The Twin Pillars of China’s Financial Transformation
How Beijing plans to use monetary policy to support Chinese stocks and bonds
One of the Chinese central bank’s (PBOC) most vocal senior officials has highlighted the need for monetary policy reforms to give greater support to Beijing’s ambitions for driving the growth of China’s stock and bond markets.
In recent opinion piece Sheng Songcheng (盛松成), formerly director-general of PBOC’s statistics department, says this support will not come in the form of interest rate cuts or quantitative easing to support China’s stock market prices.
He instead argues PBOC needs to shift towards price-based monetary policy which is more consistent with mainstream global practice, in order to give the Chinese central bank the control over money market liquidity needed to support capital market stability.
Sheng further points out that sweeping reform of the financial system is an inevitable part of the structural transformation of the Chinese economy that Beijing is pursuing to achieve more resilient and sustainable growth.
“The deep reform of China’s economic structure is currently driving a systemic restructuring of the financial sector and the monetary policy framework,” Sheng writes in the article “The Shift in the Financial Structure amidst the Transition from Old to New Growth Drivers and Considerations on Monetary Policy” (盛松成：新旧动能转换下的融资结构变迁及对货币政策的思考.)
“When the Chinese economy steps away from the old path of ‘real estate and credit’ towards the new path of ‘science and technology plus capital,’ monetary policy must also find a dynamic balance between ‘the inertia of quantity,’ and ‘the efficiency of prices.”
The twin pillars of China’s financial system reforms
Sheng notes that these paradigmatic reforms of the Chinese financial sector are comprised of two key pillars that are highly complementary in nature.
The first is Beijing’s long-term push to reduce the economy’s reliance on indirect financing through the state-owned banking system, towards greater direct financing via the capital markets.
The objectives are to channel more funding to promising firms in the Chinese tech sector through equity and bond issuance; improve capital allocation, increase household wealth through stronger capital markets, and develop the deeper, more liquid financial markets needed to support the renminbi’s internationalisation.
The second is the PBOC’s transition towards an interest-rate-based monetary policy framework, in which the pricing of short-term money-market rates increasingly serves as the primary channel for monetary policy transmission, replacing the previous emphasis on quantitative money supply targets.
Sheng points out that monetary policy reform is needed to support capital market reform, given the way short-term interest rates and money market liquidity impacts the pricing and yields of longer-term debt.
Together, these reforms reflect Beijing’s effort to move from a bank-dominated, quantity-based financial system towards one in which market prices and liquidity conditions play a much larger role in the allocation of capital and the transmission of monetary policy.
Capital markets
Expanding the role of capital markets lies at the core of Beijing’s current financial system reforms.
This was made highly evident at the recent 2026 Lujiazui Conference held in June - the annual event that PBOC governor Pan Gongsheng (潘功胜) has made a key platform for unveiling the the Chinese central bank’s sentiments and intentions.
Pan hailed the fact that bond and equity financing jointly accounted for 47% of aggregate social financing in 2025, surpassing bank lending (45%) for the first time on record. In China’s bank-dominated financial system, indirect financing has generally comprised over 80% of aggregate social financing.
Sheng outlines a slew of reasons behind the push for capital markets to play a greater role in China’s new economy.
First, the downturn in the real estate sector has weakened traditional demand for credit, while emerging growth drivers such as the tech sector, high-end manufacturing, and green low carbon development are characterised by reduced credit-intensity.
“Enterprises are shifting their asset structure from land, factories, and equipment to technology, data, brands, and human capital,” Sheng writes.
“This has resulted in a corresponding decrease in bank loans required per unit of economic growth.”
Secondly, the “high-risk, high-return” characteristics of the innovation-driven tech sector are far from compatible with China’s traditional, bank-dominated credit system, leading to greater use of direct financing.
Thirdly, China’s implementation of “more proactive” fiscal policies in the wake of worsening tensions with the US and EU has expanded the scale of government bond financing, with the outstanding balance of government bonds surpassing 100 trillion for the first time in history in May of this year.
This, of course, has also dramatically driven up the volume of direct financing in the Chinese economy, as well as its share of aggregate social financing.
A final key issue driving the rise of China’s capital market lies in the interaction between interest rate liberalisation with Beijing’s loose monetary policy settings, designed to support both the real economy and fiscal spending.
The pairing of these two policies has driven a decline in bank deposit rates, which has led to an ongoing exodus of Chinese households towards investment alternatives that channel household savings into the bond market.
The increased demand for Chinese bonds has in turn raised their prices and reduced their yields, making it cheaper for companies to raise funds via debt market issues.
Sheng highlights the role this dynamic has played in driving the growth of bond financing at the expense of bank lending.
“Interest rate liberalization helps to alleviate market segmentation, allowing the substitution effect between credit and bond financing to emerge,” he writes.
“In the first half of this year, the cumulative increase in RMB loans to the corporate sector was 11.13 trillion yuan, a decrease of 440 billion yuan year-on-year.
“Net corporate bond financing, however, was 2.07 trillion yuan, an increase of 916.7 billion yuan year-on-year, completely offsetting the decline in corporate credit growth.
“In combination, corporate debt financing still showed a year-on-year increase, with both bonds and credit contributing to the overall growth.”
This shift changes the significance of macro-financial data, with tepid growth in bank loans no longer necessarily signifying weak financing demand or scarce financing for the real economy.
“The overall financing environment for enterprises has not tightened, but rather that financing channels have undergone significant structural changes,” Sheng writes.
“Therefore, a comprehensive and holistic analysis of financial data is necessary, rather than focusing solely on a single indicator.”
Monetary policy
The rise of capital markets at the expense of credit extension via the banking sector will also lead to a corresponding paradigm shift in China’s monetary policy framework.
It will drive the mechanism for monetary policy transmission from “quantitative expansion” - or increases in the money supply, towards “price guidance” in the form of adjustments to interest rates.
“In the medium to long term, as the share of direct financing continues to increase and the interest rate transmission mechanism becomes increasingly smooth, price-based regulation will gradually assume a dominant role,” Sheng writes.
“The central bank has clearly stated that it will gradually de-emphasize quantitative intermediate targets in the future, using aggregate financing primarily as an observable indicator rather than an intermediate policy target, creating the conditions for better employing the role of interest rate regulation,” he writes.
This transition is part of a long-term process that has further accelerated since the appointment of the reform-oriented Pan Gongsheng to the position of PBOC chief.
Pan has driven the reform of China’s monetary policy framework to more closely align with global practice - in a transition that Sheng believes follows the historical trajectory of the US Fed’s earlier development.
“For more than a decade, academia and industry have continuously researched and discussed this issue,” Sheng writes.
“With the deepening of interest rate liberalization and increasingly smooth transmission channels, the conditions for price-based regulation are gradually maturing. Since 2024, China has been accelerating its transformation towards price-based controls.
“From an international perspective, the history of the Federal Reserve’s monetary policy regulation is itself a history of transition from quantity-based to price-based regulation.”
Pan Gongsheng’s post-Covid reform agenda
2024 was a pivotal year for the reform of China’s monetary policy framework. Pan cemented the status of the 7-day reverse repo rate as PBOC’s policy rate, in bid to focus more on the use of short-term rates to drive adjustments to longer-term yields.
In August 2024, PBOC complemented this move with the launch of treasury bond trading operations in the secondary market, making net purchases of 1 trillion yuan of treasury bonds over five consecutive months.
Sheng points out that the combination of these measures “represents a significant expansion of the monetary policy toolbox.”
“It signifies a shift in the channels for base money injection from traditional methods such as reserve requirement ratio (RRR) cuts and medium-term lending facilities (MLF) to a more market-oriented and diversified approach,” he writes.
“This operation not only enhances PBOC’s flexibility in regulating liquidity, it also creates conditions for the treasury bond yield curve to serve as a pricing benchmark.”
In 2025, PBOC sought to further cement these changes to its monetary policy framework, injecting a net 6 trillion yuan into the market through various open market operations, including 3.8 trillion yuan through outright repurchase agreements and 120 billion yuan through net purchases of treasury bonds.
In October 2025 PBOC resumed the purchase of treasury bonds, after previously suspending them in response to the compression in yields created by a spike in demand from institutional investors. PBOC said that it would seek to normalize treasury bond trading operations in future.
Pan Gongsheng’s pursuit of his monetary policy reform agenda has continued into 2026. At the Lujiazui Forum in 2026, he announced two key measures to improve the mechanism for controlling short-term interest rates.
The first was narrowing the corridor between the temporary overnight repo and reverse repo rates from 70 basis points to a symmetrical 50 basis points, while the second was plans to expand the variety of overnight reverse repo operations.
Sheng interprets the changes as increasing the precision of PBOC’s control over short-term interest rates, while reducing the range of movement for the overnight DR001 rate for collateralised interbank lending.
How the monetary policy shift supports capital market growth
PBOC’s new focus on overnight interest rates has profound significance for how it uses monetary policy to adjust conditions in both financial markets and the real economy.
It complements the shift from bank-intermediated credit towards a greater role for the bond market, given the way liquidity on the Chinese money market impacts longer-term debt.
Sheng notes that overnight repos in China’s money market account for almost 90% of market share, meaning they more accurately reflect changes in liquidity conditions.
The expansion of the bond market has also led to stronger demand for overnight funds, making government bond issuance, maturation and transactions important variables for determining money market liquidity.
In short, China has followed the path of the US and other advanced economies in its capital market evolution, with short-term money markets increasingly funding longer-term capital market investment. As a result, capital markets have become more sensitive to money market liquidity, increasing the importance of precision control over short-term interest rates.
“Narrowing the interest rate corridor helps guide short-term market interest rates to operate more stably around the policy rate, enhancing the precision and effectiveness of interest rate control,” Sheng writes.
“This is a crucial step towards a more refined price-based control framework and is consistent with the policy interest rate systems of major international central banks, which are centered on short-term interest rates.”
A declining role for the RRR
A final shift in Chinese monetary policy that will bring it more in line with global best practice is the declining role of the required reserve ratio, paving the way for a greater focus on short-term interest rates.
China’s RRR continues to play a highly prominent role in the injection of liquidity into the banking system.
Its relevance as a policy tool is partially the result of recent economic history, with PBOC hiking the RRR to a peak of 21.5% in June 2011, as part of efforts to sterilise forex inflows created by China’s huge trade surpluses in the first decade of the 21st century, just following its ascension to the WTO.
The weighted RRR for Chinese financial institutions still remain at around 6.2% - giving PBOC more room for reductions than the policy rate, which stands at around 1.4%.
Sheng expects the RRR to inevitably recede in importance, as a necessary condition for the transition from quantitative monetary policy towards monetary policy that focuses on interest rates.
He views this process as a case of Chinese monetary policy simply following the well-worn historical trajectory of advanced economies.
“Western countries generally adopt a price-based monetary policy regulatory framework centered on interest rates, which is predicated on a low reserve requirement system,” he writes.
“Taking the United States as an example, Federal Reserve data shows that by the end of 1990, the required reserve ratio for institutional time deposits had fallen to 0% in 2020.”
While Sheng views this development as an historical inevitability arising from the intrinsic mechanics of monetary policy systems, he also believes that China needs to make this adjustment via a gradual process that complements the steady expansion of capital markets.
PBOC still needs to capitalise upon the capacity for liquidity creation stored up in China’s high RRR - particularly given low interest rate levels.
“Quantitative tools still play an irreplaceable role,” he writes. “I have repeatedly emphasized the view that RRR cuts are better than interest rate cuts.”
For every 0.5 percentage point reduction in the RRR, China can release approximately 1 trillion yuan of long-term liquidity, which directly reduces the funding costs of commercial banks.
A second issue is the practical constraint of inability to engage in sustained or substantial interest rate cuts - particularly given the low level of the policy rate, as well as the constrained profitability of Chinese banks.
As of the end of the first quarter of this year, the net interest margin of commercial banks had fallen to a historical low of 1.40 percentage points. Sheng notes that further compression of the interest margin would affect the operational stability of banks.
“Consequently, when further easing is indeed necessary, RRR cuts are currently a better choice than interest rate cuts,” Sheng writes.
“They are more suited to China’s financial structure, where indirect financing still accounts for a relatively high proportion and there is still considerable room for RRR cuts. This direction is certain; the key lies in grasping the appropriate pace.
“During the process of transformation, it is necessary to gradually establish the core position of interest rate regulation, while effectively utilizing quantitative tools to address structural liquidity problems, achieving a dynamic balance and organic coordination between the two.”