LUBIN SCHOOL OF BUSINESS
Pace University
FIN 396T/ECO 375: The Chinese Financial System
Prof. P.V. Viswanath
Spring 2014
Final

Notes:

• If your answers are not legible or are otherwise difficult to follow, I reserve the right not to give you any points.
• If you cheat in any way, I reserve the right to give you no points for the exam, and to give you a failing grade for the course.
• You have two hours to answer all questions.
• The exam is a closed-book exam.

  Final

  Notes:

  • If your answers are not legible or are otherwise difficult to follow, I reserve the right not to give you any points.
  • If you cheat in any way, I reserve the right to give you no points for the exam, and to give you a failing grade for the course.
  • You have two hours to answer all questions.
  • The exam is a closed-book exam.
  1. (30 points) Answer any five of these question using no more than one page; rambling and illegible answers will be penalized.
     1. Why does the the China Securities Depository and Clearing Co. (SD&C) act as a counterparty in all stock market trades?
     2. What sorts of Chinese are more likely to use credit cards? What is the implication of these propensities in the development of credit cards in China?
     3. Why did early foreign PE funds choose to engage in joint ventures with SOEs rather than invest in private start-ups?
     4. Why is it important to solidify ownership rights of rural land users from an economic point of view?
     5. What is liquidity transformation? How is related to securitization?
     6. Why is the establishment of the ChiNext stock market important for private equity?
     7. What are Asset Management Companies? How have they been used to manage China's NPLs?
     8. How does the PBOC conduct monetary policy? How does it contrast with the conduct of monetary policy in the US?
        
        
  2. (30 points) Answer all of these questions using no more than one page. Rambling answers will be penalized.
     1. Why do some economists believe that shadow banking is not necessarily toxic in China and can even be a force for good?
     2. What has been the trend in local government spending versus central government spending? What are the implications of this for the provision of social services in rural areas?
     3. What was the reason that shareholder rights have slowly improved in China?
        
        
  3. (40 points) Choose the appropriate answer:
     1. The China Securities Regulatory Commission (CSRC) was created in
        1. 1949
        2. 1978
        3. 1992
        4. 2012
     2. The province of Guangdong is in
        1. the northern part of China
        2. the southern part of China
        3. the western part of China
        4. the eastern part of China
     3. The Communist Party controls the banking system primarily by
        1. using a system of covert spies embedded in the managerial cadre
        2. by controlling the appointments of top bank managers
        3. by its control of the bank trade unions
        4. by using the courts to enforce its will on the bank managers
     4. One of the reasons that the Chinese government corporatized the SOCBs
        1. in order to improve corporate governance in the SOCBs
        2. in order to raise foreign financial resources to reinforce the undercapitalized SOCBs.
        3. in order to allow bank managers to sell their shares in the banks.
        4. both (i) and (ii)
        5. (i), (ii) and (iii)
     5. The proportion of shares in SOEs held by the Chinese government until 2000 was:
        1. 25%
        2. 40%
        3. 67%
        4. 95%
     6. After the introduction of the Bankruptcy Law in 2006, it is generally the case that
        1. if a firm does not have profits in three consecutive years, it is shut down by the government
        2. SOEs are still often bailed out by the government
        3. The government policy towards unprofitable SOEs is stricter than towards unprofitable private companies because the government has to set a good example to private firms.
        4. the Bankruptcy Law only applies to private companies.
     7. China's monetary policy is implemented by:
        1. The People's Bank of China
        2. The Ministry of Finance
        3. The China Banking Regulatory Commission
        4. The State Administration of Foreign Exchange
     8. Asset Management Companies are:
        1. companies that invest corporate savings
        2. companies that were created to streamline the processing and collection of bank NPLs
        3. consulting firms that are used by corporations to better manage their fixed assets
        4. mutual funds that compete with banks for private savings
     9. Netting refers to
        1. fabric that is used to protect oneself from mosquitoes in rural areas of China
        2. the deduction of taxes in the computation of Net Profits
        3. the offsetting of payments due between two parties so that only the net amount is ultimately paid
        4. a discount provided by SOEs for clients who pay in cash
     10. Compared to US credit card holders, Chinese credit card holders tend to
         1. pay off their balance due every month, rather than roll them over
         2. use credit cards only in neighborhood stores where the merchant knows his customers
         3. use foreign credit cards more than domestic ones
         4. use credit cards more than cash for everyday transactions

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  Final Solutions

  1.

  1. The China Securities Depository and Clearing Co. acts as a counterparty in all stock market trades for the same reason that there is a clearing corporation that takes both sides of every transaction in the futures markets in the US (and elsewhere). In the absence of such an arrangement, traders would have to worry about whether the other party would honor the trade and make payments even if prices subsequently changed in a disadvantageous manner. In developed stock markets like the US, only members of the exchange can trade, and stock market membership requires having sufficient assets to back any trade. Reneging on a single trade is not worthwhile for such people. In China, too, with time, such a system might develop. However, in the short run, it's faster and more efficient for to use a clearing house with the clearing corporation being the counterparty in all trades to assure traders that the trades will be honored.
  2. Younger and more well-to-do Chinese are more likely to use credit cards, according to studies. Older, poorer Chinese who are not used to such modern technologies are likely to be unwilling to use them. Over time, though, as younger people grow older they are likely to continue using credit cards. Also, as the Chinese economy gets richer and people get richer, they are likely to follow the trend and use credit cards. Hence the use of credit cards in China is likely to grow over time.
  3. In developed capital markets, PE investors rely on their reputation, on proprietary deal sourcing networks and on market intermediaries such as investment banks, accounting firms and law firms to make connections to good investment targets. Such networks did not exist previously, though they are now beginning to develop. Hence in the beginning -- and to a certain extent even now -- PE firms sought to speed up the process by leveraging SOE relationships.  Furthermore, they also sought these connections as insurance against state expropriation. They also expected quicker clearance through bureaucratic channels.
  4. It is important to solidify ownerhsip rights of rural land owners because otherwise they will not be able to use the land as collateral for loans. In addition, farmers would be tied to the land and would not be able to transfer ownership to other parties who might be better able to use the land.
  5. Liquidity transformation refers to the use of liquid instruments to fund illiquid assets. For example, a pool of illiquid loans might trade at a lower price than a liquid rated security secured by the same loan pool, as certification by a credible rating agency would reduce information asymmetries between borrowers and savers.  The rating agency is a kind of auditing agency, that assures the investor that the loan pool has high creditworthiness. Through such liquidity transformation, the previously illiquid assets can now be traded across investors, which is, essentially, the process of securitization.
  6. The ChiNext stock market was established as a wholly-owned, but independent arm of the Shenzhen stock exchange. It is intended specifically for start-ups to list and the listing requirements are less stringent. As we know, profitable and effective private equity investing requires an exit strategy; the development of a stock exchange specifically for start-ups makes such exits easier.
  7. Asset Management Companies are institutions that are created specifically to take over NPLs from banks and to collect on them or dispose them in an efficient manner.
  8. THe PBOC conducts monetary policy primarily by manipulating interest rates. This is in contrast to the US, where the Fed primarily uses open market operations to conduct monetary policy.

  2.

  1. Some economists believe that shadow banking may not be harmful in China for several reasons. The main one is that the existence of financial repression makes it very difficult for private businesses to obtain financing; shadow banking enables this. Second, the government has, in the past, bailed out failing banks -- and many shadow banking products are sold through banks -- and as a result, a financial crisis is less likely to occur; of course, the moral hazard problem is exacerbated by this phenomenon. Third, monies raised through shadow banking channels are used to invest directly in real assets, for the most part, as opposed to the creation of complex financial product structures as happened in the US in the months leading up to the 2008 crisis. Finally, shadow banking enables savers to get a fairer return for their money and thus constitutes a kind of safety valve, in the absence of which, social unrest might result.
  2. The trend, since the 1993 fiscal reform has been that most taxes are collected at the central level, while most social service and other development expenditures occur at the local level. As a result, sub-national governments are finding it very difficult to fund their activities. Consequently, the provision of social services, such as medical care has tended to worsen over time.
  3. One answer to this question is that, in the wake of increasing NPLs and declining bank profitability, the government has turned to stock markets to sell off shares in SOEs and to raise money. Clearly, in order to be able to do this, it is necessary to have individual and institutional investor participation, which is unlikely if shareholder rights are not protected, especially as investors grow more savvy.

  3. Choose the appropriate answer:

  1. The China Securities Regulatory Commission (CSRC) was created in
     1. 1949
     2. 1978
     3. 1992
        In the early 1990s, as the movement towards a market structure intensified, the government also wanted to move the SOEs to a more independent arrangement rather than have them be departments of the government. This could be achieved by creating a corporate persona for SOEs. The government also needed to sell SOE shares to raise funds for development, since the fiscal system pre-1993 was not very efficient. However, the process of issuing shares quickly led to corruption and the government realized the need to establish a regulatory body.
     4. 2012
        
  2. The province of Guangdong is in
     1. the northern part of China
     2. the southern part of China
        Guangdong is adjacent HongKong in the very southern (eastern) part of China.
     3. the western part of China
     4. the eastern part of China
  3. The Communist Party controls the banking system primarily by
     1. using a system of covert spies embedded in the managerial cadre
     2. by controlling the appointments of top bank managers
        Bank directors and senior bank officers are directly appointed by the Communist Party Organization Department
     3. by its control of the bank trade unions
     4. by using the courts to enforce its will on the bank managers
  4. One of the reasons that the Chinese government corporatized the SOCBs
     1. in order to improve corporate governance in the SOCBs
     2. in order to raise foreign financial resources to reinforce the undercapitalized SOCBs.
     3. in order to allow bank managers to sell their shares in the banks.
     4. both (i) and (ii)
     5. (i), (ii) and (iii)
  5. The proportion of shares in SOEs held by the Chinese government until 2000 was:
     1. 25%
     2. 40%
     3. 67%
     4. 95%
  6. After the introduction of the Bankruptcy Law in 2006, it is generally the case that
     1. if a firm does not have profits in three consecutive years, it is shut down by the government
     2. SOEs are still often bailed out by the government
     3. The government policy towards unprofitable SOEs is stricter than towards unprofitable private companies because the government has to set a good example to private firms.
     4. the Bankruptcy Law only applies to private companies.
  7. China's monetary policy is implemented by:
     1. The People's Bank of China
     2. The Ministry of Finance
     3. The China Banking Regulatory Commission
     4. The State Administration of Foreign Exchange
  8. Asset Management Companies are:
     1. companies that invest corporate savings
     2. companies that were created to streamline the processing and collection of bank NPLs
     3. consulting firms that are used by corporations to better manage their fixed assets
     4. mutual funds that compete with banks for private savings
  9. Netting refers to
     1. fabric that is used to protect oneself from mosquitoes in rural areas of China
     2. the deduction of taxes in the computation of Net Profits
     3. the offsetting of payments due between two parties so that only the net amount is ultimately paid
     4. a discount provided by SOEs for clients who pay in cash
  10. Compared to US credit card holders, Chinese credit card holders tend to
      1. pay off their balance due every month, rather than roll them over
         Studies have shown that about 3 percent to 8 percent of cardholders in China roll over their debts, generating interest charges, compared with about 40 percent in the U.S.
      2. use credit cards only in neighborhood stores where the merchant knows his customers
      3. use foreign credit cards more than domestic ones
      4. use credit cards more than cash for everyday transactions