Which Comes First, China Bank Reform Or China Corporate Bonds

According to what little I know about financial sector development (FSD), banking reform will precede development of a corporate bond market. I can't seem to find the source for this, but the general FSD progression is as follows:

� Lending and money markets-->
� Treasury bill market-->
� Government bond market-->
� Corporate bond and equity markets-->
� Asset-backed securities and derivatives

Dan,

I've only been studying this stuff for a few days but I will try and give an answer. My impression from what I am reading is that robust capital markets require many more institutions than banking markets.

Banking markets reform in the following manner: decisions are taken out of public hands so that loans will be made for economic instead of political reasons. At the same time, citizens are given title to their property and land so they can borrow against it. But banks need to be protected when making these loans; you can give people title to their property and banks will still not lend if they can't get the property when the loan is not repaid. So collateral laws must be reformed so that many types of property can be used as collateral, and lenders need to be able to quickly seize and dispose of collateral in the event of default. If these steps are followed, SMEs can get credit where only big SOEs could get credit before. Borrower protection is important but there will be no borrowing if the lenders aren't adequately protected.

It seems to me that capital markets just require many more institutions. Here the focus is on investor protection and making sure two things happen: minority shareholders need adequate infomration about the value of a company's business and they need to be confident that insiders won't loot the company. But a lot of insitutions go into this: you need disclosure rules for securities offerings, independent audits, and accounting rules that give investors the right information; good accountants and investment bankers to assess the value of companies; effective regulators (both public like the SEC and private like exchanges with high listing standards), prosecutors, and courts; securities laws that impose liability for false or misleading disclosures and that impose liability for insider trading and self-dealing; etc. etc. etc. This list comes from Bernard Black's article "The Legal and Institutional Preconditions for Strong Securities Markets," 48 UCLA L. Rev. 781 (2001).

I think that is a start but of course not nearly the whole answer...

But in practice it all tends to happen together and the key comes in making sure you ride the wave rather than sink under it.

The key thing to remember is that even though China's financial system is terrible today, it is MUCH better than it was. Although the rules are frequently broken we do at least now have things like creditor databases (albeit patchy), more central office control over lending in banks, published audits on the 3 of the 4 listed big SOCBs (which have also reined in their costs), and a much more professional securities market regulator.

Also China had to clean up its banks before expanding its securities market. The situation with Chinese banks in 1998 was that they had enough cash to cover withdrawals, but they were insolvent (i.e. their liabilities were more than their assets). This doesn't create a crisis as long as the depositors don't have anywhere else to put their money, but it would if they did.

If you have a healthy securities market beside an broken banking system, then the securities market would have sucked up all of the deposits from the banks, and the banks would have collapsed. So before expanding the securities market, they had to make all of the banks solvent (which they largely are). Now the banks have positive net value, it is possible to transfer some of the deposits that are in banks into other things like bonds.

Mr. Wang --

What you say makes sense, but if investors take risks with China stocks, why can't they take risks with China bonds?