B-shares

The removal of restrictions on the holding of B-shares should have a generally positive effect on the development of the Mainland's monetary and banking systems.

Readers are aware of the recent move by the Mainland authorities to remove the restrictions on local investors in participating in the B-share market. The likely effects of this change on the monetary and banking systems in the Mainland should not be overlooked.

On the monetary front, for as long as there is, or is perceived to be, a higher rate of investment return on B-shares denominated in US dollars and Hong Kong dollars, compared with the return on RMB assets, particularly A-shares, there will be greater demand among residents for those foreign currencies. But this effect is likely to be of a one-off nature, because the higher rate of investment return in B-shares, brought about by the recent change of policy, is one-off. If and when the previously depressed prices of the B-shares converge with those of the A-shares, the residents' demand for foreign currencies should return to normal. In any case, according to the banking statistics of the Mainland, residents' foreign currency deposits currently amount to about US$75 billion, which is almost 10 times the market capitalisation of the B-share market. New investment money from residents in the B-share market is likely to come mainly from these foreign currency deposits in the form of a portfolio shift rather than from RMB sources.

The speed with which price convergence is achieved, however, may be inhibited by the fact that A-shares and B-shares of the same companies are not transferable and by the absence of currency convertibility between the investment proceeds of residents derived from the two markets. In other words, there is no scope for arbitrage, at least theoretically. However, there seems to be an understanding that, even before the change of policy, the ownership of B-shares was predominantly in the hands of residents. This, coupled with the substantial amount of foreign currency resources available to them, in the form of legitimate foreign currency deposits, does indicate some scope for residents to take rational decisions on the basis of the different rates of return available in the A-share and B-share markets. This should in time result in significant convergence. But it is difficult to estimate how long it will take. So, in the meantime, residents' demand for foreign currencies is likely to be higher than would otherwise be the case. Indeed, the sudden jump, albeit small, in the exchange rate in the "grey market" is a good indication of the underlying forces at work. This should, however, not be a matter of great concern, for we are talking about small numbers and a temporary phenomenon.

On the banking front, the change of policy may have implications for foreign currency liquidity management for the commercial banks. Hitherto, the banks have enjoyed a monopoly over foreign currency funds of residents. The policy change opens up an alternative channel for residents for investing their foreign currency savings. This will entail a different behaviour among depositors, involving more active use of their foreign currency savings, possibly manifested in more frequent withdrawals and hence a need, on the part of the banks, to maintain more liquidity in order to meet such withdrawals. I am sure the banking regulator and the commercial banks in the Mainland are alert to this implication, and are in a position to manage the risks arising therefrom prudently. Their success in doing so will facilitate what, to me, is a rather promising beginning, on the Mainland, of the type of foreign currency financial intermediation that is a common and helpful feature of any open and modern financial system.

Joseph Yam
8 March 2001

Related Viewpoint Article:

• Financial Markets on the Mainland, 1 March 2001

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