The Banking System: Flexible Institutions and Party Domination

Abstract

Throughout the nearly three decades of reform, the Chinese banking sector has evolved from an appendage of the Ministry of Finance to a sprawling bureaucracy with specialized roles and an increasingly diversified ownership structure. It also has become a central aspect of China's economy as total lending climbed well over China's GDP. As a result of its immense size, the banking sector is also the key to understanding China's inflation and financial efficiency performance. To the extent that money supply affected inflationary expectation, the speed with which the banking system created money has played a major role in inflationary outcomes. At the same time, the banking sector is still the predominant channel for financing investment in China, making it the key to understanding the efficiency of capital allocation. Undeniably, the enormously complex set of institutions governing China's banking sector has affected both monetary expansion and the allocation of capital. Nonetheless, the waves of institutional changes in the reform era have not had a significant, independent impact on our dependent variables: inflation and the efficiency of capital allocation. As this chapter demonstrates, institutional changes often followed shifts in political signals. In other instances, institutional changes, although designed to achieve monetary and distributive outcomes, ultimately had little impact on them. Rather than being an independent causal agent, changes in banking institutions were crucial steps in the causal chain that led from elite political shifts to fluctuations in the dependent variables.