), the People’s Bank and the National Development, and Reform Commission. In particular, the inter-bank market has evolved to one that’s no longer a place for inter-bank financing. Non-bank financial institutions and non-financial enterprises have been able to issue and list bonds, including medium-term notes, in the inter-bank market.

Second, the Exchange Bond Market and the inter-bank market, are divided in trading, leading to different pricing for the same bonds. In July, the central bank and the China Securities Regulatory Commission decided to agree to cooperate on undertaking interlinked and interconnected cooperation between the two markets, which is a good change and is recommended (by me) to be implemented as soon as possible.

In addition, most of the inter-bank market bonds are held by banks in large quantities. Banks underwrite and hold bonds, and market liquidity is poor. Once the debt defaults, commercial banks suffer.

There are still many problems in the bond market, and the basic condition is to have an unification of issuance standards, transaction circulation, and regulatory mechanisms

According to China’s Securities Law, the market (for bonds) should be the Exchange Bond Market, and the regulator should be the China Securities Regulatory Commission. The inter-bank market should return to its roots as the interbank lending market, corporate bonds should all withdraw (from the inter-bank market). Interest rate bonds (goverment bonds and policy bank bonds) can be traded in both markets at the same time, but the settlement should be interlinked to facilitate financing between banks, but also to enable the two markets to have same pricing for same bonds.

After the fundamental problems are solved, there are still big space for bond market reforms. We have to speed up in the problem-oriented and goal-oriented fashions, otherwise it will be the next place of big eruption of financial risks.

NOTES:

1) This is the part that has since caused the biggest pushback. Media outlets and experts apparently associated with China’s central bank have pointedly say Lou’s view is incorrect here. That pushback is NOT included in this newsletter because this is already too lengthy.

2) A number of high-profile defaults have shocked the Chinese bond market this year.

第六，要防止数据金融平台大而不能倒。

数据金融平台在我国发展很快，有相当的积极作用，主要是根据搜集的数据分析借款方的风险特征，提供给贷款银行，帮助其获客和做出风险评估。这有利于补充银行，特别是中小银行对小微企业服务能力。但也有可能造成系统性风险。有的专家已指出平台资本加杠杆，共贷份额小以致于风险留存不足，2C和2B的比例不当，数据所有权问题等，如果需要解决可以定出规范。另一个重要的风险是，如果单一数据金融平台占有的市场份额过大，它“爬”出的数据真实性，以及风险评估模型的偏差，会导致大量的信贷坏账。例如，某平台短短几年已同数十家银行合作，形成数万亿贷款。可以限制与单一平台合作的银行数量，比如不超10~15家。同时，按同样条件让多家平台做类似业务，形成竞争。有比较也便于监管，并在效率和风险之间做出平衡，防止赢者通吃“大而不能倒”，埋下系统性风险隐患。正如刚刚结束的中央经济工作会议所要求的，金融创新必须在审慎监管的前提下进行。

Sixth, we need to prevent data-based financial platform from becoming too big to fail.

Data-based financial platforms are developing rapidly in China and have a considerable positive role, mainly in collecting data and analyzing the risk profiles/characteristics of borrowers and providing them to lenders, to help lenders acquire customers and make risk assessments. This is conducive to complementing the capabilities of banks, especially small and medium-sized banks, to serve micro and small enterprises. However, the platform also have the potential to create systemic risk.

Some experts have already pointed out the platform(s) is(are) leveraged; the fintech platforms are so leveraged that, in lending, their own capital actually made up only a small percentage of the loans, resulting in insufficient "risk retention" which is in fact no skin in the game; their lending to corporate customers and to individual customers are disproportionate; there is also the issue of the the ownership of data in possession of the platforms.

Another important risk is that if a single platform has too large a market share, the authenticity of the data it "crawls" and the bias of the risk assessment model could be in question, potentially leading to a large number of bad loans.

For example, one platform has partnered with dozens of banks in just a few years, resulting in trillions of yuan in loans. We can limit the number of banks cooperating with a single platform, for example, to no more than 10-15. Also, enable multiple platforms to do similar business to create competition.

It is also easier to regulate if there are more than one platform, where it’s easier to compare and supervise, and to strike a balance between efficiency and risk, to prevent the winner-takes-all, too-big-to-fail situation, and prevent the potential for systemic risk. As the just-concluded Central Economic Work Conference called for, financial innovation must be carried out under the premise of prudential supervision.

NOTE: The whole text appears squarely aimed at Alibaba-controlled Ant (Financial) Group, to which China's anti-trust authority just opened a case on Thursday morning.

第七，宏观审慎监管要面向事前、事中。

最近对某数据金融平台约谈和暂停上市，实际上是防范系统性风险于事前、事中，这是核心点，如果系统性风险已经爆发，政府不得不救，则纳税人恐会损失。这方面国际经验可资借鉴。美国履行宏观审慎管理的是“金融稳定监督委员会”，由财长做主席，成员是各监管机构，委员会定期开会，分析各金融领域潜在风险，决策之后，由该领域监管机构“排雷”，并向委员会报告。 在财政部设有专门的团队，汇集各监管机构信息和市场变化，用模型辅助分析可能出现的系统性风险，交由委员会讨论。通过这种办法把系统性风险止于事前、事中。财长做主席的原因，是其更适于代表纳税人的利益，保护纳税人是其职责之所在。我国缺乏将多领域风险集中分析，解决在事前、事中的机制。

Seventh, macro-prudential supervision should be oriented to prior and interim supervision.

The recent interview and suspension of IPO of a data-based financial platform is to prevent systemic risk in a prior and interim fashion, which is the point. If systemic risk has already broken out and the government has to make a bailout, I’m afraid taxpayers are left to lose. In this aspect, there is international experience to learn.

The U.S. macro-prudential management is performed by the Financial Stability Oversight Council, chaired by the Secretary of the Treasury with members from various regulatory agencies. The Council meets regularly to analyze the potential risks in various financial areas. After a decision is made, the regulator in this specific area goes to “demine”/clear the land mine, and then reports to the Council.

A dedicated team in the U.S. Treasury Deparmtent compiles market changes and information from regulators, and and uses models as assistance in analyzing potential systemic risks, which are then presented to the Council. In this way, systemic risk is identified and put to a stop in the prior and interim stages.

The reason for the Treasury Secretary to chair the Council is that he or she is better suited to represent the interests of taxpayers - it’s his or her job to protect taxpayers. Our country lacks a mechanism to centralize the risk analysis from multiple areas, and address them in the prior and interim stages.

NOTE: Again, the platform Lou talked about is still Ant (Financial) Group.

第八，系统性风险处理要以纳税人利益为上。

按目前的制度性安排，人民银行负责宏观审慎监管，但显然没有做到防范于事前、事中。例如据公开报道包商银行破产案，再贷款和存保基金投入了1700亿元用于救助。实际上是冲减了应上交中央财政的“铸币税”。通俗地说，发钞产生“铸币税”，实际上不准确。财务分析上是，只要央行资产负债表存在，资产方收益必须大于负债方成本，其差额就是“铸币税”。它在央行资产负债表扩张时增加，在紧缩时减少，但总是存在。在其中扣除央行预算支出，净“铸币税”应交中央财政，统一编入预算，交全国人大批准，并将全部预算向社会公开。1700亿再贷款如果损失，就会冲减资产方收益，纳税人受损。因此，央行是最后贷款人，并不是最后损失承担人。要以纳税人利益为上，选择一个破产重组方案，尽量追回贪污、挪用、坏账损失，并追责，把纳税人当期损失减为最小，被救机构应当留有国家股权，可为可转优先股，以便在经营转好时变现退出。但无论如何再贷款本利可能难以全部收回，纳税人受损，减少财政收入增加财政赤字。包商银行在治理结构、资产质量、资本充足率等核心问题上早就存在严重问题，视而不管，风险爆发。因此，把问题止于事前、事中最为重要。我是明确反对“赤字货币化”的，即财政赤字通过向央行透支或向央行直接发债加以弥补。但是用再贷款救助系统性风险，造成的损失冲减应交由中央财政的利润，造成财政赤字扩大，成为“货币赤字化”，我更加反对。后者操作不透明，缺少全国人大和社会监督，隐含道德风险。其实恒丰银行破产重组的情况也类似，纳税人负担了当期损失，唯一的希望是新进入的国有股权今后有较好收益。在继续去杠杆，处理潜在风险过程中，类似的情况还可能发生，不得不提出来，请大家注意。

Eighth, systemic risks should be handled in the interest of taxpayers.

According to the current institutional arrangement, the PBOC is responsible for macro-prudential supervision, but apparently it failed to prevent risks from happening in the prior or interim stages.

For example, according to press reports on the bankruptcy of Baoshang Bank (ENG, Pekingnology), a total of 170 billion yuan was put into the bailout by refinancing and China’s deposit insurance fund. In fact, that amount of money was the seigniorage that should have gone to the Chinese central treasury.

A popular narrative is that issuing money creates seigniorage. That is actually inaccurate. A proper financial analysis is that, seignoirage always exists: it increases when the balance sheet of the central bank expands, and decreases when the balance sheet of the central bank shrinks.

After deductions from the central bank's budget expenditures, the next seigniorage should be paid to the central Treasury and incorporated into the national budget that will have to be approved by the National People’s Congress (China’s national legistlature). And the entire budget should be made public.

The 170 billion, from (central bank’s) refinancing, if suffers losses, then the loss will offset gains in the asset-side of the central bank’s balance sheet, and (in fact) taxpayers will suffer the loss. Therefore, the central bank is the lender of last resort, but not the last bearer of the final loss.

We have to put taxpayers' interests as the top, choose a bankruptcy and restructuring plan which recovers losses from the embezzlement, misappropriation and bad debt (from Baoshang Bank), and hold (lawbreakers at Baoshang Bank) accountable, to minimize the current losses of taxpayers.

State equity should be remain in the bailouted financial institution, and the state equity can be converted into preferred shares, so as to make an exit when the institution goes above water.

However, in any case, it may be difficult to fully recover the principal and interest of the refinancing (the loan from the central bank used in the bailout), and taxpayers’ interest are damaged; revenue of the central Treasury is reduced, and the fiscal deficit is increased.

Baoshang Bank has long had serious problems with its governance structure, asset quality, capital adequacy and other core issues, which were ignored; regulators saw it but didn’t intervene; it finally erupted.

Therefore, it is most important to stop the problem in the prior and interim stages. I am unambiguously opposed to the 赤字货币化 monetization of deficits, which is the practice of making up for the fiscal deficit by overdrafting the central bank or issuing bonds directly to the central bank. However, I am even more opposed to the use of (central bank’s) refinancing to rescue (consequences from) systemic risks, resulting in losses offsetting the profits that should be handed over to the central treasury, resulting in the expansion of the fiscal deficit, which has become 货币赤字化 running deficit because of monetization (probably a bad translation).

This is not transparent, lacks supervision by the National People's Congress and the society, and implies moral hazard. In fact, the bankruptcy and reorganization of Hengfeng Bank is similar, taxpayers are burdened with current losses, and the only hope is that the entry of state-owned equity resulting in better returns in the future. In the process of continuing deleveraging and dealing with potential risks, similar situations may still occur and this has to be brought up for your attention.

NOTES: Lou called out the People’s Bank of China by name, saying it failed in its duty. Lou also has issues with the state intervention in Baoshang Bank and Hefeng Bank, apparently believing taxpayers suffered big current losses.

Pekingnology actually ran a detailed translation on how Baoshang Bank failed in August.

以上是资本市场八个方面问题的思考，是提出问题和解决问题的建议，供大家特别是政府部门参考，助推问题解决，使资本市场发展更为健康高效，助力双循环发展新格局。

The above is a reflection on eight aspects of the capital market, to raise questions and offer solutions, for your reference, especially government departments, to help solve problems and make the development of the capital market more healthy and efficient, and contibute to the new development pattern of dual circulation.

Hope you find the long read worth your time. Happy Holidays!

The newsletter is penned by Zichen Wang, founder of Pekingnology. Feedback is welcomed at zichenwanghere@gmail.com.