Inefficiencies In China's Financial Innovation And The Negative Impacts

Financial innvoation includes financial system innovation and financial instrument innovation. The former supports the latter. A good financial innovation mechanism may promote financial deepening by improving financial ecological cycle.Most Chinese financial institutes are operating in divided management, and the comprehensive management is just at the emerging stage. The divided business mode limits the resources available to the financial institutes and weakens their capability of financial innovation. The Shanghai Stock Exchange and the Shenzhen Stock Exchange are both based on the membership mode. Compared to the incorporated exchanges, they obviously lack motives to carry out financial innovation. The membership mode is unable to stimulate exchanges' financial innovation motives.In terms of financial structure innvoation, China's problem is too much dependence on indirect funding, so too much financial risk remains in the banking sector. Size of the company bonds' market is too small, and there's no clear layer division in the stock markets. Hence, Chinese enterprises have too few funding channels, leading to high concentration of financial risks in the banking system.The problem of China's financial supervision innovation is the contradiction of the divided mode of China's financial laws and supervision system against the trend of comprehensive business operation. On one hand, the inefficient financial supervision innovation increases the system risk, and on the other hand, becomes administrative resistance to the financial instrument innovation.China's financial derivatives market is inefficient in terms of both trading types and trading volume, because domestic interest rates and exchange rates are not generated from fully free market competition and basic financial instruments are inefficient. The inefficiency in financial instrument innovation limits investors' options in the market, leading to market inefficiency.Innovation strategies targeting at the above mentioned problems are as follows.To realize the comprehensive operation mode of financial institutes, problems like business supervision and internal & external integration of resources should be addressed. To realize the incorporation of exchanges, the exchanges should be liberated from governmental functions. The comprehensive operation mode could strengthen financial institutes' capability of financial innovation, and the incorporation of exchanges could intensify exchanges' innovation motives. In terms of China's financial structure innovation, the structure of China's capital markets should be improved so that risks in the banking system could be shunted. The capital markets structure with clear layer divisions such as OTC market, growth enterprise board, SME board, main board and a larger company bonds market should be established, to gradually lessen the risks in the banking system.In terms of financial supervision innovation, current laws should be amended to cover financial holding companies, and a communication mechanism should be set up among the central bank and the 3 supervising committees. In addition, information disclosure should be improved with more emphases.To promote the financial instrument innovation in China, the first thing to do is to have the interest rates generated in a fully free market through free competition. Meanwhile, control on foreign exchanges should be removed so that demand and supply of foreign exchanges could be freely expressed to form the market exchange rates. Furthermore, the basic financial instruments should be improved. The development of fair interest rates, exchange rates and basic financial instruments, together, lay a solid foundation for the development of financial derivatives in China.