How Do Financial Risks Threaten China’s Economic Security?

Chinese leader Xi Jinping has called for China to become a “financial superpower” (金融强国) rivaling established leaders like the United States, United Kingdom, and Japan. Yet, mounting geopolitical tensions and slowing economic growth at home have sparked concerns in Beijing about the country’s overall “financial security” (金融安全).¹ China has made notable strides in recent years to shore up financial risks, but numerous challenges persist. This ChinaPower feature explores four key vulnerabilities and three strengths in China’s financial security. Taken together, they paint a cloudy picture of Beijing’s long-term prospects of becoming a global financial leader.

Vulnerabilities in China’s Financial Security

China faces four important vulnerabilities to its financial security, each of which is outlined and analyzed below. These vulnerabilities are closely inter-related: strain in one area can exacerbate problems in another area. These are not the only vulnerabilities facing China’s financial system, but they encompass the most pressing risks in the eyes of regulators and investors.

1. Exposure to foreign sanctions
   
2. High debt
   
3. Shallow financial markets
   
4. Weak oversight of financial firms

Vulnerability 1: Exposure to Foreign Sanctions

Beijing’s threat perceptions with respect to financial security have shifted as China’s domestic and international conditions have changed. One of the clearest indications of this is the political messaging coming from Xi Jinping himself. Analysis of an official database cataloging Xi’s “important speeches” offers revealing insights:²

Beijing’s worries over sanctions initially spiked during the first Trump administration, when Washington imposed sanctions on Chinese companies, including technology giants Huawei and ZTE. The Biden administration escalated efforts to sanction Chinese companies and targeted China with a suite of export controls on advanced technologies, especially semiconductors.

Such targeted U.S. sanctions are a significant concern for China, but they do not pose a systemic risk to China’s economic and financial security. However, more sweeping financial sanctions—such as those imposed on Russia by the United States and its allies since 2022—could cause much greater pain for China’s economy.

In response to Russia’s invasion of Ukraine, Washington and its allies imposed sweeping sanctions targeting major Russian banks, state-owned firms, and key individuals, including President Putin and oligarchs. These measures included freezing hundreds of billions of dollars in Russian central bank foreign reserves, removing Russian banks from the Society for Worldwide Interbank Financial Telecommunications (SWIFT) international payment system, and restricting exports of critical technologies to weaken Russia’s military and economic capabilities.

Imposing similar measures on China could inflict enormous pain on its economy. By cutting off access to dollars and dollar-based institutions, Chinese experts are worried that U.S.-led sanctions could jeopardize three major functions in China’s financial system: trade settlement, investment financing, and monetary policy operations.

U.S. sanctions could disrupt China’s trade flows by blocking cross-border payments. In 2024, China conducted $6 trillion of trade in goods with the rest of the world, roughly 71 percent of which was denominated in dollars and other foreign currencies.³ These transactions are facilitated by a series of dollar-based international institutions, most notably SWIFT, the Clearing House Interbank Payments System (CHIPS), and various intermediary banks financing the trade process. Sanctions that bar access to these institutions would significantly curtail the ability of Chinese importers and exporters to settle payments for goods.

In this scenario, some of China’s trading partners would likely attempt to utilize alternative payment infrastructure. Yet many of China’s high-value imports are manufactured exclusively by companies in the United States or allied regions and thus would be particularly difficult for China to replace. Sanctions would likely also block China’s exporters from reaching key overseas markets, undercutting their bottom lines.

U.S.-led financial restrictions could also constrain China’s ability to raise capital and finance industry growth. China’s dollar-denominated debt owed to foreign lenders totaled just over $1 trillion as of June 2024, and it continues to raise funds through bond sales overseas. Chinese companies likewise raise money in foreign equity markets. Chinese firms listed on U.S. stock exchanges held a market capitalization of $1.1 trillion as of March 2025, and many more receive dollar-based venture capital funding and other forms of direct investment. U.S.-led sanctions could sever access to these avenues for raising capital.

Last, U.S.-led sanctions could destabilize Beijing’s monetary policy priorities. Massive reserves of U.S. dollars are essential to the ability of the People’s Bank of China (PBOC) to achieve its primary mandate to “maintain the stability of the value of the currency and thereby promote economic growth.” The exact value of dollar-based assets held by the PBOC is subject to debate, but a rough estimate suggests a ballpark figure of $1.6 trillion.

If Washington and its allies sought to exert pressure on Beijing, they could coordinate to freeze China’s dollar reserve assets held within their borders. This would quickly cause a shortage of dollars in China, leading to a drop in the value of the RMB, a shock in import prices, and challenges in meeting debt repayment obligations.

“We should … oppose interference in internal affairs, oppose unilateral sanctions and “long-arm jurisdiction”, and jointly create a peaceful and stable development environment.”

Xi Jinping, 2020 BRICS Leaders’ Summit

Concerns about these threats have galvanized Beijing to accelerate efforts toward sanctions resilience. China has sharply criticized U.S. sanctions against China and Russia, describing them as acts of U.S. “long-arm jurisdiction” (长臂管辖). Beijing responded to initial U.S. sanctions by passing an Anti-Foreign Sanctions Law in 2021, which set up a legal framework for China to retaliate against sanctions. This framework was expanded in March 2024 to include a broader array of retaliatory measures, an indicator that Beijing is bracing for deepening geopolitical conflict with its international rivals.

More broadly, Chinese leaders are striving to develop alternative financial infrastructure to reduce reliance on Western-dominated systems, and they view RMB internationalization as a cornerstone of strengthening China’s geopolitical position vis-à-vis the United States. However, despite notable progress, China’s financial system continues to rely heavily on U.S. dollars and thereby remains vulnerable to the threat of sanctions.

Vulnerability 2: High Debt

Rising debt levels are another key threat to China’s financial security. China’s economy is permeated by highly indebted firms, which is a drag on overall economic performance and jeopardizes Beijing’s “bottom line of no systemic financial risks” (不发生系统性金融风险的底线). China’s high debt levels also weaken its international competitiveness by dissuading risk-averse investors from entering Chinese markets, thereby undermining Beijing’s stated goal of global financial integration.

China’s financial regulators often discuss these concerns in terms of improving China’s “macro leverage ratio” (i.e. its debt-to-GDP ratio), which the 14th Five-Year Plan highlighted as a key dimension of financial security. China’s non-financial debt reached 292 percent of GDP in 2024, which is considerably higher than most other major economies, including the United States.⁴

On paper, this debt is typically divided into central government debt, local government debt, household debt, and debt from private non-financial firms. In practice, however, these debt burdens are closely linked. Local governments that lent to questionable real estate and infrastructure projects are struggling to recoup their investments amid China’s ongoing real estate sector slowdown, and a growing number of local government-related investment products have defaulted or been flagged with warnings.

Household debt is also exposed to turbulence in the real estate market, not least because 60 percent of household debt is in the form of residential mortgages. Taken together, this brittle network of non-performing debt creates risks of financial contagion and cascading crises.

China’s debt-related vulnerabilities are complicated by its exposure to geopolitical risk. Increased tariffs levied by President Trump in March 2025 will strain Chinese manufacturers operating on thin margins and likely push some into default.  

Overseas trade in Chinese bonds is similarly exposed. The total size of China’s offshore bond market is estimated to sit at roughly $780 billion, which supplements the $579 billion worth of foreign holdings of onshore Chinese bonds.⁵ This market has historically served as a supplemental source of fundraising for local governments, one that would be cut off if U.S. investors were forced to dump Chinese assets.  

Last, Beijing’s ability to address China’s debt is constrained by U.S. monetary policy. Under normal circumstances, Chinese policymakers could ease the burden of indebted firms by reducing the PBOC’s benchmark interest rates and thereby lowering the cost of firms’ interest payments. This is more difficult, however, when the U.S. Federal Reserve maintains high U.S. benchmark rates—as it did from 2022 to 2024—because lower PBOC rates prompt global investors to withdraw investments from Chinese markets and chase higher returns in the United States.  

This threat of capital flight is illustrated in part by the widening gap in returns on U.S. versus Chinese 10-year government bonds. Now that the Fed has lowered rates, Beijing has gained more room for maneuverability to cut its own rates, but this trend could reverse if inflationary pressure returns to the United States. 

Vulnerability 3: Shallow Financial Markets

The third major vulnerability in China’s financial security is its lack of appealing RMB-denominated investment assets. Economists often describe China’s markets as “shallow,” meaning that they struggle to absorb incoming capital in a way that generates strong returns for investors. This hampers Beijing’s stated goals of attracting foreign investment and deepening global financial integration.

Xi Jinping signaled a renewed commitment to improving investor access to China in his address to the Boao Forum for Asia in 2018, the 40th anniversary of Deng Xiaoping’s pivotal Reform and Opening policy. Yet despite the ongoing commitment to financial opening (金融业开放), China’s presence in international financial markets remains small relative to the size of its economy.

Chinese-owned investments in foreign markets and foreign-owned assets in Chinese markets—respectively referred to as assets and liabilities in China’s international investment position—are a fraction of those of the United States and other financial powerhouses. In aggregate, China’s small international investment position reflects its limited integration with global financial markets.

China’s three largest financial markets face distinct challenges that limit investor interest:

• Banking is subject to hands-on state intervention that steers capital toward sectors prioritized by the central government. Foreign and domestic lenders alike face pressure to support state-affiliated firms, even though returns on these loans underperform returns on private-sector lending by as much as two percentage points.

• Equity markets, meanwhile, remain speculative and unpredictable. Despite attempts at regulatory intervention, China’s stock market performance is often untethered to the performance of its real economy, and its track record of volatility dissuades institutional investors from looking for stable sources of growth.

• Real estate was long viewed as one of the sole remaining safe havens for capital, given the lack of reliable returns on lending and equity investments. However, when China’s real estate bubble burst in 2021, would-be investors were left with few good options for investing latent savings.

Faced with few good domestic investment opportunities, Chinese investors have pursued investment opportunities abroad. To avoid the destabilizing effects of capital flight, Beijing maintains capital controls that limit the free flow of money in and out of China’s borders. Capital controls leave openings for some outbound investment into global markets, but Chinese investors must navigate complex investment mechanisms and cat-and-mouse regulatory enforcement.

Foreign investors, on the other hand, are deterred from entering Chinese markets due to the risk that resources cannot be withdrawn if their investments turn sour. These concerns are augmented by heightened geopolitical risk, which investors fear could lead to further tightening of investment restrictions.

The net effect is a barrier to China’s global financial integration and a threat to its long-term financial vitality. The shallowness of China’s markets stands in sharp contrast to the United States. The U.S. financial sector’s near-limitless ability to absorb capital from other countries is a consequence of its abundance of worthwhile investment opportunities. The United States remains a perennially appealing investment destination because investors know they can receive a strong rate of return.

One upside of China’s capital controls and other barriers to financial integration is that they significantly insulate China’s financial system from external shocks. This was demonstrated during the 2008 financial crisis, which damaged the Chinese financial system less than other financial hubs. The trade-off between insulation and integration continues to confront Chinese policymakers, and heightened geopolitical risk complicates this calculus.

Vulnerability 4: Weak Oversight of Financial Firms

China’s last major financial vulnerability is weak regulatory oversight, particularly in its management of firm-level financial risk. China’s financial system is distinguished by a strong state presence in firm management and capital allocation. In other words, the state has a strong say in what gets funded. Chinese policymakers use state-owned banks and investment funds to steer financial resources toward priority industries, which Beijing believes will foster long-term growth.

The downside is that these priority sectors tend to underperform in the short term. Because these firms are shielded from market logic (i.e. propped up by state support), they require scrupulous regulatory oversight to ensure their financial resources are not being mismanaged.

Xi Jinping and other officials have repeatedly emphasized the need for stronger firm-level financial governance. The narrowing gap between private and state-backed firm performance suggests these efforts have yielded some success. Nevertheless, regulatory challenges have continued to evolve as the financial landscape grows more complex, and financial planners have struggled to rise to this challenge.

Part of China’s regulatory failures stem from low state capacity. China’s financial regulators are often stretched thin, and many report inadequate resources and poor pay. These conditions make regulatory bureaucrats vulnerable to being bought off by companies seeking political favors or lighter regulation.

The result is endemic corruption and regulatory capture in the state-owned sector, which surpasses every other sector besides village committees in terms of corruption cases. Xi Jinping’s flagship anti-corruption campaign has attempted to curtail the problem by threatening (and implementing) harsh punitive measures, but some scholars argue that the challenge will persist until the underlying structural issues are solved.

The issue of low state capacity also relates to ongoing coordination challenges. In the past decade, non-traditional financial business models—like those of the now-curtailed peer-to-peer lending sector—dodged regulatory oversight by growing within the gaps of China’s mosaic of central and local regulatory agencies.

Beijing has attempted to address this problem through several iterations of regulatory reform. The cost of these frequent regulatory reshuffles is an exacerbated sense of policy unpredictability. In an uncertain policy landscape, businesses are reluctant to invest in new ventures, particularly given Beijing’s track record of unexpectedly censuring whole industries at a time.

Together, these factors weaken the competitiveness of China’s financial sector in the global landscape. Foreign investors complain that they face a disadvantage against state-owned firms, which receive cheaper credit and a preferential regulatory environment. Political uncertainty chills inbound investments by limiting foreign firms’ ability to forecast costs and benefits. Finally, high-profile arrests of corporate executives have soured China’s reputation as a good place to do business, and existing leaders must take great care to avoid falling afoul of regulators.

Strengths in China’s Financial Security

Despite the challenges discussed above, Beijing’s financial policymakers wield a few distinct advantages that bolster the long-term prospects for China’s financial system. Chinese policymakers have long emphasized that the “financial sector should serve the real economy,” which involves tangible goods and services. Indeed, the strongest arguments for China’s financial vitality stem not from any inherent qualities of its financial institutions but rather in the durability of its underlying economic system. China’s massive manufacturing sector, vast consumer markets, and global technology leadership all fuel the engine of growth that underpins financial resilience.  

In addition to these external sources of strength, China’s financial system also possesses three key internal advantages, each of which is analyzed below: 

1. Extensive trade ties
   
2. A growing role in multilateral governance
   
3. Innovative tools for macroeconomic regulation 

Strength 1: Extensive Trade Ties

China’s financial system benefits from its extensive trade ties. Trade has played a pivotal role in China’s economic rise and is enshrined in the 14th five-year plan as one pillar of China’s “dual circulation” strategy (国内国际双循环), which outlines an integrated economic approach to pursuing domestic and foreign market opportunities. These trade ties form a bedrock on which China can influence global financial systems.

Chinese officials point to the benefits of trade ties for accelerating financial initiatives like RMB internationalization, which in turn secures and strengthens China’s financial position in a geopolitical context. Though recent rhetoric from Beijing has sought to emphasize the domestic pillar of China’s dual circulation policy, its trade network remains integral to China’s overall economic and financial posture. 

China’s trade network spans the globe. In 2023, 44 countries listed China as their top overall trading partner by trade in goods, and 110 countries listed China as one of their top three sources of imports. In 2024, the combined value of China’s total goods imports and exports reached $6 trillion, returning to a healthy 5 percent year-over-year growth after an uneven performance during the COVID-19 pandemic.

Beijing leverages China’s trade network to accelerate its push for RMB internationalization. These efforts are most clearly seen in China’s imports of oil, gas, critical minerals, and other commodities. The Shanghai Petroleum and Natural Gas Exchange, Shanghai International Energy Exchange, and Ganzhou Rare Metal Exchange are three trade hubs launched in recent years that each facilitate RMB-denominated trade. As a result of these efforts, China conducted 28.8 percent of its goods trade in RMB in 2024, a 2.7 percentage point increase from 2023.⁶

The growth of RMB-denominated trade and financial institutions is not merely a matter of coercion on Beijing’s part. RMB-based financing provides some trade partners with meaningful benefits over dollar-based financing. When U.S. interest rates are high (as in the past few years), dollars become scarce, and dollar-based trade financing grows more expensive. RMB-based trade can help developing economies conserve their dollars during such periods of scarcity.

In addition to boosting RMB internationalization, China’s trade ties provide a deterrent against the most aggressive forms of Western sanctions. The United States and its allies continue to rely deeply on trade with China, so imposing sweeping sanctions on China would result in immense blowback for them.

Relatedly, if Western countries impose sanctions on China, China’s trade relationships with non-Western countries would provide avenues for continued economic growth. Countries within BRICS+ and China’s Belt and Road Initiative—which conceivably might not follow U.S.-led sanctions—could be willing to provide China with export markets and commodity sources even amidst a sanctions regime.

It is worth mentioning that China’s extensive trade relationships do come with downsides, particularly when its trade practices are perceived to distort domestic economies. Washington has made no secret of its frustration with China’s alleged manufacturing overcapacity, but less often discussed are parallel dynamics playing out across developing economies around the world. Beijing has shown some signs that it is listening to these complaints, but without more decisive action, more of China’s trade ties risk turning into diplomatic liabilities.

Strength 2: A Growing Role in Multilateral Governance

China’s trade ties lend heft to Beijing’s efforts to shape multilateral financial governance, which continue to gain traction. Xi Jinping articulated China’s vision for financial governance reform at the Kazan BRICS summit in October 2024 and again at the Rio de Janeiro G20 summit in November 2024. In both addresses, Xi expressed frustration about China’s disproportionately small voice (relative to the size of the economy) in established multilateral institutions like the International Monetary Fund (IMF) and the World Trade Organization (WTO).

Xi’s two-pronged approach for greater influence over financial governance includes reforming existing institutions and expanding the scope and remit of alternative institutions like the BRICS consortium. These efforts closely intersect with the RMB internationalization drive discussed above but also encompass a range of other mechanisms.

First, Chinese policymakers have been steadily working to establish bilateral currency swap agreements with central banks in partner countries. These agreements provide access to RMB during periods of financial turbulence, allowing the PBOC to function as an international lender of last resort.

Interest in RMB currency swaps has increased in recent years as dollar scarcity has created liquidity issues for many smaller economies. As of October 2024, China has signed currency swap agreements with 42 countries, with a total capacity of 3.8 trillion RMB (excluding Hong Kong and Macau). These efforts complement the RMB-based trade financing initiatives discussed above, particularly in countries with which the United States has been more reluctant to establish parallel dollar-based swap lines.

Second, Beijing has pressed for a greater role in other financial governance architecture, including financial early warning systems, reserve currency pooling agreements, and trade dispute settlement mechanisms. China’s progress on these initiatives has been uneven, but the growing ranks of countries joining China’s multilateral financial institutions point to the global appetite for alternative approaches to financial governance. The recently expanded BRICS consortium serves as Beijing’s preferred launch point for new financial architecture like the BRICS Pay cross-border payment settlement initiative.

At the same time, Beijing is pushing for a more prominent voice in established global financial governance institutions like the IMF, the World Bank, and the WTO. These efforts have begun to bear fruit in the form of higher voting shares and greater presence in leadership positions, but Chinese leaders argue that they remain under-represented in these institutions.

Last, China’s role as a regional financial leader is spurred by its significant development finance activity. Beijing conducts development finance diplomacy bilaterally through the BRI and multilaterally through organizations like the Asian Infrastructure Investment Bank (AIIB) and the Shanghai-based New Development Bank (NDB). China’s role in these institutions boosts its regional financial integration and helps it shape development priorities.

Often, these priorities emphasize infrastructure investment. By steering development capital toward infrastructure projects—as opposed to health or education projects, for instance—Chinese policy leaders create new markets for China’s massive industrial base. The role of overseas infrastructure projects rose in importance during the 2010s as China’s industrial base ran out of useful domestic infrastructure projects in which to invest. That said, the future of China’s development finance has been called into question amidst falling investment counts and mounting diplomatic pushback.

Strength 3: Innovative Tools for Macroeconomic Regulation

China’s efforts at firm-level regulation have been stymied by corruption and misaligned incentives, as discussed above, but its track record of stable governance is actually somewhat stronger. In particular, Beijing has pioneered novel tools for managing what economists refer to as macroprudential supervision (宏观审慎监管). Chinese financial regulators learned hard lessons in the wake of the 2015-16 stock market crash, which many argue was exacerbated by poor policy choices. Since then, China’s financial system has not exactly flourished, but it has avoided a repeat of systemic financial crisis. 

Beijing’s process of iterative regulatory learning has yielded a more extensive set of tools for managing financial and monetary activity. The use of state-owned banks for monetary policy objectives is one such example. Observers have noted that in recent years, China’s state-owned banks have filled roles traditionally performed by a central bank, including stabilizing exchange rates, controlling credit volumes, and serving as lenders of last resort.  

These unorthodox policy tools are only possible in China’s unique state-led model of financial regulation. Early evidence suggests that these innovations augment state financial capacity and improve monetary policy efficacy, though they create oversight liabilities as well. In any case, such novel financial levers have stymied Western analysts’ standard approaches to monetary surveillance and prompted calls for revised accounting methods. 

Beijing maintains strong control over private and semi-private lending institutions as well. This can invite the corruption-related regulatory challenges discussed earlier, but the upshot is that private sector capital can be quickly rallied to quell crises. Since 2015, Beijing has called upon its so-called “national team” of wealth management funds (illustrated below) to buy up stocks during periods of turbulence. This strategy of enlisting quasi-public firms to support macroprudential goals is often in tension with firm-level regulation, and Chinese regulators will doubtless continue to wrestle with the appropriate balance as they continue to pursue financial reform. 

Conclusion

Overall, the vulnerabilities in China’s financial security position outweigh its strengths. This assessment is reflected in China’s uneven financial performance and faltering progress toward global financial integration. As such, it is unlikely that China’s financial system will prove an equal competitor to that of the United States, Europe, or Japan in the near future. 

Many of China’s financial security shortcomings relate to its faltering progress toward financial liberalization. Beijing’s rhetorical praise for pursuing financial openness creates an odd juxtaposition with its policy track record, which still prefers state priorities and top-down directives. China’s policymakers attempt to square this circle with a signature two-track financial system, which carves out a space for market-based international competition while retaining a prominent role for state-owned firms. Yet foreign investors interpret Beijing’s regulatory mixed signals as an attempt to have its cake and eat it too.  

Nevertheless, China’s financial system does possess significant latent strengths that draw from the scale and vitality of its economy. Chinese policymakers continue to shore up financial vulnerabilities and have recently signaled their commitment toward rebalancing the domestic economy and boosting consumption. In addition, Beijing continues to expand commercial ties with partners abroad, especially with developing economies that are frustrated with the established U.S.-led financial system and seeking alternative institutions. It remains to be seen whether these strengths will translate into sustainable growth in China’s financial sector. 

Authors:
Hugh Grant-Chapman, Brian Hart, Bonny Lin, Leon Li, Truly Tinsley, Peter Dazheng Huang, Claire Tiunn

The authors would like to thank Zongyuan Zoe Liu for her thoughtful feedback on an early draft. Any errors are the authors’ alone.