In a market economy, it is inevitable that bank credit funds find channels into the securities market not only for "profit-seeking'' but also for the process of debt-to-assets management in banks. Such connections can facilitate the interactive development of the banking system and the securities market.

Originally, there was neither definite regulation backing nor clear-cut prohibition against the flow of such credit funds into the stock market in this country.

The amazing investment rate of return from China's stock market since its debut in the early 1990s has attracted numerous investors, including many from banks with astronomical amounts of funds. In fact, during the stock market's initial stage of development, bank credit funds played a decisive role in directing market trends.

To maintain a stable financial order and avoid violent fluctuations, China's financial supervisory authorities issued rules to shut off direct links between bank credit funds and the stock market.

For example, the Law on Commercial Banks, effective on July 1, 1995, stipulated that commercial banks were forbidden to engage in trust and stock operations. And in 1997, the People's Bank of China drew up circulars to ban the illegal flow of bank funds into the stock market.

The Securities Law, enforced on July 1, 1999, reconfirmed the ban but unfortunately failed to come up with a legal channel.

However, the turning point came at the second half of 1999 when the central bank published regulations on the administration of the entry of securities companies and fund management firms into the inter-bank market. Bank credit funds, for the first time, got legal access to the stock market via securities companies and fund management firms.

It is roughly estimated that the amount of bank credit funds that had flowed into the stock market by the end of 2000 stood between 450 billion yuan (US$54.2 billion) and 600 billion yuan (US$72.3 billion), quite a large proportion of which entered via illegal channels.

The report noted that legal access for commercial banks to the stock market will not only help improve the asset structure of commercial banks but will also enhance the financial strength of securities companies and boost the development of the stock market.

Such access will effectively connect the money market with the capital market to allow them to develop side-by-side. While recognizing the positive effects of such a bridge between banks and the stock market, it is also necessary to put the project under close scrutiny.

The report urges the supervisory authorities to watch carefully the following aspects:

The access of securities companies and fund management firms to the inter-bank market should be maintained and securities companies should be allowed to obtain collateral loans from banks through standardized operations.

As historical experience shows, it is not wise to completely segregate the money market from the capital market, nor is an unchecked money flow from the former to the latter a wise idea.

The most pressing task for the supervisory authorities is to make sure commercial banks, securities companies and fund management firms all operate in strict accordance with concerned regulations while taking severe measures against wrongdoers.

Banks should be prepared to grant collateral loans to non-broker customers sometime in the future. Enterprises and individuals should be strictly prohibited from buying stocks with bank loans except collateral loans on stocks.

The key problem that results from the flow of bank credit funds into the stock market is financial risk. When a large sum of bank funds enters the stock market via illegal channels, the banks, brokers and investors are all exposed to financial risks which can spread across the banking system and the capital market. And as such risks accumulate the stability of the whole financial system is undermined, warned the report.

The authorities should enhance their supervision by improving the collection of statistics to adjust the flow of bank credit funds into the stock market.

When the stock market is excessively overvalued, the financial watchdog can restrain the fund flow from the banking system to the stock market and the central bank can adopt tight money policy, suggested the report.

The administration should also be readjusted according to the situation. As market players grow increasingly risk-resistant, the supervisory authorities should allow them more autonomy in operation.

Finally, since such access involves two types of financial institution, two relatively independent financial markets and two financial supervisory departments, it is crucial that the People's Bank of China and the China Securities Regulatory Commission strengthen their co-operation and jointly draft and implement concerned policies and regulations, added the report.

(China Daily 06/01/2001)