The great deleveraging: essays on China's financial reforms of 2016 and 2017
Creators: name: Zhao, Zheng
Publisher: name: No Publisher Supplied
Year: 2022

description: The Chinese Central Government introduced economic and financial reforms (“Supply-side Structural Reform (SSR)”) in Dec. 2015 to reducing the systematic default risk in China’s economy by de-capacity (removing excessive production capacity), de-stocking (removing excessive inventories) as well as deleveraging. The achievement of deleveraging involves removing high leverage ratios in both firms and financial institutions. Shadow banking, developed since 2009 and became an important financing channel besides the traditional approach, equipped with the same “bank-centric” feature as the financial sector received a lot attention during deleveraging. Policymakers together with financial regulators working cooperatively toward deleveraging by regulating financing channels connecting banking system and the real economy and urging the reduction of leverage ratios of firms. A variety of methods were involved in the process, such as banning of shadow banking, regulating the banking system, urging bank loan repayment in targeted industries, and discouraging the issuance of new loans to these firms and industries. The retraction of bank loans, the restrictions placed on issuing new loans and fund source of banks changed financial condition for firms. This change led firms to seek financing from alternative channels which affect risk of investment in stock market. To address the change in financial conditions and its effect on stock market during deleveraging, this research discusses the issues in 3 chapters. Chapter 1 surveys the background and implementation of deleveraging policies. “Financialization”, which support overleverage ratio in real economy, was used by firms to hedge risks from uncertainty in goods market. Deleveraging has different effect on firms with different types of ownership, and operating liabilities also increased while financial debt fell due to changes in financial conditions. Updated regulations for deleveraging in financial sector (especially in banking system) designed to remove overleverage in financial system via discouraging funds into asset and firms overleveraged, reforming internal management based on macro prudent principles, and encourage funds into firms with real financing needs to develop their business. Chapter 2 discusses the choice of measuring stock market volatility risk in studying financial condition changes’ effect on stock market volatility. Among the 9 listed models for calculating volatility, Truncated Realized Volatility (TRV) is selected for volatility risk measurement. And the statistic shows mid-to-small capital sized stocks was not such volatile as large capital sized stocks before deleveraging, and it became more volatile than large capital sized stocks after deleveraging. Chapter 3 tests the dynamic relationships among the stock market volatility risk, the economy’s demand of money and the use of leverage in stock market (alternative financing approach) represented by margin trading balance using Vector Error Correction Model (VECM) during deleveraging. Deleveraging caused changes offer an opportunity of studying volatility risk in stock market through the perspective of leveraged trading and related financing conditions. Margin trading contributed to stabilize stock market volatility after the reforms were imposed, while it destabilized stock market before deleveraging. This result indicates firms’ alternative financing approach’s effect on volatility. Furthermore, tight financing conditions limited funds from the banking system (interbank market) to access the stock market directly. This reduced speculation in the stock market which further reduced volatility.