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Market Avenue

UPDATED: December 30, 2013 NO. 1 JANUARY 2, 2014
The Role of Risk

China should keep an eye on debt risks. In an increasingly volatile financial market, risks may have positive effects, as market participants can better weigh risks and returns, and respond to changes in a more accurate way.

Recent financial reforms, such as the central bank's policy on deposit certificates in the interbank market and the initial public offering (IPO) registration system adopted by the China Securities Regulatory Commission, let risks better play their role in guiding microeconomic behavior and resource allocation.

The market is fraught with uncertainties, or more specifically, risks. Just like prices, risks can also guide resource allocation. While prices reflect the supply and demand situation, risk mirrors the games between market participants and the market.

Individual market participants tend to maximize their profits by making decisions according to available price information. Without regard to risks, problems like overcapacity, bubble expansion, misallocation of resources and environmental pollution will surge.

It's not rare to see economic behavior go against the principle of sustainable development without fully recognizing the role of risks.

As a result of strict interest rate control, many Chinese banking institutions are engaged in boosting the expansion of loans, rather than fostering inherent innovation and business diversification. Chinese banking institutions all have similar businesses and scale expansion is still their sole pursuit.

The securities industry has the same problem. Although the regulatory authority has formulated delisting rules and asked public companies to improve dividend distribution, very few companies have been delisted. Some floundering listed companies managed to survive through reorganization. The lower risks of delisting, to some extent, encourage speculation.

All these indicate that it's urgent to create an environment for financial market participants to make decisions based on existing risks, which requires interest rate liberalization, risk-based pricing of capital and financial institutions' prudential operations. It also needs the deposit insurance system, a financial safety net and differentiated operations of financial institutions. Beyond that, a delisting system should be set up to strengthen external controls and strike a balance between risks and returns.

Efforts should also be made to implement the IPO registration system, nurture qualified securities investors, set up an investor-oriented price discovery mechanism, and strengthen supervision to realize more efficient resource allocation in the securities market.

In short, a risk-proof financial market is just like a pool of stagnant water. Financial reforms should be pushed forward in setting up a financial safety net, eliminating regional and systematic financial risks, and urging market participants to make decisions on their own while considering possible risks. Only in this way can the market play a dominant role in allocating resources and the quality of economic development be improved.

This is an edited excerpt of an article by Xiang Zheng, a financial commentator, published in Securities Times

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