Transcript of Question & Answer Session Remarks at the Women in Banking and Finance (WIBF) Business Series Lunch

Thank you very much for the speeches, its Geraldine O'Carroll from China Construction Bank here in Sydney. You made no comment about shadow banking, I was wondering if you had any comments on that area and lending to private enterprise, which the state owned enterprises are somewhat limited in doing. Thank you.

Maybe I'll start off. Look I think the significant growth of shadow banking is kind of a reflection, it's a manifestation of this regulatory arbitrage because China's policy you know their monetary policy is kind of a quantitative monetary policy target, they have an M2 growth target, they target credit, they have an interest rate cap but as the economy grows and develops and the needs of the economy grow people become very creative in finding ways around the regulation and that in a way manifested itself to the extent that shadow banking now is like you know 55 to 60 per cent of GDP. So the challenge here is it's not like, you know shadow banking sounds like a bad dirty word, but it's not like all of shadow banking is bad, sometimes it's a kind of a natural off shoot to kind of finance some of it, is really to finance real economic activity. The problem is because it's less well regulated there's always this risk that some of the activity is more speculative rather than real kind of – add real economic value in the economy and I think now that it's grown a lot I think Chinese Government is realising the risks involved in it and they've come up with some regulations to kind of help, kind of you know manage the risk, I don't think they necessarily want to squeeze shadow banking completely but they certainly want to take out some of the froth. Certainly the liquidity tightening we saw of the middle of last year, was partly designed because PBOC was worried, that a lot of this speculative people were funding themselves short term to do a lot of more speculative lending longer term and they wanted to kind of teach banks a little more lesson in managing liquidity. But this is way it's very important really to start developing the financial market going forward and some of these controls that they have put into place, for example the interest rate ceilings on deposits, they've already taken out the lending rate regulations a number of years ago but these deposit ceilings create a lot of distortions and therefore over time I think as the economy and financial markets develop they need to sort of advance towards that interest rate liberalisation and probably they need to at some point move their monetary policy framework away from targeting monetary aggregates which as the country develops and financially innovates targeting M2 or credit is no longer a really good metric to kind of figure out how that impacts output because there's other things going on. So they really need to do that shift. So it's a challenge and clearly I think – but again I would not say that all of shadow banking is bad but we do need to understand the nature of the risks and they need to start moving everything towards a more formal regulated financial sector, which is part of the reason why deregulation and the reforms are very important.

I was going to say financial liberalisation is very much a response to the growth of that sector but it in its self is a response to the fact that the core banking system is very tightly regulated and it's very similar to the experience we had here in the 70s, for shadow banking in Australia in the 70s, you can call it, that word didn't exist then because Paul McCullough hadn't come up with it by then, but you know that's what – it was about the same size relative to the core banking system in Australia in the 70s as so called shadow banking system in China is relative to the core banking system there now, that's what happens when you try and clamp down on the regulatory system, particularly on the ability to earn rates of return there it springs up somewhere else, that's what's happening, Chinese authorities are very much aware of that, that's why their embarking on this program of market liberalisation – financial liberalisation over the next – over the coming years. So as Johanna said it's not that you know shadow banking has this very sinister association with that word, but as I said this is just the financial sector providing necessary finance outside the core vehicle, because the core vehicles can't do – core part of the financial system can't do it, some of it is probably bad, I'm not sure it's any more or less bad as a share of their overall lending than it is on the core banking system to be honest because they're pretty good at doing some stuff that's probably not that good either. So you know it's an issue, they're very cognisant of it, they're trying to address it, again it doesn't necessarily mean it's going to be a smooth process but it's very much a similar situation a lot of advanced economies found themselves in in the 70s and the response is very similar.