There are six major facets to China’s financial system: the People’s Bank, the government, commercial banks, financial and investment institutions, enterprises and individuals. To understand this nation’s financial system, one needs to understand the function of these six entities, and the relationships among them.
1. The People’s Bank
The People’s Bank is the source of “money” and it can also be called “the lord of money”. People’s spending money, bank deposit, mortgage money, and wages are all from the People’s Bank. The People’s Bank has two functions: “banknote printing” and “bill milling”. When the market needs more money, the Bank starts the “printing” function and injects money into the market; on the other hand, when there is excess money on the market, it starts the “milling” function and takes money out of the market.
The main approaches by which the People’s Bank injects money into the market are through “rediscounting” and “refinancing” the commercial banks, and buying government bonds in the open market.
2. The government
Like companies, all levels of the government need funds to maintain daily operations. The government’s main sources of funds are from taxation, state-owned enterprises income, government charges and debts.
3. Commercial banks
Commercial banks are essentially companies, but with the difference that they are trading money instead of commodity goods. After people deposit money in the banks, the banks use the deposit to make loans to various enterprises and receive interests from them. In turn, the banks provide a small interest to the depositors to encourage them to put more money in the banks.
4. Securities companies, financial and investment institutions
When the bank interest is low and cannot keep up with the rate of inflation, more and more people tend to favor investments that have higher expected rate of return. Securities companies, for example, usually do a variety of businesses including helping customers buy and sell stocks (brokers), helping companies go public (investment banks), speculating on the stock market, and helping the rich manage their investment portfolios.
Enterprises, especially small and medium enterprises (SMEs), are a symbol of and the foundation for economic prosperity. China’s SMEs contribute to 65% of its GDP and account for 75% of the urban job market.
Enterprises usually acquire capital through profits generated in their operations.
Another way is through financing. Capital funding may come from bank loans, venture capital firms, stock market, etc., and can be divided into equity and debt. When attracting equity investment, the existing shareholders of the company need to forfeit some shares, allowing investors to become the new shareholders. The advantage of this is that the shareholders do not need to borrow money and hence are under no debt pressure. Debt investment refers to borrowing money from investors and later paying them back with interest. The advantage of debt investment is that the company’s shares need not be transferred.
As Individuals consume, invest, and save, money is returned to the financial system, and it circulates through the financial system.