China's Financial Decoupling - How Capital Markets Are Breaking Away from Bank Credit
Why the property crisis has made China's capital market liquidity far less dependent upon leverage sourced from the banking system.
(Part two of a two part series.)
In our last briefing, we explored the far-reaching implications of structural changes to the Chinese economy for growth in the money supply, as well as the central bank’s (PBOC) implementation of monetary policy and interest rate adjustments.
A paper from Zhang Lu (张瑜), researcher from Renmin University and chief macroeconomist at Huachuang Securities, argues that China’s changing growth paradigm now generates significantly less broad money creation than the preceding property-led model.
The first reason is that China has shifted towards less credit-intensive growth drivers following the crash in the housing market in 2021 - chief amongst them advanced manufacturing and hi-tech goods.
Because these sectors are less credit-intensive than the industries that dominated China’s economy in the past when it was more real estate-focused, they require fewer bank loans per unit of growth, and thus result in the creation of less broad money in the form of bank deposits.
The second reason is Beijing’s push for capital markets to play a greater role in the Chinese economy, in tandem with the fact that China’s new growth drivers make greater use of direct financing, as opposed to bank loans, as sources of funds.
Direct financing, in the form of equity or debt issues, tends to redistribute existing savings between investors, rather than creating new bank deposits through bank balance-sheet expansion.
Zhang Lu’s contention is largely consistent with remarks made by Pan Gongsheng, the governor of the Chinese central bank, at the 2026 Lujiazui Forum that was held in Shanghai in June.
The PBOC governor highlighted the declining credit-intensity of the Chinese economy, alongside the fact that direct financing surpassed indirect financing for the first time on record last year.
This briefing explores the changes in China’s liquidity ecosystem as a direct result of structural changes to the economy and related shifts in money supply dynamics.
Zhang argues that liquidity analysis can no longer simply follow the traditional framework of changes in GDP growth leading to changes in interbank rates, which in turn lead to changes to capital market liquidity before finally impacting the credit cycles of the real economy.
She instead sees interbank liquidity, capital market liquidity and the credit cycles of the real economy acting with greater independence as distinct ecosystems of the Chinese financial sector.
Interbank liquidity
In the past, economic growth in China drove robust gains in bank borrowing and thus expansion in the broad money supply.
This in turn could stoke overheating and accelerated inflation, triggering a prompt reaction from PBOC in the form of monetary tightening and interest rate hikes.
Zhang argues that the central bank is now less focused on strong growth triggering inflation, given that such growth no longer spurs expansion in the money supply the way it did in the past.
In addition to this, overcapacity issues have created long-standing deflationary pressure for the Chinese economy, reducing Beijing’s traditional concerns about overheating and inflation.
At the same time, monetary policymakers also need to balance other pressing considerations, including financial stability, asset prices and exchange-rate management.
As a result, “the rules have changed since 2025,” with interbank rates showing a downward trend, instead of rising during periods of economic strength.
Zhang expects the Chinese central bank to instead be more preoccupied with two key issues when assessing levels of interbank liquidity.
The first is asset-price dynamics and financial stability - in sharp contrast to the traditional focus of central banks on the prices for goods and services. Keeping asset prices steady is of particular importance to China’s financial policymakers, given Beijing’s campaign to drive the maturation of domestic capital markets.
For this reason, Zhang expects the key trigger for tightening of interbank liquidity to be signs of excessive speculation, while for loosening it will be any undue weakening of key market indices.
“If the central bank moderately loosens and this triggers empty circulation of funds, and it eventually brings about an asset price bubble, then this will reach the limits of loosening,” Zhang writes in the paper “张瑜：新舟已现，流“水”分层——旧尺难刻新舟之信用体系思.”
“If during the process of liquidity tightening, indices worsen and this triggers financial risk, then this hits the limits of tightening.
The second priority factor for the central bank’s management of the interbank market is the mass importation of liquidity into China’s financial system, as a result of forex inflows associated with mounting trade surpluses.
This marks the return of a historical problem associated with China’s export-oriented development model - particularly during the late 1990s and the 2000s. A protracted string of trade surpluses led to increases in China’s base money supply, which PBOC sterilised via the issuance of central bank notes and hikes to the required reserve ratio.
Zhang sees this as being a problem in future as well, due to China’s “new economy” also being heavily dependent upon strong exports - at least while domestic demand remains weak.
“The net settlement brought about by exports will continue to rise, and this will create passive injections of base money,” she writes.
Zhang further speculates that PBOC may have used adjustments to balance sheet procedures to obscure gains in forex reserves that drive growth in China’s base money supply.
She notes that the foreign exchange entry on PBOC’s balance sheet has fallen since 2025 - an item which has traditionally grown in response to trade-related forex inflows.
Her speculation is that PBOC is channelling forex settlement to the “Other Assets” item on its balance sheet, before subsequently using swaps and derivatives to smooth out exchange rate volatility and maintain the stability of foreign reserves.
Such intricate legerdemain does not alter the fact that export surpluses can still lead to the passive injection of base money, which will in turn require PBOC to make liquidity adjustments on the interbank market.
Look to borrowing via interbank CDs
Zhang says it will be difficult determine the key inflection points for levels of interbank liquidity just by looking at PBOC’s traditional instruments for open market operations - such as reverse repos and medium-term lending facilities
This is because multiple factors will impact PBOC’s decisions in future - including macroprudential factors and levels of forex settlement - which lack high-frequency readings and are difficult to track in real time.
Consequently, Zhang proposes using net financing via interbank certificates of deposit (CDs) as a key barometer of interbank liquidity shifts that could prompt PBOC to make monetary policy adjustments.
“If net financing via interbank CDs is negative, this indicates that the liabilities pressure for commercial banks isn’t large,” she writes.
“The banking system does not lack reserves, and interbank liquidity is ample.
“If net interbank CD financing turns positive, then commercial banks are seeing a rise in the demand for debt.
“Under such conditions, greater attention should be given to whether interbank rates see rising volatility, or shift away from low-level stability.”
Capital market liquidity
When it comes to assessing liquidity for China’s capital markets, Zhang believes that the deposits of non-bank financial institutions should now be viewed as the core variable.
This is because non-bank financial institutions are the main players when it comes to capital market transactions in the Chinese financial system.
Furthermore, their transactions of stocks and bonds in the secondary market do not lead to a decline in non-bank financial institution deposits, but instead simply shift deposits between different parties.
Consequently, Zhang views these deposits as “unallocated funds” for the capital market that have yet to make their way into China’s real economy.
“Changes [in non-bank financial institution deposits] can be used to measure the amplitude of liquidity on capital markets,” she writes.
“Since 2013, annualised growth in non-bank financial institution deposits and equity market transaction volumes have been strongly correlated.
“At present non-bank financial institution deposits, as a representation of capital market liquidity, are seeing annualised growth of around 11 trillion yuan, at close to the highest level on record.
“This shows that the supply of funds for the capital market is quite ample.”
The rise of China’s non-bank financial sector
Zhang further points out that non-bank financial institutions are playing an increasingly prominent role in the Chinese economy, due to the property market slump which has upended the investment preferences of households.
“Under the transition from the old to the new economy, non-bank financial institutions have become the new ‘reservoirs’ for household funds,” she writes.
“The first change in the new economy is that the main channel for household assets is shifting from real estate to financial assets.”
The rising preference for investment via non-bank financial institutions means a major increase in their deposit levels, which in turn means a changing role for the banks-driven leverage comes to the Chinese capital market.
This is because non-bank financial institutions obtain their funding from two sources - deposits placed with them by households, and financing obtained from the banks.
The rise in funding from households who have shied away from the property sector means these non-bank financial institutions have less need for banks to provide them with leverage.
“It’s not leveraged financing from the banking system that lies at the core of the current round of the high increase in non-bank financial institution deposits,” she writes.
“It’s household funds continually pouring into the non-bank financial system, while lacking adequate outlets to finance the real economy.”
The high level of non-bank financial institution deposits has been further exacerbated by the difficulty of converting all this capital market liquidity into funding for China’s real economy.
This is the result of both weak domestic demand - which has made Chinese companies reluctant to invest, as well as regulatory restrictions previously put in place to curb the shadow banking sector - chief amongst them landmark asset management rules launched in 2018.
“Under the old economic paradigm, after households made allocations to financial assets such as wealth management products, trusts and funds, non-bank financial institutions could convert their deposits into disposable financing for the corporate sector through non-standard financing, channel financing, or direct financing channels such as IPOs, refinancing, and corporate bond issuance,” Zhang writes.
“[These funds] would ultimately flow into the real economy.”
“However, the introduction of new asset management regulations has impacted the non-standard and channel businesses that lie at the core of shadow banking.
“At the same time, weak domestic demand has diminished the willingness of enterprises to engage in direct financing.
“This has resulted in a situation where, although the shift of household deposits has increased the scale of the non-bank financial system, it has failed to smoothly translate into financing for the real economy.”
Because non-bank financial institutions have seen such a large accumulation of funds from households without adequate outlets for financing, the importance of the interbank market for capital market liquidity has further markedly fallen.
Zhang notes that “this is fundamentally different from 2015,” when non-bank liquidity was high as a result of financing from the banking system, and leveraged funds drove market expansion.
Tracking capital markets
The rule that the deposits of China’s non-bank financial system are the best new gauge of capital market liquidity applies primarily to equities.
Zhang makes the caveat that when it comes to the bond market, interbank liquidity retains strong influence.
This is because commercial banks remain the dominant purchasers and holders of government bonds in China, while the interbank market itself remains the principal venue for bond trading and financing.
“Interbank liquidity has a greater influence on bond market trends, while non-bank liquidity reflects equity market trading volume and risk appetite,” she writes.
“A decline in interbank interest rates usually corresponds to an improved funding environment in the bond market.
“Conversely, high growth in non-bank financial deposits means ample available funds within the capital market, making it easier to support increased equity market trading volume and a recovery in risk appetite.”