Over lunch on a sunny June afternoon, Mr. Zhang, the enthusiastic co-founder of a local education company offering A-level courses, couldn’t contain his excitement as he shared some fantastic news. His company had secured a bank loan through standard procurement channels for the first time. This achievement marked a significant milestone, not just for his business but also as a testament to Beijing's ongoing efforts to ease financing obstacles for small and medium-sized enterprises (SMEs).

The authorities expect that funnelling lower-cost bank lending into credit-starved private firms will boost the economy’s long-term productivity.

But shifting bankers away from their long-term practice of lending primarily to state-owned enterprises (SOEs) and large private firms has been a tall order. The leadership has had to take on yet another group with strong vested interests. In another enlightening conversation, Mr. Xia, a mid-level manager at a regional development bank, shed light on what this meant for Chinese bankers.

They now face reduced wages, fewer benefits, and a stricter regulatory environment. Gone are the days when personal judgment alone dictated a company's creditworthiness. Today’s bankers must strictly adhere to prescribed rules and accept they are providing a service rather than calling the shots. This shift signifies a broader transformation within the industry, as financial institutions align more closely with national economic goals and regulatory standards.

These two stories from Enodo’s recent trip to China demonstrate how across the country, the government’s ambitious but often underplayed agenda for financial reform is translating into genuine change throughout the sector and those reliant on it.

The trip included over thirty visits to key financial institutions, such as the PBoC, regulatory bodies, exchanges, banks, securities firms, asset managers, and academic institutions. Each provided insight into how these reforms are progressing, and what we can expect to see over the course of Xi’s current term. As ever, the story is far from black or white, and often misunderstood in the West where most China watchers have concluded that Xi Jinping is far from a reformer.

How Bankers and Financiers Became a Target

As we approach the Third Plenum, Enodo has sought to underline the holistic nature of Xi’s present reform agenda.

The government is seeking to ensure that individual sectors are reformed and optimised into a whole-nation system capable of supporting Beijing’s central ambition of technological innovation.

The finance industry is no exception. Our meetings confirmed our previous observations that regulators are focused on streamlining the bloated financial sector as they see the need to redirect resources and employment to ‘real activity’ in pursuit of the technological and manufacturing dominance that China seeks to attain.

Financial services contribute approximately 8% of GDP, a higher proportion than the OECD average of around 5% or the EU’s 4%. Beijing worries that this stems from unhealthy, speculative practices that undermine long-term economic prospects. The US figure is similar to China’s, but the nation’s top graft-busting watchdog has vowed to eliminate ideas of a Western-style “financial elite”.

The Party believes that technological innovation is the primary route out of China’s economic woes, and this necessitates directing lending towards 'new quality productive forces.' And it sees the private SME sector as having an important role in fostering productivity growth.

This signifies a sweeping transformation in the finance industry. For many years, Chinese bankers have wielded considerable power over resource allocation, determining loan distribution based on their own discretion. Traditionally, they have been more willing to take risks and leverage funds, confident in their ability to secure alternative financing to meet obligations. Their preference has consistently leaned towards state-owned giants and the property sector, bolstered by the expectation that the government would step in to mitigate any substantial losses. This is no longer the case.

Two contacts from the Big Four banks described this transformation as a shift from bankers being "restaurant managers" to "waiters." No longer do they decide the menu or set the prices (determine the loan terms and beneficiaries). Instead, they now merely serve the dishes to the customers (administer loans based on new regulatory requirements rather than personal judgment).

They posited that the financial sector's disproportionate income and status, compared to its level of professionalism, impedes specialization within the real economy. Despite regulatory efforts to promote direct equity financing, our interlocutors maintained that banking would continue to be China's primary allocator of financial resources, with equity finance serving as a complementary tool.

However, the financial sector can only fulfil this role if its entire governing framework and incentive structure undergo significant changes.

Consequently, the government is changing bank practices and curbing the influence of individual bankers. Additionally, the authorities are capping salaries in the financial sector to redirect talent towards technology and manufacturing industries.

Ensuring consistent implementation of the financial reform agenda across the country will likely receive renewed focus in the wake of the Third Plenum.

The PBoC's Strategic Shift

Our first visit was to the newly operational PBoC headquarters, where we drank green tea with an old friend and discussed the central bank’s role in Xi’s reform agenda.

Source: PBoC

China’s current monetary policy framework, like its overall economy, could be best described as hybrid - a hybrid quantity and price system, but one in which administrative guidance also remains key.

On the positive side, the PBoC is progressing further with increased use of price-based instruments. On the negative side, it is also strengthening its administrative control over credit.

The establishment of a new ‘Credit Market Department’ underscores the latter shift. Beijing sees this as a strategic pivot needed to ensure the banking system enables technological innovation, the transition to a green economy and inclusive finance.

However, concerns remain that these changes could lead to increased credit rationing. There is a risk that the PBoC might overemphasize direct intervention and credit allocation, potentially restricting credit flow to specific sectors or borrower types. This could hinder efficient capital allocation, limiting innovation and growth in sectors that would benefit from more market-driven credit availability.

A National Financial Regulatory Administration (NFRA) official told Enodo that China is committed to shifting towards interest rate-focused monetary policy, aimed at managing inflation and fostering economic growth.

Indeed, at June’s Lujiazui Forum, PBoC Governor Pan Gongsheng unveiled that the central bank is considering using a single, short-term interest rate, instead of multiple policy rates, to guide the economy, as well as narrowing the trading corridor for the benchmark seven-day interbank lending rate.

By focusing on the price mechanism, the PBoC would be more closely aligned with market-oriented practices seen in other major economies. This could create more effective interest rate management and a more efficient transmission of monetary policy through the financial system, ultimately fostering a more responsive and resilient economic environment.

Where does this leave China? The NFRA official argued that the PBoC possesses sufficient and flexible tools to blend both types of monetary mechanisms effectively. In his view, balancing quantitative control over money and credit supply with market-driven interest rate policies tends to foster stable market conditions.

We expect the focus of these changes will remain ensuring financial stability as well as improving the efficiency of the allocation of credit in line with the authorities’ vision.

Governor Pan reaffirmed the policy stance against large stimulus but also hinted that the central bank will soon become more active in the secondary bond market. The PBoC’s involvement in government bond trading is an attempt to address the shortcomings of its current monetary transmission mechanism. At present, the authorities would like to temper this year’s bond market rally, which has seen yields plummet amid economic uncertainty and volatile stock markets.

Chinese officials and economists see stable CGB yields as crucial for maintaining investor confidence, especially amid poor performance from other assets and sluggish domestic demand. Their goal is to maintain a level that accurately reflects economic conditions, thereby bolstering confidence and promoting a financial environment conducive for continued reform.

Curbing Financial ‘Overcapacity’

The government has repeatedly identified overcapacity as a problem of ‘coordination.’ As we discussed, inter-provincial competition to capture shares of emerging industries has often led to duplicated industrial capacity, that goes to waste as industries consolidate.

A visit to the Shanghai Futures Exchange (SHFE) illuminated how this process is unfolding. Zhengzhou, Dalian, and Guangzhou all have individual exchanges, and within Shanghai the CCFEX and Energy Futures Exchange aim to specialise in futures for different sectors. An SHFE official framed these developments as a product of local competition to attract talent and investment to the region.

This regional competition resurfaced in discussions with Chinese bankers. One official outlined an emerging consensus against having different regions extensively develop their own financial industries, for fear that regional competition will waste resources. Another ‘Big Four’ executive argued that Shanghai and Hong Kong suffice, with their respective roles being as onshore and offshore financial centres.

The initial wave of enthusiasm for regional financial development is now being tempered.

State-owned financial entities have come to occupy a central role, with central authorities throwing cold water on regional financial sector expansion. The closure of local financial asset exchanges, initially hubs for trading local non-performing assets, underscores this recalibration.

Overcapacity has also affected the securities industry, with one industry veteran telling Enodo that the 130 securities firms that currently exist are unnecessary for financial sector needs. The industry has thus sustained the most serious salary cuts within the financial sector, with staff subject to pay drops up to 30% from their previous salary.

The economic downturn has slashed the securities industry’s bottom line and we expect significant consolidation.

Conclusion

Change has come to the finance industry. The government’s intentions are good – Enodo has long argued for greater access to finance for SMEs and unified interest rate management, and increased regional specialisation will avoid wasteful duplication that hinders more efficient development.

But the new agenda will face significant resistance. Individual bankers are already chafing under new regulations. They may be alienated further as limits on their salaries and influence intensify. Nor will local officials have great enthusiasm for reversing local financial initiatives that they have banked their careers on.

The Third Plenum, as a display of Xi’s consolidated ability to push through difficult change, will likely signal there is no other path. The finance sector will adapt whether it likes it or not. But structural and personal barriers remain high, and the risk that central over-intervention undermines progress is also significant.

How these reforms develop will be a crucial factor influencing the success of Xi’s vision for China’s development. Enodo will continue to pay close attention to changes in the industry post-Third Plenum and in the coming years.