The People’s Republic of China (PRC) has adopted a gradual and prudential approach to liberalizing its financial system. The result has been the system’s rapid development in terms of total financial assets, number of financial institutions, and share of value added in the gross domestic product (GDP). This expansion and evolution have played an important role in the country’s tremendous economic growth since the 1980s. There remains room for improvement in terms of the system’s quality. As the PRC embarks on high-quality growth under its 14th Five-Year Plan (2021–2025) for National Economic and Social Development, it is imperative to assess the functioning of its financial sector and propose necessary reforms of a strong financial system as a key building block of sustainable, green, and inclusive growth.

This report assesses the PRC’s financial system and attempts to shed light on future reform directions. The PRC’s financial system is large. Several of its commercial banks operate globally and are among the world’s largest. The PRC has performed strongly in establishing financial institutions, growing financial assets, and adapting to economic conditions. However, as the economy transitions to focus on high-quality growth, financial reforms need to be deepened. A financial system based on state-owned banks is more vulnerable to government intervention and more likely to support state-owned enterprises (SOEs). This reduces the efficiency in credit allocation across the financial system. Although prudent phased financial reform and liberalization have helped the economy grow in a stable way, the impact of repressive financial policies turned from positive in the 1980s and 1990s to negative in the 2000s. This suggests rising losses in efficiency and the need for continued reforms.

The rise of digital finance and green sustainable finance are the two most important recent developments in the PRC’s financial system. The broad access, low cost, and reliable transactions provided by digital finance have created a revolution of financial inclusion and brought major change to people’s daily lives and commercial business models. The Government of the PRC has made a sustained effort since 2016 to build and improve the green finance system. What is needed now is policy support to create a favorable institutional environment and infrastructure.

The financial system can play a crucial role in fostering innovation in the PRC, provided further reforms are undertaken. The government should open up its financial markets steadily to both foreign and domestic private capital. In addition, further financial sector development should enhance the importance of direct financing through the expansion of capital markets. Under an improved regulatory mechanism, developing multilayer equity markets could provide financing for the technological advances the country’s economic growth and next-step transitioning require. Evidence across the world shows that credit markets from commercial banks generally provide only incremental support for innovation, but equity markets provide the financing for substantial breakthroughs. In this sense, the plan to set up a third stock exchange in Beijing to serve small and medium-sized businesses is a positive step. These steps should be balanced with an improved regulatory and supervisory system.