A key task in the transition from a command economy to a market economy is to re-establish the financial system. The rudimentary financial system that existed after the Cultural Revolution had only superficial similarities with the financial systems in the market economies. During the 1980s, China experienced disorder in its financial sector because capital was still allocated by administrative decisions, not by the market. Although implementation of overall reform of the financial system began in 1994, bad debts and non-performing loans accumulated as a result of inappropriate government interventions, poor management, and weak internal controls. Resolving these problems required ownership reform, corporatization, and effective corporate governance. Furthermore, the principle guiding the stock markets—“the securities market should serve the state-owned enterprises”—created vast room for rent seeking. The solution is to establish a healthy market based on the rule of law and to redefine the regulatory philosophy.
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