Financial liberalization, or the deregulation of domestic financial markets and the liberalization of the capital account, is an engine of growth, for middle income countries that comes with risks that must, and can be minimized. This paper suggests policy- and business-related lessons that may be of relevance to a successful financial liberalization in China.

Financial liberalization can lead to productive credit expansion and a better allocation of capital, both serving as growth boosters. But it can also aggravate boom and bust cycles and worsen inequality. This duality has played out in previous recent episodes of financial liberalization in East Asia, Latin America and the Nordic countries, thereby providing insights for other countries, including China, to seize the opportunities of financial liberalization while minimizing key risks. Firstly, financial literacy plays an important role in getting the balance right. Secondly, holistic regulation and supervision mechanisms are essential to success. Thirdly, relevant reform sequencing and a flexible approach to crisis management are a needed.

China’s gradual approach to financial liberalization is working. The economy has to manage the trifecta of sustainable growth promotion, financial stability strengthening and financial liberalization development. Firstly, economic growth must be sustainable in order to move the country up from the middle-income category and keep social stability in check. A more balanced growth, based on private consumption will help achieve this goal. Secondly, maintaining financial stability will be essential to avoiding boom-bust cycles. Thirdly, financial liberalization has already begun and had results. Progress has been made, with policy makers showing considerable agility and willingness to learn from experience, theirs and others. From 2015-2017, authorities focused on improving financial foundations, namely through a stronger regulatory framework and improved supervision, effective measures for reducing financing risks and reforms for improving guidance and monetary policy predictability. 2018 started with promising indications for the second phase of financial liberalization.

Success is of critical importance, for China and for the world, given the country’s contribution to global demand, financing, liquidity and financial stability are unprecedented. Stronger financial institutions, continued efforts on financial literacy, expanding a safe and modern financial system, a successful internationalization of the renminbi (RMB) and the smart use of digital innovations are the five essential building blocks for successful financial liberalization. These actions could develop the sequenced and gradual financial liberalization policy stance being implemented by China.

From an insurer’s and a practitioner’s perspective, the lessons from Europe and Asia point to a sixth pivotal block for successful financial liberalization: State-of-the-art Asset and Liability Management (ALM). With the introduction of the C-Ross capital regime and the new Asset and Liability Matching regulation in 2018, the Chinese regulators are moving in the right direction for establishing a more economic based steering framework for the insurance industry. However, there is still a way to go for the whole industry to improve ALM capability, from mentality and corporate governance to processes and system infrastructure. Indeed, today’s situation in China is comparable with the challenges Allianz faced 20 years ago. At the time, the solvency regime in Europe was only marginally based on economic grounds and allowed for excessive risk taking. In anticipation of the looming challenges of a market-value based regulation framework (Solvency II), Allianz started from the early 2000s to embrace a more ALM and value-based driven investment approach, which led to a reduction of the high and concentrated equity exposure and ultimately to a better portfolio diversification. The subsequent steering through various financial crises was a painful exercise for the whole insurance sector. While the new solvency regime clearly led to a more sustainable asset allocation amongst insurance companies the sector faced a new challenge. “How to maintain the value proposition for the client while keeping a prudent asset allocation?” The response, only by carefully balancing return expectations for the client and for the company with the risks that need to be taken will the future success of the whole industry be ensured. In order to guarantee an attractive value proposition for customers, sustainable and risk adjusted investment returns need to be generated both for existing customers, based on promised guarantees in the past, and for new customers. In this respect, ALM is crucial because it acts as a bridge between the liability needs or product requirements and the appropriate asset allocation necessary to meet this need.

In our view, China should benefit from the lessons learned across the world and bank on solid ALM foundations for successful financial liberalization. China should first invest in cutting edge ALM infrastructure and technology to evaluate complex product design features. China should then incorporate an ALM approach and progressively reduce capital intensity in the design of new products. Lastly, China should emphasize ALM thinking in corporate culture.