Banking Regulation with Chinese Characteristics

From: English Edition of Qiushi Journal Updated: 2011-12-29 10:21
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  Since its establishment in 2003, the China Banking Regulatory Commission (CBRC) has actively adopted new ideas, new mechanisms, and new measures whilst adhering to the Scientific Outlook on Development. Through these efforts, it has repeatedly broken new ground in banking regulation, and defined a mode for the regulation of the country’s banking industry with Chinese characteristics.

  I. A framework of theories for banking regulation with Chinese characteristics has been put in place

The theoretical framework that China has developed for the regulation of its banking industry not only incorporates advanced concepts and successful practices from abroad, but also accords with the realities in China and the development stage of the country’s banking sector. This ensures that the system is well tailored to its environment, highly feasible in practice, and characteristic of its contemporary setting. The framework also embodies the lessons that China has gained from years of experience in banking regulation. It is an open, progressive, and forward-looking framework of theories for the regulation of the banking industry.

  

  World Bank President Robert Zoellick (right) speaking before the Asia Society in Sydney on August 14, 2011. During the talk, Mr. Zoellick discussed the prospects for the future of the global economy and the current fluctuations in the international financial markets. Responding to a question from a Xinhua reporter, Mr. Zoellick said that China’s policies of tightening financial supervision and restricting housing credit are aimed at preventing the econoWorld Bank President Robert Zoellick (right) speaking before the Asia Society in Sydney on August 14, 2011. During the talk, Mr. Zoellick discussed the prospects for the future of the global economy and the current fluctuations in the international financial markets. Responding to a question from a Xinhua reporter, Mr. Zoellick said that China’s policies of tightening financial supervision and restricting housing credit are aimed at preventing the economy from overheating, and are thus conducive to containing an economic bubble. / Photo by Xinhua reporter Fu Yunweimy from overheating, and are thus conducive to containing an economic bubble. / Photo by Xinhua reporter Fu Yunwei

  Clear regulatory goals. The setting of clear and precise goals is an essential aspect of scientific regulation. The goal of banking regulation as prescribed by law is to promote the lawful, steady and sound operation of the banking industry, and to uphold public confidence in the banking sector. On this basis, the CBRC has set four concrete regulatory goals: to protect the interests of savers and consumers; to boost market confidence; to help the public better understand the financial products and services offered by the modern banking industry as well as the risks involved; and to maintain financial stability through efforts to combat financial crime in the banking industry.

  Scientific regulatory concepts. Regulatory concepts are refined from past experience, serving as a guide for regulatory activities. The CBRC identified its regulatory concepts at an early stage, and has engaged in constant efforts to ensure that they are implemented in practice. These regulatory concepts are: managing legal entities, managing risk, managing internal control, and improving transparency. In light of China’s actual situation, the CBRC has established a road map for continued regulation, whose basic steps are accurate classification, ample provisions, reliable profit reporting, and adequate capital. This scheme has been used as an effective means of standardizing regulatory procedures, highlighting focuses for regulation, and exercising prudential regulation. In order to promote the attainment of regulatory goals, the CBRC introduced six standards for sound regulation shortly after it was established. These standards are applied as a set of benchmarks and a code for improving the effectiveness of regulation.

  A sound framework for prudential regulation. Firstly, a complete set of rules for prudential regulation has laid down solid institutional foundations for the steady and sound operation of the banking industry. The CBRC has promulgated more than 600 sets of regulatory rules and regulations in total, which have come together to form a statutory framework for the prudential regulation of all major financial risks. In April this year, the CBRC issued the Guiding Opinions on the Implementation of New Regulatory Standards in China’s Banking Industry. Drawing deeply from the lessons of the international financial crisis, these opinions interpret the international consensus on the need for regulatory reform in the context of China’s actual conditions. Secondly, effective regulatory tools have provided a strong basis for the specific implementation of regulatory activities. In addition to making efforts to constantly reinforce our traditional prudential regulatory tools, we have also managed to introduce and update a series of regulatory tools in recent years, such as those concerning capital, provisions, liquidity and leverage ratios. Thirdly, a rationally designed organizational system has ensured that we are able to achieve our regulatory goals. In light of features displayed by China’s banking industry in its current stage of development, we have taken steps to establish a number of functional regulatory departments, such as the Supervisory Cooperation Department for Banking Innovation. By placing an emphasis on the building of teams for the regulation of market risks, we have managed to simultaneously promote institutional regulation and functional regulation.

  Effective regulation on an ongoing basis. By stepping up market access management, on-site inspections and off-site regulation, we have exercised the power of corrective regulation and carried out effective regulation on an ongoing basis. We have emphasized that all restrictions on market access, which is the first line of defense in effective regulation, should be well-calculated and reasonable in design, and have sought to reduce all unnecessary restrictions. We have further standardized on-site inspections and off-site regulation activities, which form the core of ongoing regulation. At the same time, we have also improved joint regulatory action in an effort to gradually make our initiatives in ongoing regulation more professional and effective. The establishment of corrective regulation and risk-warning mechanisms has effectively promoted the implementation of regulatory policies. During the period from 2003 to 2010, we found out a total of 7.37 trillion yuan in unauthorized funds processed by financial institutions in the banking industry and took punitive actions accordingly, fined 14,800 offending institutions, and revoked the credentials of more than 1,400 senior managers. These actions have urged the banking industry to constantly step up its efforts to manage and control various risks.

  II. The experiences of banking regulation in China

  The innovation and improvement of the theories underpinning banking regulation with Chinese characteristics has spurred on the enhancement of regulatory activities. At the strategic level, our initiatives in banking regulation are geared towards the overall situation whilst emphasizing areas of priority; at the tactical level, we give consideration to a comprehensive range of factors and act in accordance with actual situations. Owing to such efforts, we have made major breakthroughs in the development of an institutional layout for prudent regulation and the building of regulatory capacity, which has allowed us to secure the sustained, steady and sound operation of the banking industry.

  First, we have integrated prudential regulation at both the macro and micro levels. Banking regulators are charged with the dual responsibilities of guarding against financial risks specific to individual institutions and guarding against systematic financial risks that threaten the entire sector. Drawing lessons from the international financial crisis, the CBRC has tried to implement countercyclical regulatory policies. We have required that commercial banks build up capital conservation and countercyclical capital buffers and enact dynamic and differentiated adjustments to loss provisions on lending, so as to achieve the goal of covering shortfalls with funds set aside in good times. When the real estate market was constantly overheating, we quickly adopted a series of effective regulatory measures such as loan-to-value ratio control. We have set stricter regulatory requirements for risk management and corporate governance in large banks. In addition, we have requested that such banks set aside additional capital based on systemic importance, and probed into the building of a regulatory policy framework for systemically important banks. We have conducted regular peer group analyses of risks in the banking industry; issued quarterly reports and risk warnings concerning the macroeconomic situation, financial situation and relevant major issues; and guided banks in conducting stress tests.

  Second, we have simultaneously strengthened proactive structural regulation and ongoing regulation. Along with tighter ongoing regulation, we have constantly improved the measures we employ for proactive structural regulation. In an effort to maintain the firewall between the banking system and the capital market, we have strictly prohibited bank credit funds from entering the stock market, banned banks from providing guarantees for corporate debt, and required banks to closely monitor fluctuations in the price of equity used as collateral. We have cautiously carried out trials for the integrated operations of commercial banks. The banks involved in such trials are required to possess consolidated risk management capacity and meet the necessary credentials. We have promptly carried out post hoc evaluations, with regulatory departments asking those banks engaged in cross-sectoral operations to withdraw from the relevant sectors if they have failed to reach the average profitability levels for those sectors within reasonable time frames. In addition, we have promoted the establishment of a country-specific risk management system by incorporating country-specific risks into our comprehensive risk management system. This has allowed us to improve our ability to guard against cross-border risk contagion.

  Third, we have struck an appropriate balance between uniform regulatory standards and flexible regulatory practice. In our efforts to implement Basel II and Basel III and draw up new regulatory standards, we have, in the interests of fairness, required that all commercial banks set aside regulatory capital by the end of 2011 and put in place basic processes for the self-assessment of capital adequacy; on the other hand, we have also demanded that various types of bank carefully select and implement risk measuring methods that are suited to their respective business scales and management levels. We have set unified minimum regulatory standards for various financial institutions in the banking industry, and formulated plans for the banking industry to implement new regulatory standards in stages and in a step-by-step manner based on category. We have also appropriately raised the regulatory standards for systemically important banks and adopted differentiated transitional arrangements in order to ensure the smooth transition of various institutions to the new regulatory standards.

  Fourth, we have supported sustained economic growth whilst affording due consideration to the steady and sound operation of the banking system. The CBRC highly values the role played by the financial sector in boosting the sound development of the national economy. We have called on the banking industry to earnestly implement China’s macroeconomic regulatory policies in line with the main tasks of promoting scientific development and accelerating the transformation of the pattern of economic development. We have requested that banks make reasonable adjustments to the direction in which they inject credit in accordance with the requirements for “guaranteeing the growth of some sectors and suppressing the expansion of others.” By doing so, we have ensured that credit growth levels in areas related to agriculture, rural areas and rural residents and that for small enterprises are not lower than the average growth levels for other types of loan. We have also strictly controlled lending to energy-intensive and highly polluting industries as well as those with excess production capacity, and implemented differentiated housing lending policies, thus effectively boosting the sound and rapid development of the real economy. We have actively guided the banking industry in stepping up industry risk monitoring and management so as to ensure that risk limits are held to. We have also urged the industry to improve its credit management policies and workflows in order to promote favorable interactions between the financial industry and the real economy.

  Fifth, we have achieved mutual promotion between external regulation and internal self-discipline. Under the unified arrangements of the State Council, the CBRC has actively promoted the share structure reforms and introduction of strategic investors in state-owned commercial banks. This has brought noticeable improvements to the corporate governance structures of these banks. In recent years, by improving the corporate governance system and adopting other measures, we have guided the banking industry in strengthening corporate governance. Such improvements relate to the exercise of due diligence by boards of directors, the performance of duties by directors, and governance frameworks. In light of the comprehensive review of corporate governance that has taken place in the international arena, we have promptly unveiled methods for evaluating the performance of duties by the directors of commercial banks as well as regulatory guidelines for remuneration mechanisms. By doing so, we have urged banks to establish incentive and constraint mechanisms that tie performance evaluations to risk. This has served to constantly strengthen the internal restraint within banks.

  Sixth, we have effectively applied best international practices to the realities of China. The CBRC has successively conducted four self-assessments against the Core Principles for Effective Banking Supervision. This has become an important mechanism for China to improve its capacity in banking regulation, playing an important role in improving the effectiveness of China’s financial regulation and putting the financial industry on a more stable footing. At present, we have achieved major headway in the implementation of Basel II, having basically completed the drafting and issuance of supporting regulatory statutes. We have also promptly released a timetable and a basic scheme for the implementation of Basel III, and incorporated the relevant requirements into the Measures for the Administration of Capital of Commercial Banks, for which public opinion is currently being solicited. The CBRC has developed a number of objective and scientific regulatory principles in light of the realities in China. We have also extensively participated in the formulation of international regulatory rules, which has allowed us to draw on international experience and lessons and safeguard the interests of China and other developing countries. These efforts have played a positive role in promoting the formation of a prudential regulatory system in China that is suited to the requirements of the modern banking industry.

  III. The prospects of banking regulation in China

  The Twelfth Five-Year Plan represents a key stage in China’s drive to deepen reform and opening up and accelerate the transformation of the pattern of economic development. It is also a crucial period in China’s push to build a moderately prosperous society in all respects. In terms of banking regulation, we need to constantly improve our prudential regulatory framework, enhance our regulatory methods and approaches, and actively develop long-term mechanisms for the prevention of systemic risks with a view to enhancing the comprehensive risk management capacity and international competitiveness of China’s banking industry.

  We need to constantly improve our regulatory tools and methods in order to put the framework for banking regulation with Chinese characteristics on a solid footing. First, we will place equal emphasis on capital and liquidity regulation by encouraging banks to establish stable, high-quality and diversified capital replenishment mechanisms as well as more effective systems for liquidity risk management. Second, we will continue to participate in the reform of international regulatory rules, progressively promote the adaptation of Basel II and Basel III to conditions in China, guide the banking industry in steadily implementing new regulatory standards with Chinese characteristics and thereby entrench a sound risk culture in day-to-day operations and management. We will optimize the regulatory organization system, improve regulatory workflows, enhance the efficiency of off-site regulation and on-site inspections, and promote the development of regulatory capacity on an ongoing basis. We will vigorously step up post hoc evaluations of the implementation of prudential regulatory policies and regulatory tools, conduct in-depth assessments of the effectiveness of regulation, and make timely improvements to regulatory policies, tools and methods in order to constantly improve the regulatory system.

  We need to improve macro-prudential regulation and develop long-term mechanisms for preventing systemic risks. We will step up efforts to monitor and analyze systemic risks and issue early warnings, actively develop long-term mechanisms for the prevention of risks, and improve our capacity to deal with risk. We will scientifically employ regulatory indices such as capital conservation and countercyclical capital buffers, dynamic provisions, loan-to-value ratios and leverage ratios, and deepen efforts to improve and implement the countercyclical regulatory system. We will explore the possibility of implementing more comprehensive and stringent regulatory standards for systemically important institutions, and establish regulatory mechanisms whose regulatory intensity and resources match systemic importance, thereby reducing moral hazards that result from the idea of being “too big to fail.” We will also further improve our consolidated regulatory capacity and improve firewall mechanisms.

  We need to strengthen regulatory enforcement and enhance the effectiveness of regulation. First, we must ensure that the exercise of regulation remains independent by rejecting administrative interference and attempts to loosen standards. Second, we should ensure that regulatory measures are proactive and interactive by exercising necessary regulation over the contracts and sales of banking products. Third, risk assessments and inspections of banks should be forward-looking and properly targeted in order to promote efforts by banks to constantly improve their comprehensive ability to recognize, manage and control risk. Fourth, banks that “are too complex to regulate” should not be allowed to exist. Fifth, intervention measures should be flexible, effective, and taken with appropriate frequency depending on the degree of risk. Sixth, regulatory departments should be able to intervene at the highest levels of decision making in banks when necessary in order to rectify the incidence and accumulation of imprudent events at the source. Seventh, institutions that are subject to regulation must have access to timely and accurate data to underpin rational decision making and management in accordance with the requirements of regulatory departments. Eighth, both banks and regulatory departments must understand the scope of modeling and be able to independently conduct stress tests and share the related information.

  We need to strengthen cross-border regulatory cooperation and improve our crisis management capabilities. We will raise the standard of cross-border regulatory coordination, and enhance coordinating mechanisms such as the joint conference system for regulating systemically important banks. We will actively guard against cross-border risk contagion by promoting the establishment of global standards for effective and continuous prudential risk management and financial stability. We will also promote the establishment of mechanisms for responding to and relieving global financial crises by strengthening cross-border crisis management arrangements, thereby enhancing the ability to jointly tackle crises.

  We need to deepen institutional and structural reforms to promote the sustainable development of the banking industry. We will deepen the reform of mechanisms for the evaluation of bank performance, and realize sophisticated and intensive development by optimizing workflows, improving management, and employing other means. We will urge banks to link pay incentives to long-term risk responsibility, and to implement a system for the deferred payment, recovery, and deduction of remuneration for bank employees who have failed in their duty, thus establishing remuneration mechanisms that embody the concept of sustainable development. At the same time, we will urge the banking industry to establish scientific and efficient mechanisms in regard to decision making, implementation, supervision, and checks and balances. We will ensure that banks strengthen their modern corporate governance structures and internal controls so as to improve self-restraint. We will continue to guide the banking industry in adopting differentiated development strategies and developing strengths based on special services and market brands in order to effectively address the homogenization of competition, thereby constantly improving the core competitiveness of the banking industry.


(Originally appeared in Qiushi Journal, Chinese edition, No.18, 2011)

Author: Chairman of the China Banking Regulatory Commission

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