China's Financial System: Growth and Risk

We provide an updated and comprehensive review of China's financial system and explore the possible challenges in the future. First, China's financial system has been dominated by a large banking sector, which has played an important role in financing the real economy in the past decades. With the interest rate liberalization, the profitability of banks will go down and the competition in the banking sector will become stronger in the future. Moreover, this sector still needs to meet the challenge to reduce the amount of nonperforming loans. Second, the role of the stock market in allocating resources in the economy has been limited and ineffective. However, with the rapid growth of the markets and the introduction of more financial products, financial markets are expected to play a more important role in the economy going forward. Third, a nonstandard sector that consists of alternative financing channels is the most successful part of the financial system in terms of supporting the growth in the past decades. The co-existence of this sector with banks and markets can continue to support the growth of private and local government firms. Finally, in order to sustain the economic growth in China, policies need to reduce the likelihood of damaging financial crises, including a banking sector crisis, a real estate or stock market crash, and a "twin crisis" in the currency market and banking sector.