Yan Xiang, Chief Economist of Huafu Securities, This article was published in China Banking and Insurance News
May 16, 2024
"The position of the development strategy and business model of financial institutions in supervision" is a new issue faced by the practice of financial supervision in recent years, and the attention of the industry and academia is also increasing. This paper analyzes this issue based on the latest development of domestic and foreign financial markets.
Changes in the business model of financial institutions
It is of great significance for financial supervision
In the supervision practice of financial institutions and financial products, in addition to using various mature quantitative methods to monitor risk and compliance factors, the development strategy of financial institutions, whether their business models are sustainable, and whether they can cope with complex environmental changes have gradually become important issues in domestic and foreign financial supervision. Among them, strategy is related to the direction, which is reflected in the vision of compliance, the scale of pursuit, and the influence exerted, while the business model includes the established customer structure, business structure, profit base, and operation management system. To a large extent, whether the development strategy and business model are compatible with the resource endowment and external operating environment of the institution, as well as whether it has sufficient adaptability, determines the sustainable operation ability of the institution.
With the deepening of global financial liberalization and globalization, the breadth and depth of the financial market have developed substantially, but financial risk events are still frequent, especially in the context of substantial changes in the external environment, the development strategy and business model of financial institutions usually face great challenges, which can easily lead to crises, especially before and after the Fed's continuous interest rate hikes, geopolitical conflicts, the new crown epidemic and other events.
The Silicon Valley Bank incident in the United States in 2023 is the most recent typical case of a financial crisis that was almost triggered by a company's strategic mistakes. In March 2023, against the backdrop of the Federal Reserve's continuous interest rate hikes, startups' cash flow tightened, and Silicon Valley Bank's deposits continued to decline, and it was necessary to sell securities assets to replenish liquidity, resulting in the transformation of its securities assets from floating losses to actual losses. The huge losses triggered a massive run, with SVB withdrawals amounting to $42 billion on March 8, 2023 alone. On March 10, 2023, the California regulator announced the closure of Silicon Valley Bank and its takeover by the Federal Deposit Insurance Corporation (FDIC). In addition to the relative lack of supervision of small and medium-sized financial institutions in the United States, the serious mismatch of Silicon Valley Bank's balance sheet is the main factor. Most of its deposits come from start-up enterprises, the proportion of savings deposits is low, and the debt structure is not stable enough. On the asset side, only 35% of its loans are invested, while 57% of its assets are invested in U.S. Treasuries and mortgage-backed securities. In the context of the Fed's rapid interest rate hikes since 2022, the deposit interest paid by Silicon Valley Bank has been increasing, and the interest rate on asset-side bonds has continued to rise, causing its losses to continue to expand, eventually causing a run and the bankruptcy and restructuring of Silicon Valley Bank.
Chinese financial institutions
Evolution of business models
Compared with overseas developed economies, China's modern financial industry started relatively late, but it has developed rapidly.
From the founding of the People's Republic of China to the reform and opening up, under the guidance of the planned economy, the country implemented a highly centralized "great unification" financial system. All kinds of commercial banks and financial institutions across the country have been withdrawn and merged into the People's Bank of China system. The financial market was abolished, and all financial operations were concentrated in the People's Bank of China. The People's Bank of China is both the central bank and the commercial banking business.
With the reform and opening up, the reform of the financial system and the development of marketization have begun to advance. In terms of the banking system, from 1979 to 1984, the four major banks became independent one after another, and successively opened cash cashiers, residents' savings, loans, international finance, and various principal-agent businesses, which greatly enriched the functions of commercial banks. In the 90s of the 20th century, financial institutions developed in the direction of diversification and marketization. In terms of the banking system, "new players" such as joint-stock banks, policy banks, urban commercial banks, and foreign-funded banks have been restructured and entered the market, a diversified and multi-level financial system has taken shape, and the modern commercial banking system has begun to occupy the mainstream. In the securities market, the Shanghai Stock Exchange and the Shenzhen Stock Exchange opened one after another from 1990 to 1991, marking the beginning of the development of China's securities market and the start of direct financing.
Since the beginning of the new century, the internationalization and diversification of financial institutions have been strengthened. After China's accession to the WTO in 2001, China's economic development entered the fast lane. In order to meet the needs of economic development, in 2004 the State Council launched the reform of the shareholding system of state-owned banks, and completely eliminated the historical burden through state capital injection and financial restructuring. In the securities market, in 2005, the reform of equity division was launched, and it continued to develop in the direction of marketization, specialization and diversification. After the 2008 financial crisis, the "four trillion" stimulus policy was introduced, which drove urban investment and real estate financing, and accelerated the development of financial institutions. In a relatively relaxed regulatory environment, financial innovation models have emerged, interbank innovation has prevailed, and non-bank institutions have developed rapidly, but they have also objectively led to an increase in the number of funds idling and shifting from real to virtual.
In 2017, under the guidance of deleveraging and risk prevention policies, the financial business gradually returned to its origins, and high-quality development became the main idea. The 2017 National Financial Work Conference proposed to focus on the three tasks of serving the real economy, preventing and controlling financial risks, and deepening financial reform. It is necessary to strengthen the coordination of financial supervision and make up for the shortcomings of supervision. The 2023 Central Financial Work Conference proposes to promote high-quality financial development, comprehensively strengthen supervision, and emphasize the political and people's nature of financial work. In this context, on the one hand, domestic financial institutions have deleveraged, channeled, and chained to actively resolve and prevent risks; On the other hand, we will take the initiative to serve the national strategic goals, increase support for small and micro enterprises, inclusive services, science and technology, manufacturing and other businesses, and better serve the real economy.
financial institution
The direction of the evolution of the business model
Looking ahead, under the policy tone of high-quality economic and financial development, the subsequent evolution of the business model of domestic financial institutions needs to focus on the following three aspects.
In order to cope with the pressure of narrowing net interest margins, banking institutions should optimize their asset structure, improve the efficiency of capital operation and control the cost of liabilities. In the context of indirect financing, the banking system is still an important part of China's financial system at this stage. According to data from the State Administration of Financial Supervision and Administration, by the end of 2023, the net interest margin of China's commercial banks had fallen to 1.69%, falling below 1.7% for the first time, which is at a historically low level. The net interest margin continued to narrow, on the one hand, due to the continuous interest rate cuts on the monetary policy side, and on the other hand, due to the increase in fee reductions and concessions by financial institutions to the real economy. As an important indicator of bank profitability, net interest margin continues to decline, which means that banks, especially small and medium-sized banks, are facing increased operating pressure. Looking ahead, in order to cope with the pressure of the continuous narrowing of net interest margins, banking institutions should optimize the asset structure on the asset side, pay more attention to the revitalization and adjustment of existing assets, reduce the proportion of inefficient assets, and do a good job in the allocation of large types of assets to improve asset operation capabilities. On the liability side, banks should promote the reduction of the cost of liabilities, appropriately reduce the cost of high-cost deposits, and avoid malicious competition for deposits at high interest rates. In addition to the deposit and loan business, banks should actively explore intermediate businesses such as wealth management and asset management, diversify their development, and reduce the negative impact of net interest margin on bank profits.
Actively respond to the economic characteristics of the "post-real estate" era, and take the opportunity of new quality productivity to find new growth points. From 2000 to 2021, real estate played a crucial demand-driven role in China's economy, and the upstream and downstream industrial chains accounted for 1/4 of GDP. Benefiting from the upward cycle of real estate in the past, all kinds of financial institutions have developed significantly. However, looking ahead, the era of real estate-driven economy is likely to be over, and financial institutions need to actively look for new profit growth points to achieve sound operation. On the one hand, the demand for finance has gradually changed from indirect financing to direct financing, and the securities market is expected to usher in rapid development. On the other hand, innovation-driven new qualitative productivity is expected to become a new growth engine for China's economy. For banks, securities, insurance and other financial institutions, finding new growth points under the framework of new quality productivity will be a topic that their business models must face for a long time in the future.
Serve the construction of a financial power and take the road of financial development with Chinese characteristics. Guided by the spirit of the Central Financial Work Conference, domestic financial institutions should better serve the real economy and national strategies in terms of strategic layout, get rid of virtual and real, and use more financial resources to promote scientific and technological innovation, advanced manufacturing, green development and micro, small and medium-sized enterprises, and to meet the growing financial needs of economic and social development and the people; On the other hand, under the requirements of comprehensively strengthening financial supervision, it is necessary to strengthen its own regulatory self-examination and self-correction mechanism, eliminate blind spots, actively prevent and resolve various risks, and take the road of financial development with Chinese characteristics.
Looking ahead, the evolution of the business model of financial institutions under the new situation is an important step for them to improve their operational stability and practice high-quality development. For supervision, how to effectively evaluate the adaptability and adaptability of financial institutions' development strategies and business models will continue to be an important research topic in supervision.
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