People's Republic of China
Financial System Stability Assessment
Author:
International Monetary Fund
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Publication Date:
14 Nov 2011
eISBN:
9781463924546
Language:
English
Keywords:
ISCR; CR; interest rate; banking system; bond market; financial system; central bank
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This report discusses the IMF/World Bank Financial Sector Assessment Program (FSAP) exercise for China undertaken during June–December 2010. The assessment concluded that reforms in China have progressed well in moving toward a more commercially oriented financial system. Despite success and rapid growth, China’s financial sector is confronting several near-term risks, structural challenges, and policy-induced distortions. A properly composed and timely implemented set of reforms would help address these challenges. A framework to resolve weak financial institutions on a timely basis is also needed.

Abstract

This report discusses the IMF/World Bank Financial Sector Assessment Program (FSAP) exercise for China undertaken during June–December 2010. The assessment concluded that reforms in China have progressed well in moving toward a more commercially oriented financial system. Despite success and rapid growth, China’s financial sector is confronting several near-term risks, structural challenges, and policy-induced distortions. A properly composed and timely implemented set of reforms would help address these challenges. A framework to resolve weak financial institutions on a timely basis is also needed.

Table 1.

China: Key Recommendations

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Notes: NT (Near Term) means implementation completed within three years; MT (Medium Term) means implementation completed in three to five years.
Table 2.

China: Risk Assessment Matrix

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Source: China FSAP team. Note: Qualitative assessment is based on ratings of high, medium, or low for likelihood that the vulnerabilities will be exposed by shocks over a three-year horizon. Assessment of the impact on financial stability if the threat is realized is classified with ratings of mild, moderate, and severe. The assessment incorporates stress test results as well as other quantitative and qualitative elements of the FSAP analysis.

I. Overall Stability Assessment

A. The Macro-Financial Environment

10. China has maintained high growth rates over the past three decades. Since the start of reforms in 1978, growth has averaged close to 10 percent and inflation has remained relatively subdued. Productivity growth has been rapid and capacity has been expanded by very high levels of investment. The commercial banking sector has also grown rapidly and become more diversified (Figure 1). Banks’ lending to households, though low compared with other countries, has picked up sharply following the housing sector reform a decade ago (Figures 2 and 3).

Figure 1.
Figure 1.

China: Evolution of the Commercial Banking System

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.
Figure 2.
Figure 2.

China: Scale of Retail Lending in Selected Banking Systems, 2009

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; national authorities; IMF WEO; and IMF staff calculations.
Figure 3.
Figure 3.

China: Growth of Mortgage Lending

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.

11. The macroeconomic and institutional environment, however, has contributed to credit allocation inefficiencies and a build-up of vulnerabilities:

  • First, the relatively low cost of capital distorts saving-investment decisions. The low cost of capital reflects the ceiling on deposit rates and abundant liquidity, lessens foreign exchange sterilization costs, and supports investment and industrialization. It distorts real activity by generating incentives to over-invest and by suppressing household income through low returns on deposits.

  • Second, underdeveloped capital markets limit the alternatives for corporate funding and household savings. Households are limited to holding low yielding savings accounts, suppressing income and consumption. The limited availability of insurance products also creates incentives for higher precautionary savings. At the corporate level, lack of access to capital markets by small, private enterprises creates incentives for higher corporate savings. Finally, the search for higher yielding alternative investments by both firms and households adds to the likelihood that asset bubbles may develop, particularly in real estate (Box 1).

  • Third, due to incomplete interest rate deregulation and limited exchange rate flexibility, banks and other market participants lack sufficient incentives to improve their assessment, management, and pricing of risks. Banks have some flexibility in setting interest rates on loans, but most lending is clustered around the regulated benchmark loan rate (Figures 4 and 5). Also, the high levels of structural liquidity allow most banks to operate with underdeveloped internal liquidity management processes.

Figure 4.
Figure 4.

China: Benchmark and Average Lending Rates

(Percent)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: PBC; and CEIC.Note: Average lending rate prior to Dec 08 refers to the rate applied to loans with maturity between 6 months and one year.
Figure 5.
Figure 5.

China: Distribution of Lending Rates

(Multiples of Benchmark Rate)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: PBC; CEIC; and IMF staff calculations.

Real Estate Sector and Banking Sector Soundness

The sharp increase in China’s real estate prices combined with extraordinarily high bank lending to the real estate sector (Figures 6 and 7) has heightened the prospects of a negative impact of price corrections on China’s banking sector. The ongoing tightening measures, however, have slowed down loan growth to the real estate sector and the related price increases. Continuous monitoring, stress test, and a comprehensive set of policies are needed to contain the impact of a real estate price correction on financial stability.

Several fundamental factors are driving the real estate prices in China. These include rapid income growth, low return on deposits, abundant liquidity, lack of alternative investment vehicles, low cost of home ownership, and local governments’ reliance on land sales revenues.

The banking sector’s direct exposure to the real estate sector is moderate (Figure 8) but the indirect exposure is much higher. Real estate sector related loans account for some 20 percent of the Chinese banking system’s total loans, relatively low compared with, for example, Hong Kong SAR or the United States. However, indirect exposure is higher. Loan terms in China depend heavily on collateral use. In the five largest banks, 30–45 percent of loans are backed by collateral, the majority of which is real estate. A large real estate price correction would reduce collateral values, and hence loan recovery value should borrowers default. In addition, credit to industries that are “vertically integrated” with the real estate sector (such as construction, cement, and steel) are also exposed to these risks. Given the importance of the real estate sector for economic growth, an economic slowdown as a result of a real estate price correction could adversely affect the banking system’s asset quality. Last but not least, local governments’ ability to support local government financing platforms (LGFPs) via land sale and subsidies—essential for those LGFPs with limited cash flows to repay the loans—heavily depends on the real estate market.1

In the short-term, the impact appears manageable especially if the current growth momentum continues. There does not appear to be significant over-valuation of residential real estate prices in China as a whole, though there are signs of overvaluation in some market segments. Also, the moderate direct exposure and low leverage ratio (Figure 9) would limit the impact of a real estate price correction on banks’ asset quality. Stress testing banks’ exposure to the real estate sector alone, or in combination with the “vertically integrated” sectors (Section I. D), suggests a modest impact on banks from credit quality deterioration in the real estate sector.2 However, if a growth shock materialized concurrently then the impact on the banking system and its spillovers would be severe.

Over the medium- to long-term, the risk posed by the real estate sector depends on whether the fundamentals behind the real estate price increases are addressed by policy measures. A comprehensive set of measures—including the completion of the interest rate and exchange rate reforms, further capital market development, gradual opening of the capital account, and fiscal reforms, including initiating a broad-based property tax—is needed to promote the orderly development of the real estate market. In the meantime, the authorities should monitor real estate market developments and their potential impact on the banking sector and financial stability, and take prompt corrective steps in case of real estate price overshooting.

1 On average, 29 percent of their total revenues were from the sale of land use rights in 2010 (UBS, 2011, “Measuring Property Bubble in China,” March 22, 2011). Total revenues include mainly local government revenues, transfer and tax refunds from central government, and land sales revenues. 2 Due to data issues, the stress testing exercise did not explicitly take into account regional differences in real estate market developments.
Figure 6.
Figure 6.

China: Residential Housing Prices and Mortgage Lending

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.
Figure 7.
Figure 7.

China: Bank Loans to the Real Estate Sector, Year-on-Year Changes

(Percent)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.
Figure 8.
Figure 8.

China: Share of Real Estate Sector Loans in Bank Loans

(Percent)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.
Figure 9.
Figure 9.

China: A Proxy for Loan-to-Value Ratio

(Percent)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.

12. Continued reliance on credit growth targets, even if supplemented by other policy instruments, undermines the efficiency of credit allocation and disrupts monetary policy transmission. Such credit targets have meant that banks have strong incentives to expand market share to boost interest income and use off-balance sheet channels to circumvent credit targets, compromising monetary control; and that the corporate sector tends to over-borrow, knowing that at some point credit will be rationed. Controlling interest rates and determining quantities of lending also mean that policy makers cannot rely on market prices (such as short-term interest rates) to assess macroeconomic and liquidity conditions.

13. A by-product of the existing macro-financial and institutional environment is low investment efficiency. Since 2001, it is estimated that every US$ 1 of Chinese GDP growth has required, on average, nearly US$ 5 of investment, 40 percent more than in Japan and Korea during their take-off periods.1 In addition, while the share of China’s total savings and investment in G-20 aggregates is more than 20 percent, its GDP share is about 10 percent. These may be a reflection of misallocation of capital to some projects with low rates of return.

14. The state is also directly and indirectly involved in the financial sector. A large share of the banking sector is state-owned, as is much of banks’ corporate client base. As the principal shareholder, the state appoints senior management in all major banks. In the absence of an explicit deposit insurance system and a resolution framework, the state also implicitly insures all deposits. The heavy involvement by the state in many aspects of the financial system reduces market discipline, weakens corporate governance, and is likely to create soft budget constraints.

15. Such state involvement has been illustrated by the important role of the banking system in the conduct of fiscal policy. To counter the impact of the 2008–09 global financial crisis the authorities launched a stimulus package that was implemented through bank credit expansion. Local governments’ eagerness to undertake infrastructure projects coupled with revenue-expenditure mismatches and their inability to borrow directly, resulted in a rapid increase in using LGFPs to serve as indirect vehicles to collect bank loans, often using state-owned assets such as land as collateral. As a result, the contingent liabilities of the public sector from such activities increased considerably.

B. Financial System: Structure and Inter-linkages

16. China has made progress in moving toward a more commercially-oriented financial system (Table 3). This has been underpinned by reforms that included recapitalizing the banking system, creating new capital markets, introducing a prudential regulatory regime, opening the financial system following accession to the World Trade Organization, and taking steps to reform interest rate and the exchange rate policies. Reform of the joint-stock banks has boosted the commercial orientation of the banking system and reform of the rural credit cooperatives has yielded some initial results. In the securities sector, key companies have been restructured, and a resolution mechanism and investor protection scheme set up. Pension sector reform has also progressed, with National Social Security Fund established in 2000.

Table 3.
Table 3.

China: Financial Sector Reforms—Selected Benchmarks

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Note: The Big 4 banks are ICBC, CCB, ABC and BOC, which have been commercialized in recent years. The Big 4 and Bank of Communications together are referred to as large commercial banks.

17. Nonetheless, banks, particularly the largest ones, dominate financial intermediation (Tables 4 and 5, and Figure 10). The large commercial banks (LCBs) make up almost two-thirds of commercial bank assets (Figure 11) with the assets of the four largest banks each exceeding 25 percent of GDP. The fixed income market has grown as an alternative funding channel, but remains heavily concentrated in public sector securities (Figure 12). The equity market mainly meets the needs of large enterprises, in spite of recent progress in establishing a multilayer equity market to facilitate funding to SMEs. Assets under management by the insurance sector corresponded to less than 11 percent of household bank deposits. Trust, financial leasing, and finance companies have all been growing rapidly but remain small relative to banks. China also has a flourishing informal financial sector, parts of which provide funding to SMEs and small retail investors.

Figure 10.
Figure 10.

China: Credit Intermediation, 2010

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: Bloomberg L.P.; IMF International Financial Statistics; Bank for International Settlements; CBRC, CSRC, and IMF staff calculations. Note: In the case of China, private sector credit refers to domestic credit minus claims on central government and NBFIs.
Figure 11.
Figure 11.

China: Commercial Banking System Structure by Assets, 2010

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.
Figure 12.
Figure 12.

China: Fixed Income Markets in Selected Countries, 2009

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: Chinabond, 2010, “China’s Bond Market—the View.”
Table 4.

China: Structure of the Financial Sector, 2007–10

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Sources: PBC; CBRC; CIRC; CSRC; NBS of China; and Ministry of Human Resource and Social Security; and IMF staff calculations.

As there is no insurance company engaged in both life and non-life business, data of reinsurance companies are provided instead. In 2007 the insurance sector adopted new accounting principles which are applied to the data starting from 2007.

Proceeds raised by securities investment funds are managed by fund management companies on behalf of fund unit holders.

The table excludes assets of the four AMCs. According to the FSAP team’s calculations, the book value of the non-performing assets transferred to the AMCs amounted to about RMB2.6 trillion as of end 2006 (about 6 percent of total financial system assets or 12 percent of GDP). Comparable data for 2007-10 are not available, as the AMCs have not released financial statements since 2006.

This table does not include informal finance, the estimates of which vary.

Notes: Data for 2008, 2009, and 2010 were provided by the Chinese authorities in the context of the FSAP. Data for 2007 were collected from publically available sources, particularly the annual reports of the three financial regulatory commissions and the financial statements of the NSSF. Data on rural and urban credit cooperatives were collected from the CBRC’s annual reports.
Table 5.

China: Financial Development Indicators, 2005–10

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Sources: PBC; CBRC; CIRC; CSRC; MOHRSS; CFETS; BIS; IFS; WDI; Swiss Re Sigma; and ChinaBond.com.cn.

Including credit to public enterprises.

Labor force data for 2010 is an estimate.

Including all the A and B shares of companies listed on SSE and SZSE.

Data for government bonds are from the BIS and include both treasury securities and central bank bills/notes.

Estimates by CFETS.

18. While China’s financial markets are still in a development phase, cross-market integration has been increasing. There is distinct separation within domestic markets (for example, the domestic bond market is divided into exchange traded/retail and interbank/wholesale markets) and between Chinese markets and the international financial markets (in part, due to widespread capital controls). Nonetheless, shocks do get transmitted across different domestic markets, as illustrated by a positive correlation of yields. Connectivity between markets is likely to grow fast.

19. Linkages among the banks are mainly transmitted through the interbank repo market. The repo market is necessary for many small banks and nonbanks to fund their activities, and for larger banks to place their surplus funds. Consequently, it is the market through which a liquidity squeeze in one part of the banking system can and does spread to others (Section I.C).

20. Inter-connections between banks and nonbank financial institutions (NBFI) have begun to grow. Laws and rules permit more complex structures even though supervisors are challenged to meet the key elements of the principle of consolidated supervision. Interlinkages are increasing with the rise of FHCs, which have expanded considerably since the initiation of a pilot program on integrated financial services under the 11th Five-Year Plan (2006–10) and industrial-financial integrated groups have developed rapidly. At the same time, regulatory policies applying to shadow banking and their interconnections needs to be clarified and made transparent. A more structured oversight, regulatory, and supervisory approach is needed to prevent and to manage systemic risks via cross-market products and institutional structures.

21. Finally, the financial linkages between China and the rest of the world have historically been limited, but are growing rapidly. The growth in RMB deposits in Hong Kong SAR has been rapid (Figure 13), though the amount is insignificant relative to the RMB onshore deposits. Cross-border portfolio capital investment is subject to Qualified Domestic Institutional Investor (QDII) and Qualified Foreign Institutional Investor (QFII) programs.2 The markets for B shares, through which foreign investors are allowed to invest in China’s stock exchange markets, and H shares (China companies listed in Hong Kong Stock Exchange) are eclipsed by the markets for A shares (Figure 14). In addition, the financial transmission between A share and H share is still limited (Figure 15). While the balance sheet positions of China’s banking system vis-à-vis banks located in other countries do not yet fully match the interlinkages of the world’s leading banking centers, they have increased by 80 percent in the last ten years.

Figure 13.
Figure 13.

China: RMB Deposits in Hong Kong SAR

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.
Figure 14.
Figure 14.

China: Market Capitalization of A, B, and H Shares (RMB billions)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.
Figure 15.
Figure 15.

China: Hong Kong SAR Market Premium for Chinese Equity

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; Bloomberg; and IMF staff calculations.

C. Banking System Performance, Soundness, and Resilience

22. The banking sector’s balance sheet has expanded rapidly, in part due to the investment-driven stimulus policies of recent years. In 2009, the total amount of outstanding RMB loans expanded by 33 percent although credit growth slowed down in 2010 (Figure 16). The rapid growth in foreign currency loans is likely linked to the expectation of RMB appreciation. Bank exposure to infrastructure construction increased, driven largely by an expansion of LGFPs, while the share of manufacturing-related loans declined. The upswing in the real estate market also fueled demand for mortgage loans. Banks’ off-balance sheet exposures expanded rapidly, mostly as a result of banks’ promoting wealth-management products as the government began to limit the pace of new lending.

Figure 16.
Figure 16.

China: Loan Growth Rates

(Year-on-Year; Percent)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.

23. Banks’ funding appears stable. The sizable and low-cost domestic deposit base has contributed to stable bank funding. While household deposits remained critical to the growth of banks’ funding base for most of the reform years, the incremental growth in domestic corporate deposits in 2009 has been significant (Figure 17). Maturity mismatches have also risen. Increasing reliance on medium- and long-term loans for investment project financing has lengthened banks’ average asset maturities (Figures 18), particularly for large commercial banks.

Figure 17.
Figure 17.

China: Levels and Incremental Growth of Bank Deposits

(RMB trillions)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CBRC; and IMF staff calculations.
Figure 18.
Figure 18.

China: Loans by Maturity

(Percent)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.

24. Bank profits remain high (Table 6). The credit expansion has supported bank profitability, despite a partial contraction of the interest rate margins in 2009. Chinese banks’ limited earning diversification and strong reliance on interest income, however, makes their porfits prone to changes in regulated interest rate margins and limits on lending volumes.

Table 6.

China: Selected Indicators of Financial Health, 2005–101

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Sources: PBC; MOF; CBRC; CIRC; State-Owned Asset Administration Commission; NBS of China; IMF Global Financial Stability Report; Bankscope; and IMF staff calculations.

All data for this table unless noted otherwise were provided by the Chinese financial regulatory and supervisory commissions in the context of the FSAP. The following footnotes describe some cases in which the figures were obtained from other publically available sources or calculated by the FSAP team.

Comparability across years is limited due to differences in data coverage. Data for 2005 and 2006 refer to the total banking industry as reported in the IMF Global Financial Stability Report, whereas data from 2008 to 2010 refer to the 17 major commercial banks as reported by Chinese authorities to the FSAP team.

Capital adequacy and asset quality indicators were calculated with data from CBRC’s 2010 annual report. Capital to assets ratio is defined as equity to assets ratio. Interest rate spreads were calculated with data from PBC’s Monetary Policy Reports.

Ratios where the numerator and denominator were compiled on a domestically consolidated basis (DC).

Simple averages of 17 major commercial banks. FSAP team’s calculations based on the banks’ financial statements and Bankscope.

Available solvency margin over required solvency margin.

Number of non-financial State-Owned Enterprises (SOEs) above Grade Three. The State-Owned Assets Supervision and Administration Commission directly held SOEs are Grade One. Grade One SOEs directly held subsidiaries are Grade Two. Grade Two enterprises directly held subsidiaries are Grade Three.

Earnings before interest and tax as a percentage of interest and principal expenses.

Number of SMEs in the industrial sector.

Percent change in commercial real estate and house price indices.

CBRC’s statistics based on credit data on institution (legal person).

25. The banking systems’ nonperforming loan (NPL) ratio has been on a downward trend, reaching 1.1 percent at end-2010 (Figure 19). This decline was driven by the rapid expansion of credit, a decline in NPL levels, and a RMB 816 billion NPL carve-out from one major bank in 2008. Over a longer horizon, large scale NPL carve-outs associated with the 1999–2001 and 2004–05 state-owned bank restructurings have kept overall NPL ratios low.3 The low level of reported NPLs has also been helped by strong economic growth and some improvements in risk management in banks. The rapid credit growth, however, could result in a deterioration of bank asset quality in the coming years. In addition, about 95 percent of bank loans re-price in under one year; this could lead to higher borrowing costs and loan servicing problems for weak borrowers if the PBC moves along a tightening cycle.

Figure 19.
Figure 19.

China: Nonperforming Loans to Total Loans

(Percent)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: CEIC.

26. Exchange rate exposure is large at the central bank. Large current account surpluses and the management of the exchange rate regime result in the accumulation of sizeable foreign exchange reserves and a large net open foreign currency position for the central bank. Commercial banks, in aggregate, are also long in foreign assets (Figure 20) though in a much smaller scale.

Figure 20.
Figure 20.

China: Depository Corporations’ Foreign Asset and Liability Positions

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Sources: CEIC; and IMF staff calculations.

27. The near-term risks of liquidity stress appear limited. The banking sector’s basic liquidity indicators appear healthy. Larger banks typically recycle liquidity through the interbank markets to smaller banks and other financial institutions (Figures 21 and 22). The dominant share of secured interbank lending, high quality collateral, and abundant liquidity limit the prospects of market stress in the near term. Interbank markets, however, are subject to some risks. There are persistent liquidity imbalances among the banks, with small banks and non-banks particularly reliant on wholesale funding. A localized liquidity squeeze could spread from a small set of institutions that face a liquidity shock and cannot realize the face value of their pledged security to a broader liquidity shock. The PBC standing facilities should act as a liquidity backstop when liquidity is unavailable from the market.

Figure 21.
Figure 21.

China: Flow of Funds in the Interbank Market—Repos

(RMB billions)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC.
Figure 22.
Figure 22.

China: Flow of Funds in the Interbank Market—Call Loans

(RMB billions)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC.

D. Stress-Testing Results Summary

28. To capture the key risks of the Chinese financial system, a stress testing exercise was jointly conducted by the FSAP team and PBC/CBRC team.4 The results of the PBC/CBRC team’s top-down and banks’ bottom-up calculations—based on a sample of 17 banks—were provided to the FSAP team at the aggregate level and by bank type. The FSAP team also carried out its own set of top-down calculations, based on publicly available data on the same set of 17 banks.

Caveats

29. A full assessment of the extent of the risks and how they could permeate through the economic and financial system was hindered by various factors. First, it was not feasible to fully cover all the differentiated risks confronting the banking system due to data constraints on the sectoral exposures and types of entities that banks lend to. Also, data constraints prevented an explicit analysis of off-balance sheet positions and operations, except for those relating to the direct exchange rate risk. Moreover, much of the calibration in the macro-scenario tests was based on relatively short time series of key financial data (e.g., for NPLs) with structural breaks in the series; this limited a solid econometric analysis. Full-fledged comparison, analysis, and cross-check of the results were not possible in areas where publicly available information is imprecise, insufficient, or nonexistent (e.g., exposures to LGFPs and the contagion risk exercise) due to the constraints on the FSAP team’s access to confidential data. Finally, the stress tests assumed the status quo (i.e., current macro-financial environment). As reforms begin in earnest, the banking system may face an amplification of existing risks or new uncertainties—although a properly implemented reform process and stronger risk management and corporate governance practices will help mitigate adverse financial consequences.

Table 7.

China: Stress Tests for Banks

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Source: FSAP stress testing team.

30. Keeping these caveats in mind, the stress testing results suggest that major banks can absorb moderate potential losses. This reflects improved profitability and balance sheets in recent years, which allowed banks to build up buffers. The single-factor sensitivity calculations indicate that the system would be able to withstand a range of sector-specific shocks occurring in isolation. These specific shocks include asset deterioration in bank credit to the real estate sector, LGFPs, export sector, and other sectors. The macroeconomic scenario analysis suggests, however, that the system could be severely impacted if several major shocks materialized concurrently.

Credit risks

31. The system appears able to withstand relatively sizeable aggregate increases in credit risk (Figure 23). If NPL levels were to increase by 400 percent in two years (i.e., post-shock NPL ratio reaching about 6 percent), calculations based on end-2010 data suggest that no banks would have capital adequacy ratio (CAR) below the regulatory minimum (i.e., 8 percent). The improvement in resilience from 2008 to 2010 reflects the decline in NPL levels. In addition, the buffer provided by stronger bank capital positions in 2010 helped prevent participating banks from failing to meet the regulatory minimum CAR under the most severe assumptions.

Figure 23.
Figure 23.

China: Aggregate Credit Risk: Sensitivity Analysis

(Percent)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC/CBRC.

32. The resilience was also confirmed by a reverse stress test (“threshold approach”) conducted by the FSAP team and PBC/CBRC team. For instance, based on end-2009 data, for half of the banking system (in terms of total assets) to breach the regulatory minimum CAR, the ratio of gross NPLs to total loans would have to increase to almost 11 percent. Or, assuming that the banking system requires a capital injection of 6 percent of GDP, the NPL ratio would need to reach 24.8 percent (compared with 1.6 percent at end-2009).

33. Stress tests conducted by the PBC/CBRC team and the banks indicate the impact of credit quality deterioration from a shock to the real estate sector would be contained. Two tests were conducted. The first test, conducted by the PBC/CBRC team and individual banks, involved assuming NPLs increase in the segments of personal mortgage loans, real estate development loans, and land reserve loans. Based on end-2010 data, if 15 percent of developer and land reserve loans, as well as 7½ percent of mortgages become nonperforming, the aggregate CAR falls by about 1 percentage point but no banks fall below the regulatory minimum (Figure 24). The second test, conducted by individual banks, was an expanded version of this first exercise whereby—in addition to the three segments listed above—the impact of the real estate price decline was carried through to create insolvencies in six industries that are “vertically integrated” with the real estate.5 A 30 percent decline in property prices, higher interest rates, and the resulting impact on related industries has only a minimal impact, lowering the aggregate CAR by less than ¼ percentage point (Figure 25).

Figure 24.
Figure 24.

China: Credit Concentration: Real Estate Sensitivity Analysis,

(Percent)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC/CBRC.Note: Mild scenario—5 percent of real estate development and land reserve loans and 3 percent of personal mortgage loans become NPLs; medium scenario—10 percent of real estate development and land reserve loans and 4.5 percent of personal mortgage loans become NPLs; severe scenario—15 percent of real estate development and land reserve loans and 7.5 percent of personal mortgage loans become NPLs.
Figure 25.
Figure 25.

China: Change in CAR: Credit Concentration: Real Estate—Alternative Approach, March 2010

(Percentage point)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC/CBRC.Note: Mild scenario—real estate prices decline by 10 percent, and interest rate increase by 27 bps; medium scenario—real estate prices decline by 20 percent, and interest rate increase by 54 bps; severe scenario—real estate prices decline by 30 percent, and interest rates increase by 108 bps.

34. The stress testing exercise has also assessed the potential losses on LGFP lending. The results show that, based on a bottom-up stress test conducted by individual banks, losses equivalent to 15 percent of the banks’ LGFP loans would result in a fall in the CAR to below the regulatory minimum for only two small joint-stock commercial banks (JSCBs) (Figure 26).

Figure 26.
Figure 26.

Test for Banks’ Exposures to LGFPs, End-2009

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC/CBRC.Note: The information on Banks’ exposure to LGFPs is not made available to the FSAP stress testing team.

Direct interest rate risk

35. Direct interest rate risks on banking book and trading book appear manageable. Shocks to loan and deposit rates were used in the analysis, and their impacts were evaluated by the PBC/CBRC team and individual banks in terms of the implied change in the CAR. The results suggest that even under the severe combination of shocks, the CARs for all the 17 banks declined slightly (Figure 27). The risk of a parallel shift of yield curve on trading accounts was also tested by individual banks and the results again suggest the impact would be very small (Figure 28).

Figure 27.
Figure 27.

China: Interest Rate Risk: Banking Book, End-2009

(Percentage point)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC/CBRC.
Figure 28.
Figure 28.

China: Interest Rate Risk: Trading Accounts, End-2009

(Percentage point)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC/CBRC.Note: results evaluated at one quarter.

Direct exchange rate risk

36. The direct impact of exchange rate movements on the banking system would be limited. The results of the PBC/CBRC team’s top down and individual banks’ bottom-up stress tests suggest that under the severe stress scenario, the CAR for the system as a whole falls by less than 0.1 percentage point and the CARs for all 17 banks would still exceed the minimum requirement (Figure 29).

Figure 29.
Figure 29.

China: Direct Exchange Rate Risk, End-2009

(Percentage point)

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC/CBRC.Note: Shocks refer to the appreciation of RMB against USD while exchange rates of USD against other currencies are assumed to be stable.

Liquidity risk

37. Two rounds of liquidity risk stress tests have been conducted. The results suggest that in the first round (i.e., without considering banks’ ability to sell off bonds) the impact could be substantial, with, for instance, six banks having a negative cash flow gap at the seven day horizon. The results of the second round, which assume that banks are able to sell off bonds at a discount, are more benign, with all banks except one (at the 30 day horizon) having positive cash flow gaps.

Macro-scenario tests

38. The macroeconomic scenario analysis suggests a severe impact on the system if several major shocks materialized concurrently (Figure 30). For example, a severe scenario (involving a slowdown in GDP growth to 4 percent year-on-year) implies a system-wide CAR of about 8 percent, with banks accounting for some ¼ of the total assets of the 17 banks covered by the stress tests falling below the 8 percent minimum CAR. It is encouraging also that the results of the scenario analysis were broadly consistent with the suggestive conclusions drawn from a survey of available results in previous FSAPs (i.e., in a major slowdown of GDP), NPL ratios tend to increase by at least one percentage point for each one percentage point decrease in the rate of output growth.

Figure 30.
Figure 30.

China: Macro-scenario Results, End-2009

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: PBC/CBRC.

II. Managing Risks: Upgrading the Crisis Toolkit

A. Financial Stability Framework

39. To enhance macro-prudential surveillance, a permanent Financial Stability Committee should be established, with the PBC as its secretariat. It should be chaired by a very senior official and have a clear mandate and authority to identify and monitor the emergence of systemic risks and to make recommendations to address them. Members would include the PBC, the three supervisory commissions, the MOF, and other relevant ministries or agencies. The PBC, as the Committee’s secretariat, along with each of the commissions would be empowered to provide and to receive necessary information, including confidential institution-specific supervisory information.

40. Data collection should be enhanced to facilitate a good understanding of financial institutions’ balance sheets and linkages. Such data should include the level of leverage, maturity mismatches, large exposures, contingent liabilities, off-balance sheet positions, unregulated products, and cross-border and sectoral (e.g., housing, local government) exposures, which in turn requires improving data collection on financial institutions’ non-financial counterparts. Development of a forward-looking early warning system incorporating macro and financial indicators, financial soundness indicators, systemic risk indicators, and balance sheet information would help identify macroeconomic and financial developments with a potential to threaten the financial system.

41. Continued efforts are needed to build a comprehensive macro-prudential framework for measuring and managing systemic risks. China already has several macro-prudential tools to handle these risks, including capital surcharges for systemically important financial institutions (SIFIs), dynamic provisioning, variable capital requirements, reserve requirements, and requirements related to loan-to-value and loan-to-deposit ratios. A clear indication of how these buffers and requirements may vary as conditions change needs to be developed. Increasing the PBC’s and the regulators’ resources and capacity to monitor financial stability and carry out regular stress tests is also needed.

B. Systemic Liquidity Management

42. The PBC should begin to absorb the significant liquidity overhang that is currently present in the financial system. This will involve a much more aggressive use of open market operations to reach a point where the PBC no longer needs to rely on administrative limits on bank lending. As liquidity conditions tighten, banks will have incentives to improve their internal liquidity management functions and focus more on assessing risk-return trade-offs in allocating loans.

43. At the same time, considering reserve averaging would be a useful step. Its introduction could facilitate liquidity management and enhance stability and efficiency. The daily nature of the reserve requirement means that it is principally an aggregate liquidity management tool rather than a prudential buffer for banks. Banks end up holding substantial under-remunerated excess reserves for buffer purposes—effectively an additional tax on intermediation. Across the banking system these reserves have averaged around 2–3 percent of deposits, but the actual holdings vary substantially by type of bank. Therefore, reserve averaging could help reduce this additional tax and make liquidity management for all, particularly smaller, institutions easier, and limit the possibility for liquidity stresses to transmit across institutions.

44. The central bank should begin by targeting a short-term repo rate. To further strengthen the management of short-term interest rates, the central bank could raise the rate paid on excess reserves to narrow the corridor implied by the difference with its discount rate. To support the use of indirect instruments and supplement structural liquidity withdrawal, the PBC could lengthen the maturity of its open market operations through greater use of longer-term repos.

45. Overtime, the PBC should enhance its capacity to undertake daily liquidity operations. Recent international experience has demonstrated the potential for a liquidity crisis to occur even when liquidity appears abundant. The PBC needs to implement higher frequency liquidity forecasting, which in turn requires an increased flow of information among the MOF, State Administration of Foreign Exchange (SAFE), and the PBC.

46. Access to the PBC’s standing facilities should be made more automatic and transparent, with moral hazard concerns addressed through pricing of the facilities. The PBC exercises considerable discretion over access to standing facilities, complicating and potentially delaying the disbursement of funds. This could be addressed by reducing PBC’s discretion and making the use of each facility automatic, with collateral requirements identical across all domestically incorporated institutions. This would also strengthen PBC interest rate guidance by providing a binding and effective interest rate corridor.

C. Crisis Management, Resolution, and Deposit Insurance

47. China’s crisis management arrangements fall under the purview of the State Council (SC). The resolution toolkit needs to be expanded as the financial system is becoming complex. The current toolkit is essentially based on an “open resolution” approach towards nonviable banks and an implicit blanket guarantee for depositors, with the PBC in practice taking responsibility for backing up deposits. This implies significant moral hazard. A more comprehensive toolkit would comprise a safety net and an effective institutional arrangement in which relevant authorities have operational autonomy and legal authority to intervene promptly in weak and nonviable financial institutions.

48. The introduction of an explicit deposit insurance scheme, which is under consideration, should be accelerated to provide a structured safety net. It will also help facilitate the orderly resolution of failing banks. The design features should incorporate the principles being developed by the International Association of Deposit Insurers. Its institutional structure should be appropriately designed taking into account the large number of depository institutions, growing complex structures, existing roles of various organizations in a resolution, and the need to clarify the contingent liability of the government, particularly of the PBC, when resolving failed institutions.

49. Laws concerning the insolvency of financial institutions need to be reviewed and strengthened in all sectors. A designated separate entity should be provided with the capacity to manage the intervened institution and with resources to resolve the institution through recapitalization, sale, in whole or in part, or liquidation. The entity should be funded by industry to reduce if not eliminate the need to rely on government support. The institutional capacity to deal with troubled assets in failed institutions is an important component. The entity could assume responsibility for administering the deposit insurance scheme and assets of failed institutions. As for the existing four public AMCs, a strategy is needed. As a first step, the AMCs should be required to publish periodic financial statements and management reports and eventually, most, if not all, should be converted into commercial entities.

D. Macro-Financial Framework

50. The linkages between the macroeconomic policy framework and financial sector are intrinsic to financial stability in China. It is for this reason that while the financial system looks stable in prudential terms, with a small level of problem loans, extensive credit provisioning, and (still) low leverage of main borrowers, allocative inefficiencies, and structural vulnerabilities still remain. As stated earlier, commercial banks often act as the channel of monetary policy and as facilitators of fiscal policy. The existing policy framework thus creates large distortions to incentives and places risk on the public balance sheet as contingent liabilities. While improvements in risk management, prudential regulation, and supervision remain necessary, and need to be strengthened, the further deepening and maturation of the financial system will be addressed in a large part by the process by which the macroeconomic policy framework evolves.

51. The PBC should rely more on indirect monetary policy instruments to exercise macroeconomic control. Instead of credit growth targets, market-based interest rates should become the primary instrument for managing credit expansion. This will reduce the risks that monetary control will be increasingly circumvented and ineffective in the face of capital inflows, off-balance sheet lending, and other financial innovations. It will also enhance banks’ scope to differentiate loan rates and improve the credit allocation.

52. A liberalized and flexible exchange market is necessary for the conduct of monetary policy by reducing PBC’s liquidity management challenges. The current high levels of foreign currency intervention require significant sterilization efforts. In addition, the perception of a one-way bet on the currency provides incentives for capital inflows that serve to complicate financial market outcomes. Moving to a more flexible exchange market would reduce the financial stability risks associated with cross-border flows and transactions; lessen the liquidity management challenges faced by the PBC; and give greater scope for independent use of indirect instruments of monetary policy. These measures would require the strengthening of market and systemic risk monitoring, and cross-border regulation and supervision.

III. Bolstering Financial Sector Oversight

53. An assessment of the regulatory and supervisory framework (Table 8) reveals a high degree of adherence to international standards, but challenges remain.6 The challenge is to increase its efficiency, quality, and responsiveness. The appropriate balance has to be struck between the degree of regulatory control and the need to enable useful innovation and development of the financial system. A central theme of the assessments is to improve operational autonomy of the regulators, upgrade skills and risk monitoring capabilities, increase resources, and strengthen interagency coordination.

Table 8.
Table 8.

China: Financial System Architecture

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Notes: The thickest connecting lines correspond to the highest levels of authority in financial policy making. The NPC promulgates all financial sector laws and the State Council executes financial regulation and issues mandatory policy directives to all the financial regulatory and supervisory agencies. The dotted connecting lines indicate the three primary functions of PBC—formulating monetary policy, maintaining financial stability, and providing financial services—and the triple role of the MOF as tax administrator, treasurer, and owner of several commercial banks. The thinner connecting lines emerging from CBRC, CSRC, CIRC, and MHRSS reflect that these entities are mostly responsible for regulating and conducting supervision and oversight of their respective financial sectors. Additional notes: The SAFE is responsible for foreign exchange operations of securities and insurance companies. The China Development Bank and the Postal Savings Bank are in the process of reforming into commercial banks. Central Huijin exercise rights and obligations as an investor in major state-owned financial enterprises on behalf of the State. The National Social Security Fund has also a dual role as an institutional investor and a stakeholder in some of the largest commercial banks.

54. China’s sector-based regulatory and supervisory framework demands a high degree of coordination to limit supervisory “blind spots.” There is a need to develop a framework for regulation and supervision, by a single entity such as the PBC, of FHCs including industrial conglomerates investing in financial firms. The PBC has been authorized by the SC to draft administrative rules working with the three other regulatory commissions. In the interim, acquisition of a regulated institution should be approved by the relevant regulatory commission responsible for the underlying financial institution. In addition, the regulatory policies applying to the shadow banking system need to be clarified (Table 9). Interagency coordination arrangements among the PBC and three commissions backed by memoranda of understanding for information sharing need to be strengthened along with the removal of any legal restrictions on such sharing.

Table 9.

China: Shadow Banking

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Sources: The PBC; CBRC; CSRC; NDRC; and IMF staff. Note: (1) According to the FSB definition, shadow banks are those entities that engages in credit creation and maturity/liquidity transformation outside the banking system and that have an element of leverage, and that includes MMMFs, finance companies, ABCP vehicles, SIVs etc. Due to limited data, this table does not include these entities. (2) This table only includes those that are identified by the authorities (informal financial sector and private equity) and those that are taken as shadow banks by the FSAP team (trust companies and wealth management products).

A. Commercial Bank Regulation and Supervision

55. The CBRC has a clear safety and soundness mandate. However, its operational autonomy is often undermined by the use of commercial banking system for development purposes. The CBRC has made strides in improving its framework for supervising commercial banks and emphasizing prudential goals. Nonetheless, it will be important to ensure the agency’s ability to pursue its mandate is unencumbered. This will be facilitated by ensuring more stable resourcing arrangements that permit greater flexibility in building up a skilled and professional staff and continued commercialization of the banks.

56. The legal and regulatory framework for banking has been brought closer in line with international standards, but gaps remain. There is no legal requirement to be informed of changes in indirect control and to identify ultimately beneficial owners and clients of banks. Complex structures should be prohibited where consolidated supervision may not be possible. Rules for identifying related parties and rules underpinning bank resolution need to be strengthened. The prudential regime for asset classification and provisioning works well, but there are limitations in actual bank practices. Minor deviations from the Basel I framework7 may potentially overstate bank capital in the future.

57. Banks’ risk management techniques and practices need to be upgraded. Large banks have built their risk management systems around simple yet conservative regulatory metrics and techniques but systems in some of the smaller banks need to be strengthened. All banks will need to update their risk management practices to keep pace with the ongoing market orientation and increasing international presence. While the major banks are developing more granular two-dimensional classification systems, their uses in risk differentiation and loan pricing is currently limited. The strong dependence on collateral and the lack of forward-looking valuation practices need to be addressed to mitigate credit risk and pro-cyclicality in lending (Figure 31). The liquidity and market risk management framework works efficiently in the current environment, but may be inadequate as the market configuration and banking conditions change. Implementing comprehensive, enterprise-wide risk management should be a top priority for the major banks. Country and transfer risk management guidance has only recently been consolidated, and its implementation has to be strengthened in view of increasing international exposure and presence. Operational risk management processes need to be strengthened by the small and medium-sized banks.

Figure 31.
Figure 31.

China: Reliance on Real Estate Collateral in Bank Lending, 2007

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: IFC, 2007, “Reforming Collateral Laws and Registries: International Best Practices and the Case of China.”

58. The risk management framework of banks is hampered by the current macroeconomic and institutional environment. Effective credit risk management in banks is discouraged by the implicit backstop of the state for their credit exposures. Banks’ credit risk strategies are dominated by loan growth guidelines, and both bank risk management and supervisory assessments focus more on NPL ratios than on forward looking assessments of credit risk.

B. Securities Intermediaries and Securities Market Regulation

59. While the CSRC has taken an active and strategic approach to regulate securities markets, the legal and regulatory system needs improvement. Similar to other commissions, the CSRC is not operationally autonomous given the state’s role in staff appointments and its influence over CSRC’s operating structure. The CSRC needs greater budgetary flexibility to acquire qualified experts in an environment of rapidly growing markets. The accounting and auditing profession has made great strides in a short time frame in auditing listed companies and this needs to develop further. The newly introduced risk-based net capital rule should be monitored to ensure that it captures all risks. While there are adequate provisions for dealing with failed intermediaries, the threshold for action should be lowered to allow for early intervention.

60. To bolster oversight, it would be beneficial to introduce a formal program of regular comprehensive on-site inspections of the exchanges. Stronger emphasis is needed on illegal investment activities and monitoring of hedge funds and private equity funds. Implementation of the “know-your-client” rules that require securities and futures companies to maintain comprehensive records of customers’ identity, transaction records, and account data could be more carefully monitored to ensure that they result in investors making more informed decisions.

C. Insurance Regulation and Supervision

61. The CIRC has a comprehensive supervisory framework in place but the solvency regimes need to be strengthened. The minimum solvency margin should be risk-based. The continued issuance of new business by companies operating below the 100 percent solvency level is undesirable. Explicit and clear regulation is needed for facilitating the exit of insurance companies from the market via policy liability run off or portfolio transfers. Off-site monitoring could be strengthened through reinstatement of the early warning ratios previously required in insurer returns.

62. The developmental mandate for the CIRC should focus on its broad public good nature as a regulator to ensure safe practices. The current prescriptive, rules-based system, and close monitoring of insurance company activities on a monthly basis place a strong burden on staffing, and should be reconsidered. As the market and the newly introduced risk-based supervisory regime mature, the CIRC should move away from its current direct involvement in insurers’ product, distribution, and investment strategies. CIRC’s staffing levels need to be reinforced with suitably skilled personnel in key operational areas.

IV. Upgrading the Financial Infrastructure and Legal Framework

A. Payment and Securities Settlements Systems

63. The assessments of the High Value Payment System and securities and derivatives settlements systems suggest broad compliance with international standards but identify room for improvement in several areas. The PBC has carried out a comprehensive reform of the China National Payments System. Going forward, the authorities should ensure that the legal framework gives full protection to payments, derivatives, and securities settlement finality. The PBC should clarify in detail its policy stance in payment system oversight and determine the scope, major policies, and instruments of the function. It should also clarify the criteria for determining the systemic importance of a system, and strengthen institutional arrangements and cooperation in the payment system arena. A more proactive oversight by the PBC over the China Foreign Exchange Trade System is advisable.

B. Legal and Regulatory Structure

64. A “stock-take” of the gaps, overlaps, and clarity in the body of laws governing the financial sector is necessary (for a partial overview, see Table 10). While the rule-based approach to regulation has been appropriate for China thus far, China would benefit from gradually applying a more principle-based approach in the formulation and implementation of laws to deal with increasingly complex and new issues.

Table 10.

China: Legal and Regulatory Structure for Selected Financial Products

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Sources: CBRC; CIRC; and CSRC.

65. The legal framework for consumer protection needs to be clearly enunciated, advocated, and implemented. Consumer protection must be strengthened not only in terms of courts’ capacity to enforce contracts but also in empowering consumer organizations to play an effective role, enhancing personal data and privacy protection in the law as well as requiring market practices and codes of conduct to be in place.

66. The framework for creditors’ rights also should be reviewed to provide for efficient and effective exit mechanisms. Detailed laws concerning the insolvency of financial institutions have not been developed for some sectors (e.g., insurance sector). Measures are needed to provide for a continued training of judges in principles of insolvency law as well as in the specifics of the Enterprise Insolvency Law and other relevant judicial interpretations.

C. Market Integrity

67. The June 2007 Financial Action Task Force (FATF) mutual evaluation report indicated that China made significant progress in implementing its AML/CFT system, but it also highlighted important shortcomings.8 The AML/CFT system has since been strengthened, including through legislative changes to bolster preventive measures, notably in the areas of customer due diligence and suspicious transaction reporting. However, two significant shortcomings remain. First, Chinese law and practice provides limited ability for authorities or financial institutions to have access to the identity of the beneficial owners of legal persons. Second, preventive measures have not been extended to the majority of the non-financial businesses and professions designated by the FATF Recommendations. Deficiencies also remain with respect to the criminalization of self-laundering, and the freezing of terrorist assets. In addition, there is a need to improve information sharing and coordination arrangements among the PBC and other agencies on AML.

V. Broadening Financial Markets and Services

A. Fixed Income Markets

68. The incentive for banks to use fixed income instruments to manage their balance sheets has been held back by partial interest rate liberalization. The absence of market-based funding and dominance of lending activities act as disincentives for banks to become active in asset liability management to hedge mismatches in their balance sheet. In addition, guaranteed interest margins reduce banks’ incentives to engage in fee-generating businesses in the capital market. The regulatory and operational repo market framework would need to be upgraded to increase market liquidity, enhance risk management, and reinforce the money and bond market nexus.

69. Steps should be taken to ensure regulations of fixed income markets and products are consistent, and clearly communicated to the market. Respective roles of three agencies (PBC, National Development and Reform Commission (NDRC), and CSRC), particularly in the corporate bond market, should be further clarified. Equivalent regulations should apply to similar types of participants even when coming under different regulators. A possible option that would support existing market practices would be to delineate a division between wholesale and retail markets and divide regulatory responsibilities between the PBC and CSRC, respectively.

70. A more proactive and sustained benchmark-building strategy is required across all maturities of the yield curve. Currently, the MOF’s treasury securities share the risk-free fixed income markets with the PBC bills in the short-to-medium terms and with the more liquid policy bank bonds in the medium-to-long term (Figure 32). There is a need to improve debt issuance strategy through the further strengthening of coordination between the MOF and PBC. To limit the impact of the PBC’s liquidity management activities on the yields in the MOF issuances, the PBC should seek to limit the issuance of its paper to the short end of the yield curve. Longer term liquidity withdrawal could then be undertaken by rolling over these securities, or by PBC undertaking longer-term repo operations.

Figure 32.
Figure 32.

China: Each Public Sector Debt Issuer Dominates in a Different Maturity Segment, 2009

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: Chinabond.

71. The development of a proposed sub-national debt market where local governments can issue debt is a welcome step but carries associated risks. In the absence of a proper medium-term fiscal framework, debt sustainability analysis (DSA), and a medium-term debt management strategy (MTDS), debt issuance by provincial government could rapidly become a contingent liability and adversely affect the development of the national fixed income market. Timely and adequate data will need to be provided on projects for which bonds are issued to help investors assess risks. The role of rating agencies would also have to be properly defined so that a consistent bond rating methodology could be applied.

72. In the corporate bond market, developing a segment that accommodates lower, yet credible credit rating standards might allow enterprises, currently excluded from the securities markets, to access corporate debt markets. Easing the legal limit of 40 percent of net assets on bond issuance will enable a more extensive use of direct funding to all corporations. In addition, upgrading links between CCDC and SD&C to enhance connectivity between IBBM, SSE, and SZSE, support further development, and contribute to efficiency in all three markets.

B. Equity Markets

73. Further development in equity markets hinges on addressing legacy issues and better servicing the needs of SMEs. Residual legacy constraints and anomalies relating to nontradable, “A” and “B” shares should be addressed and the current free float of shares in public companies expanded. The build-up of a smooth conduit between the private and public offer segments is critical as this could make sustainable funding options available to SMEs and increase the presence of private companies on the exchanges. Launched in 2009, the Growth Enterprise Board is expected to provide exit channels to private financing.

C. Insurance Sector

74. There is a need to achieve a better trade-off between scale and competition. Most of the insurers licensed in the past decade continue to lose money (Table 11). Introducing more comprehensive risk-based capital requirements and requiring shareholders to achieve these over a suitable period is recommended. Strengthening the actuarial oversight of non-life claims provisioning and clarifying the voluntary wind up and exit rules and processes are also desirable steps. The fact that staff salaries and benefits and secured borrowers rank ahead of life policyholders in the event of a wind up is contrary to international best practice. Other strategies could involve taking action to enable insurers to generate more stable but higher returns to equity.

Table 11.

China: Insurance—Operating Performance by Size, 2009

(In Percent)

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Source: Insurance Yearbook 2010.

D. Pension Sector

75. The emphasis of the pension system should be on the funded component. Pension reserves of the first pillar remain invested in inefficient portfolio. Capital protection—enterprise annuity system’s most popular investment strategy—will not be able to generate sufficient returns to obtain reasonable pensions in the future. Longer-term horizon strategies require greater allocations in equity and longer-term bonds than the ones that are currently in place. Investment regulation should discourage short-term evaluation of performance and focus on the long-term actuarial objectives of the fund. Given China’s strong culture of saving, one option is to expand the scope of personal defined-contribution pension plans by designing attractive personal income tax incentives or matching fund contributions for low income individuals.

E. Access to Finance

76. The approach thus far in promoting rural and MSE finance may need a paradigm shift. An evaluation of the existing government programs is needed to determine their effectiveness in promoting rural and MSE finance and the government should formulate an integrated and coherent rural and MSE finance strategy. Several steps can be taken to substantially broaden access to finance. Government should continue to reform rural credit cooperatives to enhance their efficiency and sustainability as commercial providers of financial products and services. It is also important to complete the reform of the Postal Savings Bank by optimizing equity ownership, overhauling the bank to become a corporation, and building effective corporate governance.

VI. Sequencing Financial Reforms

77. Further financial reforms are crucial for sustaining China’s growth and will need to be carefully crafted to limit risks to financial stability. Country experiences have shown that while financial liberalization can spur growth and development, it also entails risks if not properly designed and composed. Given the breadth of China’s envisaged reform agenda, it is important to devise a strategy that anticipates the complications and uncertainties that may arise, and provide guidance on how best to arrange the policy measures without delaying necessary changes. Reform without the necessary preconditions in place can be extremely perilous for financial stability.

78. While there is no “one size fits all” approach towards financial liberalization, some broad principles apply in the case of China (Figure 33). A key overarching precondition for a smooth transition would be to put in place a well functioning legal, regulatory, supervisory, and crisis management framework with adequate technical capacity. This is essential to monitor financial institutions and manage risks. Another precondition is an early absorption of the current liquidity overhang in the financial system to prevent an unintentional loosening of monetary and credit conditions. Reserve averaging and regular open market operations should be introduced early to help absorb some of the liquidity overhang. At the same time, greater reliance on indirect monetary instruments and more flexible exchange rate would increase the scope for macroeconomic control.

Figure 33.
Figure 33.

China: Sequencing Financial Reforms

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: China FSAP team.

79. A modern financial infrastructure and a more market-based financial system will enhance a steady integration with the global financial system. The banking system needs to operate on a more commercial basis and be closely supervised to avoid overly risky behavior and an unsustainable compression of bank margins. The government would need to reorient its role in the financial system so as to reduce the incidence of direct and contingent risks on its balance sheet and remove the moral hazard problem. Alongside such improvements, the gradual liberalization of deposit and loan rates can be successfully implemented. As the banking system becomes more commercially-oriented, broader financial deepening could be accelerated without the risk of disorderly disintermediation. With interest rates set by supply and demand and monetary control exercised through short-term policy rates, China could then move more toward full liberalization of the capital account.

Appendix I: Stress Testing

80. The stress testing exercise was a collaborative effort between the FSAP stress testing team and a PBC/CBRC stress testing team. This was to ensure that the stress test work (i) captures the key aspects of the Chinese economy and the financial system; (ii) builds, to the extent possible, on relevant analytical work already being carried out; and (iii) establishes a coherent operational framework that the authorities could use, and build upon, following the completion of the FSAP.

81. The tests covered 5 LCBs and 12 JSCBs. Taken together, these 17 major banks accounted for about 66 percent of China’s banking sector assets and 83 percent of China’s commercial banking sector assets as of end-2010. The tests did not cover non-banking financial institutions. All the tests were carried out on end-2009 audited or supervisory financial positions of the 17 major banks and, for comparison purposes, top-down aggregate credit risk and real estate risk analysis was carried out for end-2008 and end-2010 positions of the same banks. In the absence of reliable market-based indicators for these banks, the approaches used in the stress tests relied on data from the banks’ public financial statements, prudential reports and banks’ internal data systems.

82. The exercise built on three pillars: a bottom-up pillar and two top-down pillars (Figure 34). The 17 banks selected to participate in the exercise implemented the bottom-up calculations, using the same set of shocks and assumptions. The PBC/CBRC team implemented top-down calculations on a bank-by-bank basis using supervisory data and applying an agreed methodology. Both sets of results were provided to the FSAP team at the aggregate level and by bank type. The number of banks that fall below regulatory requirements and their share in the overall banking system’s total assets was also provided. The FSAP stress testing team carried out its own set of top-down calculations, based on publicly available data. The results of the three approaches were compared, analyzed, and cross-checked.

Figure 34.
Figure 34.

China: Stress Testing Exercise: Three Pillars

Citation: IMF Staff Country Reports 2011, 321; 10.5089/9781463924546.002.A001

Source: FSAP stress testing team.

83. The tests included a range of sensitivity analyses and scenario calculations. They examined aggregate credit risk, concentration of credit risk, direct exchange rate and interest rate risks, liquidity risks, contagion effects via the documented interbank market, and the joint effect of a set of macroeconomic shocks.

84. Sensitivity tests estimated the impact of changes in individual variables on banks’ portfolios. In a sensitivity analysis framework, shocks are assumed to stem from a single risk factor, holding other risk factors constant. Shocks are assumed to occur instantaneously, unless indicated otherwise. The sensitivity analysis covers all positions sensitive to risk factor changes. To the extent possible, these included all long (buy) and short (sell) positions, both on-and off- balance sheet.

85. Credit risk was a key area of focus. The sensitivity analysis for credit risk included an aggregate shock to asset quality, and a set of separate shocks, each aiming to examine a different aspect of credit risk concentration. The aggregate test assumed an overall deterioration in asset quality. In addition, part of the exercise was carried out to pick up the differentiated risks based on the economic sectors and types of entities to which banks lend, as well as the regions in which banks concentrate their operations. However, it was not feasible to fully cover all these dimensions given data constraints. In light of this, a set of separate shocks, each run separately, covered: (i) largest individual exposures; (ii) real estate sector exposures; (iii) exposures to LGFPs; (iv) exposures to overcapacity industries; (v) exposures to export sectors; and (vi) exposures to sectors (industries) and regions with the most rapid loan growth. The equity market shock was not conducted on as banks are prohibited from directly investing in equity markets and the indirect exposure is infeasible to estimate.

86. Macro-scenario tests were a key part of the exercise. Three adverse macroeconomic scenarios were assumed: mild, medium, and severe. Based on an analysis of past growth rates of real GDP in China, as well as the experience of other countries, the assumed annual real GDP growth rates under the three scenarios were 7 percent, 5 percent, and 4 percent, respectively.

87. The scenarios were calibrated with inputs from a panel of leading experts on Chinese economy. To arrive at meaningful scenarios combining GDP growth rates with other variables, the PBC/CBRC stress testing team, in coordination with the FSAP stress testing team, solicited opinions from an expert panel. To increase the comparability of experts’ views, and given that all the banks use GDP as one of the macroeconomic indicators, the GDP growth rate was provided to experts as a key variable for each scenario and their views were solicited on the behavior of other variables under the assumptions. Table 12 summarizes the selected macroeconomic scenarios.

Table 12.

China: Macroeconomic Scenario Assumptions

(Changes in Percent, unless Indicated Otherwise)

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Note: These are not forecasts, but assumptions about potential adverse developments in the future. Source: FSAP stress testing team and PBC/CBRC, based on inputs from a panel of leading experts on Chinese economy. The assumptions are derived from the averages of the experts’ inputs, excluding two outliers.

88. The macroeconomic scenarios were examined using both top-down and bottom-up approaches. For the bottom-up exercise, banks relied on a combination of econometric models and expert-based approaches, although the exact implementation depended on the capacity of individual banks, with some having sophisticated internal models, while others relying on more basic modeling approaches or on loan officers’ expert judgment. For their top-down estimate, the PBC/CBRC team used an econometric equation estimated on recent data for China. The top-down estimate done by the FSAP team included cross-checks based on international experience.

Table 13.

China: Recommendations for Improvements in Stress Testing

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Source: FSAP stress testing team.

Annex: Observance of Financial Sector Standards and Codes—Summary of Assessments

This Annex contains the summary assessments of China’s observance of international standards and codes in the financial sector.

These assessments have helped to identify the main strengths of the supervisory, regulatory, and market infrastructure framework in managing potential risks and vulnerabilities in the financial system. They also suggest areas that need strengthening and further reform.

The summaries are based on detailed assessments of the following international standards:

  • Basel Core Principles for Effective Banking Supervision—by Nicholas Le Pan (World Bank consultant), Walter Yao (IMF consultant), and Aditya Narain (IMF)

  • IAIS Insurance Core Principles—by Henning Göbel (World Bank consultant)

  • IOSCO Objectives and Principles of Securities Regulation—by Greg Tanzer (World Bank consultant)

  • CPSS Core Principles for Systemically Important Payment Systems—by Massimo Cirasino (World Bank), and Mario Guadamillas (World Bank)

  • CPSS-IOSCO Recommendations for Central Counterparties—by Massimo Cirasino (World Bank), and Mario Guadamillas (World Bank)

Annex I: Observance of Financial Sector Standards and Codes—Basel Core Principles for Effective Banking Supervision: A Summary

A. Introduction

89. Regulation and supervision of China’s banking system has made impressive progress. Significant improvements in risk measurement and risk management have occurred. These are backed up by a regulatory system that demands high-quality capital and liquidity, often through simple and basic regulatory requirements. However, as further opening up and innovation occurs, and China’s banks expand, complexity and risks will increase. The CBRC and banks must evolve quickly in the short term to be ready to meet those challenges. The framework of laws and guidance is generally of high quality, but much of it is relatively recent. Implementation by banks needs to be improved, in some cases materially. Enhanced vigilance is required by banks and the regulator to keep risks under control in China’s system, in which banks are looked on by the State to be heavily, directly involved in achieving economic and social goals. The CBRC is widely-respected and has demonstrated its willingness to act in pursuit of its safety and soundness mandate. It urgently needs to have a plan to enhance its experience and expertise, ensure progress to date is sustainable, and needs continued support of government in that endeavor.

90. This assessment of the current state of the implementation of the Basel Core Principles for Effective Banking Supervision (BCP) was undertaken between June 7 and June 25, 2010. It reflects the regulatory and supervisory framework in place as of the date of the completion of the assessment. In line with the BCP methodology, the assessment focused more on the major commercial banks and their regulation and supervision, given their importance to the system.

B. Information and Methodology Used for Assessment

91. The assessment team reviewed the legal framework for banking supervision, held extensive discussions with the staff of the CBRC and two of its regional offices. The assessors also met with officials of the central bank—the PBC, the MoF, the National Audit Office (NAO); several commercial banks, audit firms, rating agencies, and the China Bankers Association. The team examined the current practice of on-site and off-site supervision of the CBRC. The assessment team had the benefit of working with a comprehensive self-assessment completed by the CBRC, enjoyed excellent cooperation with its counterparts, and received the information it required.

92. Reaching conclusions required judgments by the assessment team. Banking systems differ from one country to another, as do their domestic circumstances. The banking system has undergone tremendous change in China in the recent period and this process is still ongoing. The CBRC is a relatively young agency, having been created in 2003 from the PBC as part of the major banking sector reform instituted by the Chinese authorities. In addition to the strengthening of financial sector regulation and supervision, these reforms have also led to the conversion of four large state-owned banks into joint-stock companies; reform of rural credit cooperatives; restructuring of joint-stock banks and securities companies; and reform of the insurance sector.

C. Institutional Setting and Market Structure—Overview

93. The Chinese financial system is dominated by the rapidly-growing banking sector, with nonbank financial institutions accounting for only a fraction of the system. The banking system accounts for nearly 80 percent of the net new lending every year. China’s capital markets remain relatively shallow, and over 60 percent of outstanding bonds issued by the government and the majority of the remaining being issuances by the large financial institutions, with policy banks (which are state owned and provide a range of development finance services in support of infrastructure, agricultural development, export insurance, etc.) and China Development Bank being the second largest issuers. The insurance sector, however, is rapidly growing, though, as are linkages between banks and insurance companies.

94. Although the banking sector is extraordinarily large with assets over 200 percent of GDP the financial systems is still relatively new, simple and evolving. Key financial prices remain regulated, which insulates banks from market risk. Despite gradual interest rate liberalization over more than a decade, retail interest rates remain partly regulated—deposit rates are subject to a cap and lending rates to a floor. Banks can price lending above the floor to a degree, and do so in practice.

95. Within the banking sector, the five large commercial banks account for just over half of the banking system assets. The next Tier of banks are the joint stock commercial banks, followed by city commercial banks and rural commercial banks which have been formed by the reform of city credit cooperatives and rural credit cooperatives respectively. These are followed by deposit taking institutions such as rural and city credit cooperatives, postal savings banks, village and township banks. Despite over 200 branches and subsidiaries operating in China, foreign banks remain a small presence with assets less than 2 percent of the total. However, in recent years, overseas financial institutions have made significant equity investments in Chinese banks.

96. The prudential ratios on capital adequacy, NPLs, and liquidity, for instance, for the banking system have improved significantly. A significant amount of the bank assets represent exposures to central bank, and central and local governments, and there remains scope for further gains to be made in wider intermediation.

D. Preconditions for Effective Banking Supervision

97. The legal system in China brings together a number of distinct legal traditions within the overarching framework of a civil law system. The structure of the legal framework has undergone a series of phased transitions, first to enable complete state ownership until the 1970s, and more recently to facilitate China’s move towards a more market-oriented economy within a socialist political and economic framework.

98. In lieu of a Commercial Code, China enforces a series of commercial laws, providing a mechanism to regulate commercial activities. In its place, the government legislated a series of distinct measures to regulate commercial relations. More recently, a number of symbolically and legally important measures have been passed, notably the Property Law of 2007, that further recognizes private property rights, as well as the Enterprise Bankruptcy Act 2007, which seeks to give greater protection to secured creditors than has otherwise been accorded under Chinese law (e.g., by giving secured creditors priority over worker’s wages on winding up). There is little data with reference to enforcement of bank debts, but available data suggests that that enforcement of contracts in general by Chinese courts has improved dramatically in some urban centers to keep pace with economic reform.

99. China is gradually building up an infrastructure that promotes and supports market discipline. The Company Law, Law on Commercial Banks, Law on Banking Regulation and Supervision, Securities Law, and Insurance Law all provide specified requirements on information disclosure. The CBRC was established in 2003 as a stand-alone prudential authority and is widely credited with having made significant achievements in its short existence, having been the key driving force in improvements in risk management, corporate governance and internal control and disclosure in Chinese banks. In practice, all banks are required to publicly disclose their information in their annual reports, including audited financial statements, corporate governance, capital adequacy, risk exposures, risk management strategies and practices, and other quantitative and qualitative information. In addition, the listed banks are subject to information disclosure requirements set forth by the CSRC. Considerable efforts have also been made by the financial regulatory agencies to improve the corporate governance of financial institutions. Under corporate governance rules banks have a dual board. There is a full-time board of directors. There is also a supervisory board which oversees the performance of the board and senior management. It is not involved in strategy formulation, but receives reports from audit and control functions to ensure that the board and management are performing as expected and following the board-approved strategy.

100. Since 2005, China accounting standards have substantially converged with International Financial Reporting Standards (IFRS) and International Standards on Auditing, respectively. In February 2006, the MoF which sets accounting and audit standards promulgated the Accounting Standard for Business Enterprises, which replaced the previous China Accounting Standards and became effective in January 2007. The new accounting standards consist of one basic standard and 38 specific standards, which have substantially converged with the international standards and were recognized by the International Accounting Standards Board (IASB). Currently, all listed companies, financial institutions and non-listed large and medium-sized enterprises have adopted the new accounting standards. Also, in 2006, the MoF issued a new set of auditing standards; one review engagement standard; two other assurance engagement standards; two related service standards; and one quality control standard, which have also converged with the international standards and were thus recognized by the International Federation of Accountants.

101. Accounting and auditing professions have grown considerably, though certain areas need improvements. Over the past three decades, China’s Certified Professional Accountant (CPA) industry has been growing steadily. Currently, there are more than 7,000 accounting firms registered in China, with more than 97,000 CPAs in practice. The MoF is responsible for regulating the accounting and auditing professions, with the regulatory responsibilities including qualification review and approval, professional performance supervision, and overseeing the activities of relevant industry associations. Coverage of bank audits is adequate, as the CBRC requires banks with total assets exceeding RMB 1 billion to receive financial statement audits; however, some weaknesses exist. Earlier reports and market participants interviewed by assessors have cited that the audit quality of smaller accounting firms needs improvements. The credibility of the audit profession would be enhanced as the authorities implement the standard auditor independence regulation recently incorporated in the China Code of Professional Ethics for Certified Public Accountants and increase their oversight of the profession by performing regular and more frequent review of accounting firms’ audit quality.

102. In recent years, the PBC has carried out a major reform of the National Payment System (NPS), by launching the China National Advanced Payment System (CNAPS). The CNAPS consists of the High Value Payment System (HVPS) and the Bulk Electronic Payment System. The HVPS is a real time gross settlement systems and mainly used for large value transfers. It is used to provide fast, efficient, secure and reliable payment clearing services to banking institutions, private and public entities and financial markets. Currently the system has more than 1,600 direct participants. China is also evolving to a more intensive use of non-cash payment instruments, especially cards.

103. China does not have an explicit public safety net in the form of deposit insurance but is considering its introduction. Given the high level of government ownership of banks, there may be a public perception that the State would stand behind all depositors in the case of a closure. The central bank has authority to make lender of last resort loans to banks.

104. There have been restructurings of several banks with serious financial difficulties. These have tended to involve “whole bank,” going concern solutions whereby another bank has been convinced to take over the assets and liabilities of the problem institution (or at least the deposit liabilities). There is no explicit resolution framework for such eventualities but the authorities have demonstrated the ability to achieve such solutions using the existing bankruptcy and other laws. There are several aspects of the bankruptcy laws that deserve consideration in order to increase systemic protection and reduce contagion risk in the event of bank failures. The authorities should consider whether a separate insolvency regime for banks may serve them better especially given the increasing internationalization of the large banks and the current global focus on developing more compatible cross-border resolution frameworks.

E. Main Findings

Objectives, independence, powers, transparency, and cooperation (CP 1)

105. The objectives and responsibilities of authorities involved in banking supervision are clear. CBRC’s mandate has enabled it to focus on a single mission of safety and soundness and that has helped it become a high-quality organization. Using this mandate, CBRC has been very successful in articulating to banks and the public the need to achieve both safety and soundness and the needs for economic and social progress through the banking system. Indeed, safety and soundness contributes to development goals. CBRC has pushed for high-quality risk management by banks as part of their delivering on economic and social objectives. Following its mandate, and as a result of observed or potential deficiencies in risk management practices, CBRC has recently introduced a range of prudential measures, including more stringent credit risk management of loans to local government platforms and real estate lending. It has also successfully pushed banks to hold more capital and more provisions in the face of rapid loan growth as part of the stimulus package.

106. The potential conflict between safety and soundness objectives and other objectives exists in many countries but can be more acute in China because of the predominant use of the banking system, much of which is state owned, to achieve economic and social goals. The 12th plan for the financial sector being developed as part of the 12th Five-Year economic plan under the SC for the NPC should reinforce the importance of safety and soundness and CBRC’s early intervention to resolve potential problems before they become serious. It should also make a priority for continued improvement in banks’ risk management with a focus on assuring all banks, not only the most advanced, make needed improvements and ensure that improvements already made are well entrenched in their operations. The importance of safety and soundness and high quality risk management to economic and social objectives should be explicitly recognized by the authorities. Current CBRC leadership has played a key role in promoting prudential goals and dealing with issues of possible conflict of safety and soundness objectives with national economic policies. It will be important to continue this.

107. The arrangements for resourcing in CBRC leads to potential independence issues, and hampers effectiveness, particularly as banks become more complex and innovative, and expand abroad. So does the potential ability for the SC to override CBRC rules, though this has never been exercised. The CBRC law mandates it to take decisions free from interference from any party, and CBRC reports that no interference has occurred since its creation. However the existing arrangements could be problematic in future. The laws, rules and guidance that CBRC operates under generally establish a benchmark of prudential standards that is of high quality and was drawn extensively from international standards and the BCP themselves.

108. However, much of the guidance is relatively new and the issues raised in assessment of various CPs are often ones of better implementation. In many ways, the strength of CBRCs regulation to date lies in the deliberately simple, conservative approach it has taken, often relying on specific prudential ratios that banks must meet. This is true for liquidity and for capital adequacy, for example. The challenge going forward is that this approach, by itself, will not be sufficient as markets and banks evolve. CBRC is well governed within the constraints it faces and has steadily and materially increased its transparency. There is need for: more forward resource planning; an urgent government-supported strategy for material upgrading of skills especially specialist skills; and more flexibility in budgeting and pay to support this strategy and attract and retain talent. CBRC’s performance reporting has greatly improved but more is possible.

109. The legal framework for banking supervision has been revised to incorporate legislation, guidelines and rules (which all have legal standing) based on international standards. CBRC has authority to take a wide range of corrective and remedial actions, and is clearly willing to use them. CBRC staff is legally protected from the consequences of acts committed in good faith. CBRC also has the legal authority to share information with other regulators, domestically and internationally and does so through networks of Memorandum of Understanding (MOUs).

Licensing and structure (CPs 2–5)

110. China defines the permissible activities of banks and operates an extensive licensing and approval process for banks. Considerable staff is involved in approving new institutions, new branches or sub-branches of existing institutions, new products, as well as changes in ownership. Fit and proper criteria apply to board and senior management, but also extend to many other positions in a bank. The use of the name “bank” is properly controlled and shell banks are not permitted. Minimum capital requirements to start a new bank depend on the type of bank and are in line with or higher than international norms.

111. CBRC implements an appropriate approval process for changes in ownership and major acquisitions. However, the Chinese system is evolving from a system of state ownership to more private ownership, opening up the possibility of more complex ownership structures for banks. In this context CBRC’s lack of legal authority could impede their ability to review beneficial owners or indirect changes of control. They report that they do usually get information on beneficial/indirect owners through the direct acquirer or through other indirect means. The assessment team did not come across instances where supervision effectiveness has been compromised because of this issue but this legal authority should be bolstered. Other CBRC rules that also involve potentially more complex bank ownership structures (e.g., related party rules) should also be reviewed to ensure that such structures are clearly covered by the rules. Investments by banks, including in overseas branches, require approval as part of the general approval system. While banks are generally prohibited from investing in nonbank activities, in the recent past exceptions have been permitted for investment in financial leasing and asset management. Bank-insurance and bank-fund management company investments have not been allowed until recently, when four cross-ownership pilots are in process. In those cases CBRC imposes firewalls between the banks and the other entity. Among other considerations, there are also explicit provisions that these pilots must earn at least average industry returns or they are to be dissolved.

Prudential regulation and requirements (CPs 6–18)

112. The capital adequacy rules are based on Basel I. Basel II is being introduced over the 2011–2013 period for six banks that must adopt it on a mandatory basis. Some other banks have also decided to adopt it on a voluntary basis. Basel II was not formally assessed as it was not in place at the time of the mission. The choices China has made in implementing Basel I have generally been conservative, and result in Chinese banks uniformly having capital ratios above the Basel minimum. Banks’ capital is composed primarily (approximately three-quarters) of high-quality core capital. The minimum required capital is 8 percent. Recent measures have raised expected capital ratios above the Basel minimum to 11.5 percent for the five major banks and 10 percent for all other banks, as part of a move to counter-cyclical buffers. How these buffers will work in a counter-cyclical way has not been specified. CBRC needs to review and communicate what its ongoing expectations are for banks to hold capital above the minimum and the criteria it will use to decide how to alter the buffer. There are a few aspects of the rules that are less conservative than the Basel I provisions, that should be reviewed.

113. Risk management is evolving in Chinese banks. CBRC has played a major role in the significant and impressive improvements that have occurred. Less than fully compliant ratings in certain areas in this assessment generally reflect deficiencies in the legal framework, which can be amended, or that banks have yet to fully implement CBRC guidance. CBRC itself is performing excellently in a challenging and fast-changing environment. It is on the right track with its reform agenda and needs to persevere in a sustained way in its current direction. It will need the full support of all other parties in the government to succeed in the goals it has set for itself. Most major banks have developed risk management systems for each of the major individual risks they face, though improvements are required in certain cases. CBRC guidance is generally of high quality and was often developed directly from Basel documents. Framework guidance in some risk areas is relatively new, with some being issued as recently as the last half of 2009. A period of settling in is required for effectiveness to be enhanced, for those banks who are not the most advanced to catch up, and for CBRC to ensure that all banks have risk management systems commensurate with the risks they are assuming.

114. The new risk governance, risk measurement and risk management systems have not been tested under stress and some areas for material improvement are clearly evident. Board-approved strategies are often too focused on target loan growth in various sectors and not enough on targeted risk measures linked to the bank’s own risk systems, as opposed to regulatory requirements. Comprehensive, enterprise-wide risk management that takes account of interactions between risks in measuring, managing and stress testing, and that relates capital to risk is at an early stage in some banks, including some major banks. For many banks the priority is not to move to this stage quickly, but rather to ensure that a sound risk management framework is fully in place, imbedded in their culture and group-wide operations, and sustainable. While much of banking in China is deposit taking and lending, major Chinese banks are some of the largest in the world, and the Chinese lending market is complex by virtue of its scope and diversity, and banks are getting into new areas of lending and other activities. So risk management needs to be commensurate with these realities. China is considering introducing explicit deposit insurance arrangements. It will be important as it does so that it carefully considers the roles of the various organizations in a resolution.

115. Credit risk is the most important risk facing Chinese banks and will remain so for some time. It has received the most focus by banks and CBRC and is generally well controlled. However there is intense focus on NPL experience by banks, policy makers and by a considerable part of CBRC staff. This is understandable given the serious bad-loan experience in the early part of the decade. But this almost sole focus sometimes is at the expense of attention to other early, forward-looking measures of credit risk that need to be responded to. Senior leadership in CBRC and some banks understand the need for forward-looking judgment but assessors sensed that this message has yet to flow fully through their organizations. The rules and practice for problem assets, provisioning for listed banks are otherwise adequate. They are based on IFRS-equivalent accounting rules and regulatory requirements for classifying loans. CBRC does regular, extensive and in-depth reviews of asset quality and replication of the provisioning system. Major audit firms audit the majority of listed banks. The regulatory system has encouraged additional provisions and requires further buffers to be held as part of firm’s equity.

116. Traded market risk in the Chinese banking system is low in aggregate and for major banks individually. This will likely increase as market liberalization occurs. The exchange rate liberalization announced recently could increase foreign exchange (FX) risk for banks and their customers. Risk management tools, information technology (IT) and data infrastructure to support them are generally commensurate with the level of risk, though there are areas for improvement. However, sophistication will likely need to increase considerably in the near future. The move to Basel II will assist. Interest Rate Risk in the Banking Book (IRRBB) is a more-prevalent risk for a wide number of banks. These will also likely rise as further liberalization occurs. Tools need to move rapidly beyond the static gap analysis based on contractual maturities of assets and liabilities that many banks are now employing. CBRC could also enhance its outlier analysis for this risk. This affects more than just the listed banks, and the improvement does not require adoption of models.

117. Operational risk has been a focus of banks for a number of years. The two main operational risks have related to possible internal control breakdowns and fraud, and IT risk. These have received considerable focus at banks and they and other observers reported that such incidents have trended down significantly in recent years. The challenge now is to put in place more comprehensive frameworks to deal with all elements of operational risk relevant to individual banks, which has started. More bank business units should be doing regular risk and control self assessment (RCSA) and developing, monitoring and refining key operational risk indicators. Again, a move to complex advanced measurement approaches (AMA) models for capital purposes is not required to make improvements.

Methods of ongoing banking supervision (CPs 19–21)

118. Supervisory approaches are increasingly risk focused. However, use of the CAMELS+ rating system and various other aspects of the supervisory methodology (including its newness in some respects) mean that supervisory assessments are not as forward looking as desirable. As well, heavy reliance on the few basic simple ratios, while appropriate, may discourage more judgment-based assessment of inherent risk and the quality of individual bank’s risk management and governance. There is need to maintain the benefits of simple basic indictors while reinforcing banks complying with CBRC guidance which requires use of more sophisticated approaches than some banks are using. That would also encourage more of a risk culture in banks as well, rather than them relying excessively only on complying with regulatory requirements.

119. More attention may need to be placed on mid-size and smaller banks to ensure that they upgrade their risk management and governance performance. CBRC has all the necessary tools of on-site and off-site supervision. There is an extensive system to capture frequent and periodic information from banks. However, disclosure by banks or CBRC of important safety and soundness information, such as capital and liquidity position is less than in a lot of other markets. This should be examined and improved.

Accounting and disclosure (CP 22)

120. China has developed an accounting system that has substantially converged with the IFRS. A recent World Bank study also commended China’s effort though certain areas of improvements were identified. Continued attention will need to be given to the development of the private accounting and audit profession in China to ensure that financial statements are professionally prepared and audited. The CBRC should be empowered to reject and rescind the appointment of an external auditor who is deemed to be unfit to perform a reliable and independent audit.

Corrective and remedial powers of supervisors (CP 23)

121. CBRC has the authority and demonstrated willingness to act to resolve problems. Dealing with problem banks has been on the basis of going concern solutions. Capability to close institutions may need to be enhanced going forward.

Consolidated and cross-border banking supervision (CPs 24–25)

122. Consolidated supervision of banks and their direct subsidiaries and branches on the mainland or offshore is of high quality. However, existing laws may permit more complex structures where consolidated supervision may not be possible. On occasion, CBRC has used indirect and informal means to deal with the situation and bring about needed changes in structure. The mission’s recommendations (CP 4) to amend laws to formally require CBRC approvals of ultimate beneficial ownership and indirect changes in control would also help address this issue. Reliance by one supervisor on the work of others in mixed corporate groups (bank/insurance/fund management/pilots) may not always work well in practice and has yet to be tested. In terms of home-host relationships, CBRC has a wide network of formal and informal arrangements and has used these effectively as both a home and host.

Table 14.

China: Summary Compliance with the Basel Core Principles

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Table 15.

China: Recommended Action Plan to Improve Compliance with the Basel Core Principles

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F. Authorities’ Response

123. The Chinese authorities welcome and support the BCP assessment as an opportunity for reflection and improvement for banking regulation and supervision according to international standards. The assessment team has undertaken excellent work, demonstrating high quality professionalism, dedication and the ability to cut through complex issues in a constrained timeframe. The authorities appreciate the opportunity to provide the following comments on the assessment.

124. The CBRC, with strong support from the Chinese government, has actively pursued its statutory mandate for safety and soundness of the banking sector through promulgating a prudential framework benchmarked to international standards and continuously improving supervisory effectiveness. This effort is facilitated by substantial enhancement in corporate governance and risk management in the Chinese banking industry through three decades of reform and opening up. These achievements and progress have been largely recognized in the assessment report. The assessment demonstrates that the banking supervision in China is broadly in compliance with the BCP.

125. There are a number of issues in the assessment for which the authorities would like to provide further clarification. The assessment identifies the potential ability for the SC to override CBRC rules as a potential threat to CBRC’s operational independence. The CBRC does not see this as an independence concern that would compromise its effectiveness. According to the Law on Banking Regulation and Supervision, the CBRC shall, in accordance with applicable laws and administrative regulations, formulate and promulgate supervisory rules and guidelines for banking institutions. And according to the Legislation Law, only under the circumstances of violating laws and regulations, or existence of inconsistencies between rules issued by different ministries or commissions, the SC may alter or annul “inappropriate” rules issued by the ministries or commissions. Therefore, the CBRC can perform its rule-making authority independently unless its rules and guidelines contravene relevant laws or administrative regulations. Such an arrangement serves as a check and balance on the CBRC and other government agencies to exercise authority in accordance with law. This also helps maintaining the integrity and consistency of the legal framework in China. In practice, the SC has never altered or annulled the rules and guidelines issued by the CBRC.

126. The assessment also indicates that the CBRC’s current budgeting and headcount arrangements could lead to potential independence issues and hamper supervisory effectiveness. Since its establishment, the CBRC has received unrelenting support from the SC and relevant ministries in undertaking banking regulation and supervision. The CBRC has upgraded the efficiency and quality of its staff through continuous recruiting, training and development efforts, while the efficiency of supervision has also been enhanced through effective application of IT. However, the CBRC acknowledges that, like many banking supervisory agencies around the world, it faces challenges in attracting, developing and retaining supervisory talent in an increasingly competitive and complex industry environment. By working closely with relevant government agencies, the CBRC aims to further increase supervisory resources where appropriate, upgrade staff skills and retain high-quality front-line supervisors, in order to fulfill its mandate for safety and soundness in a fast changing industry environment.

127. The CPs revised in 2006 place a greater emphasis on risk management, and the methodology requires assessors to consider the practices of banks as well as supervisory agencies. The CBRC, since its establishment, has made great efforts to improve its risk-based supervision capacity, while requiring banks to enhance their corporate governance and risk management capabilities. To this date, the main business of Chinese banks is still traditional deposit-taking and commercial and retail lending. It is only in recent years that a few banks have been allowed to enter into non-bank financial businesses on a trial basis and these operations remain very small. As a result, China’s banking sector is much simpler than those of developed markets, where the risk environment is much more challenging due to greater complexity and interconnectedness. The assessment acknowledges that the CBRC has played a major role in the significant and impressive progress that banks have made in improving their risk management, while identifying a number of areas for further improvement. The authorities’ view differs from the assessment in the degree to which banks’ risk management is commensurate with the current risk environment they operate in. However, the authorities concur that continued improvements in banks’ risk management are needed, as financial reform deepens and liberalization creates greater interconnectedness and complexities in the Chinese financial system. For example, looking ahead, comprehensive enterprise-wide risk management that takes account of interactions among risks and effectively relates capital to risks will need to be further strengthened at the Chinese banks. Meanwhile, the CBRC will also continue to enhance its capability in evaluating banks’ risk profiles and risk management processes together with the increase in size and complexity of the Chinese banking sector.

128. The assessment has proven to be valuable and rewarding in generating insights and suggestions that will contribute towards the improvement of banking supervision in China. The CBRC appreciates the recommendations made in the assessment, and will take actions on those that are considered appropriate and applicable. Some of them are already being implemented and others taken into account in the CBRC’s medium- and long-term plans to improve supervisory effectiveness. The CBRC will also continue to push forward the reform and opening-up of the Chinese banking sector, which has proven a key driver in enhancing the safety and soundness of Chinese banks. In the meantime, the CBRC will continue to actively engage in the activities of the FSB and the BCBS to develop and reform international banking supervisory standards, so as to contribute towards the enhancement of the resilience of the global banking system.

Annex II: Observance of Financial Sector Standards and Codes—IAIS Insurance Core Principles: A Summary

A. Introduction

129. Insurance companies in China are closely supervised and generally subjected to appropriate regulation. The CIRC, employs a rules based framework and has achieved a high level of regulatory compliance from supervised companies. Generally, a high level of observance with the core principles can be seen on those core principles where a rules based approach and control can be exercised. In contrast insufficient regulation exists on market exit and portfolio transfers. Supervision should be strengthened on the adequacy of reserve levels, the insurer’s observance of solvency requirements and the strictness with which CIRC ensures compliance with capital requirements. A shift from rules based to principles based supervision is likely to become necessary if resources are to meet growing demands. However in the immediate future rules based approach seems most appropriate.

130. This assessment of compliance with International Association of Insurance Supervisors (IAIS) Insurance Core Principles (ICP) was carried out as part of the 2010 FSAP. The assessment is based on the 2003 version of the IAIS Insurance Core Principles and Methodology. It took into account relevant IAIS standards and guidance in addition to the ICPs.

131. The CIRC conducts its duties through its headquarters in Beijing and 35 regional branches, the insurance bureaus. Insurance regulations issued by the CIRC are guided by high level regulations issued by the SC (including on compulsory motor insurance) and the basic law issued by the People’s Congress. In addition to formal regulations, CIRC has issued a range of directives, guidance notes etc under its mandate to develop the SC’s commercial and social policy objectives for the insurance market.

132. This assessment is based upon information made available to the assessor in preparation for and during the June 2010 FSAP mission. CIRC contributed a self-assessment and further information in response to requests before and during the mission. Requested documentation, including relevant laws and a number of key regulations were supplied in English. However many of the 42 key CIRC regulations and supporting directives and explanations were only available in Chinese. The assessment has been informed by discussions with regulators and market participants. The assessors met with staff from the CIRC Headquarters (HQ), two large regional insurance bureaus, insurance companies and intermediaries, and with the accounting and actuarial professions. The assessors are grateful for the full cooperation extended by all.

B. Institutional and Market Structure—Overview

133. The Chinese insurance market is the six largest in the world. At the end of 2009 there were 59 life insurers, 52 non-life (Property and Casualty (P&C) or property) insurers, and nine reinsurers, including one specialist credit insurer, and four specialist agricultural insurers (one of which is a mutual). The four specialist heath insurers are classified as part of the personal (life, etc.) insurance sector. Non-life insurers may now also write short term medical coverage. Eight insurance groups have been formed under holding company structures and 10 insurers have established asset management companies. Life insurance premium income in 2009 was US$109.2 billion, a penetration of 2.3 percent of GDP and a metric typical of a relatively advanced economy. In 2009 non life insurance generated US$ 53.9 billion of premium, a penetration of 1.1 percent of GDP. The P&C sector is dominated by motor insurance (which accounted for 70 percent of gross written premium) a metric more characteristic of an emerging market. This unusual pattern is likely to reflect both cultural and historical roots.

134. China’s life insurance market is highly concentrated. The top 10 insurance companies account for nearly 90 percent of gross premium. With the exception of American International Assurance Company (AIA), life insurance business is not open to foreign funded companies except through joint ventures where the foreign shareholder may have up to 50 percent of the equity.9 The non-life business is also highly concentrated and continues to be dominated by the leading P&C Insurance Group the People’s Insurance Company of China (PICC).

135. The life insurance business mix has changed significantly in the last half of this decade. The traditional guaranteed return business has dropped from 42 percent to 23 percent of life policies and being replaced by Universal Life and Investment linked business. Participating business10 throughout the decade has held approximately 55 percent of the market as it has provided a reasonably consistent and stable profit margin for the insurers and offers the possibility of an enhanced return to the policyholders.

136. The non life business mix has remained largely static. Motor and commercial property accounts for 80 percent and liability, Marine Aviation and Transit (MAT) and accident jointly account for another 11 percent. The only clear upward trend in share of premium has been in the agricultural and medical insurance lines. Household insurance accounts for only 1 percent of non-life premium and China, unlike other countries, is not seeing a boost in insurance sales from the development of the mortgage markets. It appears in part this may be due to banks not being prepared to monitor and enforce policy continuance.

C. Main Findings

137. The preconditions for effective supervision are generally met. Where principles are not full observed, generally one of two reasons applies:

  • CIRC or other empowered official agencies have intentionally decided that the full implementation of the respective core principle would not fully take into account the current development phase of the Chinese insurance market or would be in conflict with constitutional arrangements. This observation may be applicable to principles on: supervisory authority, supervisory objectives, investments, derivatives and AML.

  • CIRC has—in contrast to its overall comprehensive regulations—insufficient rules for some important areas of supervision. China takes a fairly pragmatic approach to regulation and will often wait for the actual emergence of business cases demanding new rules before acting. It is responsive rather than proactive and has thus missed important areas. This observation is applicable to principles on: change in control and portfolio transfer, exiting the market and insurance activity.

138. There also areas, where CIRC has strong and explicit regulation in place but its application or implementation is assessed as being too loose and also bearing substantial reputational risks for CIRC. This observation would be applicable to principles on: liabilities and solvency regime.

  • CIRC has implemented a comprehensive supervisory framework and strong emphasis has been given to the implementation of suitable corporate governance rules and sufficient risk management systems for all insurance companies. The conditions for effective insurance supervision are largely met with some impediments stemming from the continuing battle of Chinese officials against corruption and bribery.

  • The supervisory system is strong and well organized but CIRC has a compelling need for additional resources in its core supervisory departments. CIRC is responsible for a wide range of tasks in a very large and diversified market. It also has to be prepared for the continuing rapid growth of the scale and scope of China’s many and diverse insurance markets. Today, its qualified staffing in some departments may not be adequate to permit it to carry out its responsibilities in a growing and changing market.

  • The principles regarding the supervised entities are largely observed. Further regulation should be issued to facilitate portfolio transfers and to disconnect licensing arrangements from the registration of the legal entity.

  • CIRC’s ongoing supervision of insurance companies and the supervision of markets and consumers are tight and display a strong level of control. Most principles in these sections are fully observed. In fact, some of the supervisory reporting requirements seem almost too comprehensive and are reported too frequently. Disclosure and consumer protection are adequate and have recently been improved.

  • The application of prudential requirements needs to be strengthened substantially, especially the liabilities and the solvency regimes. There are also some deficiencies in the regulation regarding quantitative investment requirements, but the authority has signaled that further regulation will be issued shortly. CIRC should also review its current arrangement with PBC on fighting Money-Laundering. The shared responsibilities are not reflected in the activities carried out solely by PBC. The lack of adequate reporting back to CIRC is not acceptable and bears a reputational risk for CIRC. Processes and responsibilities should be reviewed and restructured to address this weakness.

Table 16.

China: Summary of Observance of the Insurance Core Principles

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D. Key Recommendations

139. The assessment team found several improvement opportunities, summarized in the Table below:

Table 17.

China: Recommended Action Plan to Improve Observance of the Insurance Core Principles

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F. Authorities’ Response

140. We appreciate the FSAP assessors’ recognition of what the CIRC has achieved in supervisory enforcement, categorized supervision, market analysis, regulatory cooperation, information sharing, and consumer protection.

141. The assessors have also acknowledged the CIRC’s efforts and progress made in corporate governance, internal control, group supervision, solvency regulation, risk management, and off-site supervision.

142. The assessors understand that, in the few areas where full observance has not yet been achieved, the CIRC has taken appropriate regulatory measures and approaches based on China’s own conditions including its unique market environment and development stage. The regulatory philosophy we follow is consistent with IAIS’s core principles for insurance regulation. We focus on prudential supervision, emphasize risk prevention, make vigorous efforts to maintain the market order and to protect consumer interests, thus we have effectively maintained the stability of the market.

143. As a response to the assessor’s comment on solvency supervision, the CIRC attaches great importance to this task. Drawing upon the solvency supervisory standards of the European Union (EU) and the U.S., we have established a solvency supervisory system tailored to China’s realities. The current system reflects the status quo of China as an emerging market and facilitates the stability of our insurance market. The fact that China’s insurance industry remained resilient to the global financial crisis proves the risk-control ability of our solvency supervisory system. Specifically, the current system takes into account the underwriting risk, investment risk, interest rate risk, credit risk and asset liability matching risk of insurance companies. The system has the basic features of a risk-based solvency supervisory system and provides a good foundation for the transition to a comprehensively risk-based system. Currently the CIRC is studying the solvency supervisory systems in the world and dedicated to further improve its own system.

144. With respect to AML, it should be seen that China has its unique mechanism for this function. As provided by China’s Anti-Money Laundering Law, the PBC leads the work of AML and other authorities should actively assist it in its work. The division of responsibilities among relevant authorities is clear. The CIRC bears its share of responsibility and carries it out in its daily supervision. In practice, insurance institutions observe the AML rules put in place by both the PBC and the CIRC. They have established complete internal controls and other relevant measures for this purpose, and are actively carrying out the AML obligations. In order to supervise the risks of insurance companies, the CIRC carries out inspections on their internal controls, which include AML controls, and exchanges information with the PBC (the AML Bureau) through adequate channels.

145. To address the emerging issues and changes as market develops, the CIRC has been improving its rules and regulations and striving to enhance effective supervision. Since the newly revised Insurance Law was promulgated on October 1, 2009, the CIRC has formulated and introduced new rules and revised old rules covering personnel qualification, information disclosure, asset management, equity management and other aspects. Efforts have been made to further enhance industry order, strengthen corporate governance and internal control, promote risk management capabilities of insurance companies, and fundamentally safeguard the legitimate interests of the stakeholders.

146. We also appreciate the recommendations of the assessors. We will carefully study these recommendations and take them into consideration in our regulatory practices and the formulation of rules and regulations.

Annex III: Observance of Financial Sector Standards and Codes—IOSCO Objectives and Principles of Securities Regulation: A Summary

A. Introduction

147. This assessment was performed in 2010 as part of the FSAP of China. The assessment used the IOSCO Objectives and Principles of Securities Regulation (May 2003) and the Methodology for Assessing Implementation of the IOSCO Objectives and Principles of Securities Regulation (February 2008). It was assisted by a self-assessment prepared by the CSRC, public information contained on the CSRC website and the websites of other entities in China, and a review of relevant Chinese laws and regulations.

B. Institutional and Market Structure—Overview

148. The CSRC performs centralized supervision and regulation of the securities and futures markets on the Chinese mainland. China has adopted a sectoral supervision model for its financial industry, with securities market under separate supervision by CSRC. In accordance with the laws, and as duly authorized by the SC, the CSRC performs centralized and unified supervision and regulation of the nation’s securities and futures markets, with the aim both of promoting soundness in the markets and promoting market development.

149. Under this arrangement, the CSRC headquarters undertake the following responsibilities: formulating, amending and revising rules and regulations concerning the securities and futures markets, making market development plans, processing key reviews and approvals, guiding and coordinating efforts in risk disposals of insolvent securities or futures companies, organizing investigation of and enforcement against material violations and non-compliances, and guiding, inspecting, promoting and coordinating the nation-wide regulatory efforts. Under the supervision of the CSRC headquarters, its 36 regional offices are responsible for front-line supervision within their respective jurisdictions.

150. SROs are critical components of the regulatory system. To supplement the regulatory activities of the CSRC, SROs including the stock and futures exchanges, SD&C, Securities Association of China (SAC), China Futures Association (CFA) are responsible for self-regulation and front-line supervision over securities/futures trading activities of their members or listed companies. In addition, the National Association of Financial Market Institutional Investors (NAFMII) was established in 2007 to oversee the trading of fixed term instruments through the inter-bank lending and bond market.

151. The CSRC is subject to the general authority of the SC which appoints the Chairman. The Chairman holds Minister rank in the Chinese Government, on the same level as the Chairmen of the CBRC and CIRC. The responsibilities of the CSRC are clearly articulated in the Securities Law and the Law of the Peoples Republic of China on Securities Investment Funds (henceforth the Fund Law) and in a series of related laws that have expanded the duties and powers of the CSRC.

152. The CSRC has broad regulatory authority over the stock and futures exchanges, the SD&C and other clearing and settlement institutions, securities companies, futures companies, and collective investment scheme (CIS) operators. Other governmental agencies in China have responsibility for discrete regulatory functions that are included in the IOSCO principles. The major authorities are described below. Others are mentioned in the detailed principle-by-principle assessment. Of particular relevance to the IOSCO assessment the Peoples Bank of China is primarily responsible in China for AML regulation, guiding and organizing the AML work of the financial sector and regulators including the CSRC and monitoring relevant fund flows. It also regulates the inter-bank lending market and inter-bank bond market, and was the Government entity which provided seed funding for the Securities Investment Protection Fund (SIPF), which was established to assist with the resolution of a large number of failed securities companies and compensate investors earlier this decade.

153. The SSE was established in 1990. At the end of 2009, SSE had a total of 870 listed companies, 1,351 listed stocks with US$ 2.78 trillion market capitalization, and US$ 5.22 trillion stock turnover. It has 107 securities firm members and seven domestic and overseas special members. Securities listed on SSE are traded through an electronic bidding system with automatic price matching according to price and time priority through the SSE’s mainframe. The Shenzhen Stock Exchange was also founded in 1990, and has a Main Board, SME Board, Growth Enterprise Board (GEB) and the stock transfer agent system. The exchanges’ trading and business rules are subject to the approval of the CSRC.

154. There are three commodities futures exchanges and one financial futures exchange in mainland China. These consist of the Shanghai Futures Exchange (SHFE), the Dalian Commodity Exchange (DCE), the Zhengzhou Commodity Exchange (ZCE) and the China Financial Futures Exchange (CFFEX). The CFFEX, which is owned by the other commodity futures exchanges, recently commenced trading in stock index futures, China’s first financial derivative contract, and it is intended to launch other market-oriented derivatives such as options and potentially futures and options on treasury bonds and foreign exchange to diversify the financial derivatives market. The commodity exchanges’ trading and business rules are subject to the approval of the CSRC.

155. The SD&C was founded in 2001 and establishes rules for participants in the clearing and settlement process, in particular for managing clearing and settlement accounts. The SD&C is required as a securities registration and clearing institution to establish securities and clearing accounts, clear and settle securities and the cash associated with securities transactions, and distribute entitlements as instructed by the issuer (Article 157 of the Securities Law). It has developed detailed rules to ensure its members’ compliance with the relevant laws and regulations, including rules related to the administration of securities accounts, administration of clearing participants, and the administration of securities reserve funds, which are subject to the approval of the CSRC. The disciplinary powers include restricting or cancelling the use of participating accounts, and suspending or terminating the clearing participants’ clearing rights.

156. There are two primary types of CIS business in China: securities investment funds managed by fund managers, and collective asset management business conducted by securities companies. Wealth management products have grown considerably in size in recent years—at the end of 2009 wealth management products of banks totaled US$ 147.6 billion, of which, investment grade products accounted for more than US$ 96.4 billion. In addition, some funds, specifically private equity style funds administered through a trust company, are regulated by the CBRC; and some other funds, specifically private equity funds linked to industry development, are regulated by the NDRC.

157. The SAC and the CFA are national SROs for the securities and futures industries respectively. They aim to implement self regulation over the securities and futures industry under the centralized supervision and regulation of the CSRC; to serve as a bridge between the government and the securities and futures industries; and to maintain fair competition in the securities and futures industries, promote transparency, fairness and equitability of the market and its healthy and steady development. The SAC and CFA are responsible for frontline supervision of members and under delegation from the CSRC conduct initial qualification examinations for members of the securities and futures industries.

158. The Chinese securities sector has seen considerable volatility but overall has grown very quickly, especially in the last five years. At the regulatory level, there have been a number of important regulatory reforms to support the movement towards a more modern capital market. The reform of non-tradable shares introduced a market-based pricing system for so-called non-tradable shares in listed companies closely held by government and semi-government authorities. The securities sector also underwent a significant overhaul in the early part of this decade following widespread solvency problems and misappropriation of funds held on behalf of clients in securities firms and funds management companies. This overhaul included introducing extensive third party custodian requirements for handling client property and risk-adjusted capital requirements for securities firms. These reforms appear to have been successful in providing greater stability to securities firms and in protecting client assets.

C. Preconditions for Effective Securities Regulation

159. The Chinese regulatory regime has adopted a clear set of accounting and auditing standards. These are well advanced in the process of converging with IFRS and IAS and which are of high and internationally acceptable quality. The accounting and audit profession is growing and developing in professional competence and capacity. Similarly, the private legal profession and the capacity of the judicial system to handle commercial disputes has also been developing, but the involvement of institutional and retail shareholders in corporate governance is less well developed. As a result, more of the burden of dealing with commercial failures that involve regulatory breaches falls onto the CSRC than in jurisdictions with more active shareholders and easier access to litigation to resolve serious disputes.

160. There are various levels of law making within China. The highest levels are laws developed by the National People’s Congress (NPC) or its Standing Committee, which include the Securities Law and the Fund Law. At the next level there are Administrative Regulations promulgated by the SC subject to the Constitution and other laws. At a third level, there are rules and regulations developed and promulgated by the CSRC in accordance with (and subordinate to) the laws and regulations of the SC. These CSRC rules and regulations may be described as “Tentative” or “Trial” where they are new regulatory requirements or relate to innovations, but they have the same status as other rules or regulations promulgated by the CSRC and are enforceable as such.

161. In some cases the strict letter of the law has been buttressed by opinions issued by the Supreme People’s Court, and these appear to have been effective. For example, the Supreme Court has issued opinions that establish the legality and enforceability of Article 139 of the Securities Law and similar provisions which establish that in the insolvency of a securities firm funds held on behalf of a client shall not be treated as part of the liquidation but remain the property of the client: see the Circular of the Supreme People’s Court on Relevant Issues Concerning the Freeze and Transfer of Funds in the Clearing Accounts of Stock or Futures Exchanges (1997). In the bankruptcy case of Minfa Securities, the insolvency administrator had proposed that around US$ 11.29 million worth of clients’ transaction settlement assets it had secured should be regarded as property in the liquidation. The Supreme People’s Court ruled that such funds did not belong to the liquidation and should be used to cover the shortfall in clients’ transaction settlement funds.

D. Main Findings

162. As noted above the Chinese securities and futures industry and their regulation has undergone considerable development since the establishment of the CSRC less than 20 years ago. Reforms in recent years, in particular the non-tradable shares reforms, the introduction of stock index futures trading in 2010, and the overhaul of third party custodian and risk-based net capital requirements for securities firms, have enhanced the transparency of the market, broadened the range of available products and improved the financial soundness of intermediaries, to the considerable benefit of investor protection in China. These reforms have been carefully planned and implemented, and have been welcomed by market participants. They provide evidence of an active and strategic approach to regulation of the Chinese securities markets on the part of the CSRC and other authorities. These reforms have built on an extensive set of regulatory provisions which have drawn on the experience of other more developed securities markets, the United States and Hong Kong amongst others. There are few areas in which the regulatory framework needs further work in order to fully meet the IOSCO standards. Some of the areas for improvement identified in this report look to further improvements in the legal and accounting environment.

163. The Regulator: The responsibilities of the regulator responsible for securities regulation, the CSRC, are clearly set out in three primary pieces of legislation: the Securities Law, the Fund Law, and the Regulations on the Administration of Futures Trading. A sectoral approach to regulation applies in China, under which the CBRC regulates banking and banking institutions and the CIRC regulates insurance and insurance companies. Where banking or insurance companies engage in securities type activities, such as establishing and distributing wealth management products, the CBRC and CIRC have corresponding regulatory authority. In addition, some entities such as hedge funds and private equity funds are either not regulated or lightly regulated by other entities. In the interests of avoiding regulatory arbitrage, products performing a similar function should be regulated in a similar way, and the authorities should pay particular attention to wealth management products in this regard. With respect to hedge funds and private equity funds, the IOSCO Principles as in force at the date of this assessment do not require their regulation. However, given the rapid growth in these funds (especially private equity funds) and the potential for them to be used as retail investment vehicles, the authorities should consider placing them under the regulatory authority of the CSRC. The CSRC has power to develop rules and regulatory documents within the authority granted by laws and the Legislation Law for the purpose of performing its functions. It operates in practice as an independent agency free from political or commercial interests, but as a SC administrative organ it is required to follow civil service staffing and budgetary procedures which do not necessarily keep pace with developments in the regulated population, and some greater flexibility in this regard would help it discharge its regulatory functions. The CSRC’s budget is not sufficient to enable it to exercise its powers and responsibilities, given the rapid growth in the market and the nature of other market discipline mechanisms at this stage of China’s capital market development. There is considerable attention devoted to investor education, but significant further efforts are required to address retail investors’ understanding of the market and risk.

164. SROs: The regulatory arrangements in China place significant reliance on SROs to perform regulatory functions, under the authority and supervision of the CSRC. These SROs include the exchanges, clearing and settlement institutions, and industry associations. Given the growth of the Chinese capital markets and in particular in listed companies, retail investors and regulated entities, the SROs will need to give continued attention and resources to their regulatory functions. While the CSRC exercises significant authority and oversight over the SROs and communicates regularly with them, it should consider instituting a formal program whereby it conducts regular comprehensive inspections of the exchanges.

165. Enforcement: The CSRC has comprehensive powers related to inspection, investigation, surveillance and enforcement, and in particular has a useful power under which it can freeze assets by administrative order for the purpose of safeguarding them during the completion of an investigation. The laws and regulations provide a range of private rights of action for compensation and other action in the event of non-compliance causing damage to investors, but the legal system (in particular, the commercial courts) and the effect of market discipline provided by institutional investors and other participants on corporate governance is not as significant in China as in other jurisdictions. While private enforcement action is not a substitute for public enforcement action, supervision and regulation, it can supplement and support it. In combination, these factors undermine the capacity of private legal action to have a meaningful practical impact on compliance. Given the very high level of retail participation in the market, this means that the CSRC and authorities a greater share of the burden of ensuring compliance than in other markets. Arrangements for surveillance of abnormal trading are extensive and some substantial enforcement actions have been taken to deter market manipulation and insider trading, but there is need for continued attention and resources to enforce the laws with respect to illegal investment activity (including Ponzi schemes and bucket shops).

166. Cooperation: The CSRC has the ability to share public and non-public information with both domestic and foreign counterparts without other external process, for the purpose of performing regulatory and supervisory functions. The CSRC has established formal information sharing arrangements with the CBRC and CIRC, and with a large number of foreign securities and futures regulators. The CSRC and other domestic regulators should give more consideration to the efficacy of their cooperative arrangements, especially with respect to ensuring that products or activities that have a similar function are regulated similarly to avoid the potential for regulatory arbitrage. The CSRC is a signatory to the IOSCO Multilateral Memorandum of Understanding on Exchange of Information (MMOU) and actively makes and responds to requests for information and assistance with foreign regulators.

167. Issuers: The regulatory regime contains detailed requirements and follow-up mechanisms of the CSRC and exchanges for the disclosure of comprehensive information about financial results and risks of listed companies and other investment offers. The CSRC should promulgate a clearer requirement that advertising refer potential investors to the prospectus, similar to the requirement for CIS. The regulatory regime adequately addresses the rights and equitable treatment of shareholders, including with respect to mergers. However, the timeframes for the provision of annual and semi-annual financial statements, and the thresholds for reporting changes in substantial shareholdings, appear long by the standards in place in other major markets and should be reviewed. The regulatory regime has adopted a clear set of accounting and auditing standards which are well advanced in the process of converging with IFRS and which are of high and internationally acceptable quality. Continued attention will need to be given to the development of the private accounting and audit profession in China, and the level of fines for the provision of false or misleading financial statements should be reconsidered, to ensure that financial statements are professionally prepared and audited.

168. CIS: There are clear regulatory requirements for those that wish to operate or market a CIS, which provide reasonable entry requirements, ongoing eligibility and conduct rules, and requirements aimed at managing conflicts of interest. The regulatory regime adequately provides rules governing the legal form and structure of CIS. Segregation and protection of client assets is assured through a mandatory system of third party custodianship, and there are comprehensive disclosure requirements to enable a prospective investor to evaluate the suitability and prospects of the scheme. There are adequate provisions governing valuation requirements including audit requirements, and specific requirements concerning the pricing of subscription to or redemptions from funds. However, the provisions related to the professional qualifications and experience of fund managers should be reviewed as the industry develops. Given the high level of retail participation in the market, it is very important that all information should be provided in clear and simple language, and the CSRC will need to monitor this closely. The CSRC should be wary of the potential for unlicensed CIS activity, such as Ponzi schemes, to arise in the Chinese market and give attention to detecting and deterring it.

169. Market Intermediaries: The Chinese regulatory regime requires that market intermediaries must be licensed with the CSRC, and are subject to initial and ongoing capital and experience and qualifications requirements. The CSRC should consider amending its rules on investment consultants to require such consultants to disclose in detail to clients their personal backgrounds and career records, working experience, compliance record, investment strategies and fee structure, as the development of an independent financial advising capacity can be an important part of markets with significant levels of retail participation. The regulatory regime in China provides appropriate prudential controls with respect to market intermediaries and that relate to the risks involved in the particular businesses that market intermediaries undertake. The initial registered capital requirements and the ongoing risk-based net capital requirements provide a significant level of prudential buffer in respect of risks. As the system of risk-based net capital is relatively new, the CSRC should continue to monitor it carefully to ensure that it captures all relevant risks. The regulatory regime requires market intermediaries to have an internal risk management function and controls to protect the interests of clients. The CSRC could consider some extensions of technical aspects of the regulatory regime to cover existing parts of the industry, such as whether the concept of suitability included in the requirements for trading in stock index futures should be more generally applied, in light of the broad retail participation in Chinese capital markets and the need for investors to be informed about the risks of products appropriate to their circumstances, and whether some form of third party custodianship should apply to the management of client margins currently held by futures companies. The Chinese regulatory regime makes adequate provision for dealing with the failure of an intermediary, building on experience with significant failures of securities companies in the early part of this decade. However, the authorities should consider altering the threshold in the relevant regulations, that in the absence of a failure to observe a rectification order that the failure “severely threaten the order” of the market, to ensure that the CSRC can act promptly before the problem becomes too large.

170. Secondary Markets: The Chinese regulatory regime makes adequate provision for authorization and oversight of entities which wish to operate a stock or futures exchange, covering the exchanges themselves, admission of products to trading, trading information, and execution procedures. The regulatory regime provides for market authorities to monitor the risk of large and open positions that pose a risk to the market or clearing. In the event of default, there are procedures in place to ensure that the problem is isolated and does not affect other market participants, and for apportioning any loss appropriately. While CSRC staff maintain regular dialogue with the stock exchanges especially on listed company disclosure and trading issues, and membership and trading rules of the exchanges are subject to approval by the CSRC, instituting a formal program whereby it conducts regular comprehensive on-site inspections like for other exchanges should also be considered. The CSRC and exchanges have implemented systems for the ongoing surveillance and supervision of trading to ensure market integrity, and have devoted considerable human and technological resources to detecting and deterring insider trading and market manipulation. At the same time, given the size of the market, its rapid growth, and the enormous interest generated by new listings, the number of abnormal trades detected and on which action is taken seems low. The CSRC should consider some extra and continuing efforts to detect and deter unfair trading practices.

Table 18.

China: Summary of Observance of the IOSCO Principles

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E. Key Recommendations

171. The assessment team found several improvement opportunities, summarized in the Table below:

Table 19.

China: Recommended Action Plan to Improve Implementation of the IOSCO Principles

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F. Authorities’ Response

172. CSRC appreciates the immense time, efforts and resources devoted by the FSAP Assessors, the World Bank and the International Monetary Fund, to the FSAP assessment, and to the compiling of the Report of Observance of Standards and Codes: IOSCO Assessment of Securities Markets (hereinafter: the Report). The Report has, in a general sense, managed to reflect the implementation of the IOSCO objectives and principles by China’s securities and futures regulatory system. We fully understand how challenging and complex it was to conduct such a project as to review China’s capital market, the world’s largest emerging market in transition. Therefore, we marvel at and are moved by how much the Assessors managed to accomplish in relatively limited amount of time. They held scores of meetings with the CSRC headquarters and regional offices. They met with various regulated entities, SROs, service providers and local governmental officials. They also went through colossal volumes of reading materials. The Assessors have not only conducted comprehensive reviews of China’s capital market and its regulation, but also put forward many valuable comments and recommendations.

173. We are grateful for the opportunity to make a formal response to the Report. We identify with most of the Report, including its major Findings and part of the Recommendations. To start with, the Report highly recognizes the development and achievements of China’s capital market over the past two decades, as well as the regulatory efforts thereof, noting “Reforms in recent years, in particular the nontradable shares reforms, the introduction of stock index futures trading in 2010, and the overhaul of third party custodian and risk-based net capital requirements for securities firms, have enhanced the transparency of the market, broadened the range of available products and improved the financial soundness of intermediaries, to the considerable benefit of investor protection in China. These reforms have been carefully planned and implemented, and have been welcomed by market participants. They provide evidence of an active and strategic approach to regulation of the Chinese securities markets on the part of the CSRC and other authorities.” Meantime, the Report also points out that these reforms have built on an extensive set of regulatory provisions which have drawn on the experience of other more developed securities markets, and that there are few areas in which the regulatory framework does not meet the IOSCO standards. In addition, the Report acknowledges that “the Chinese regulatory regime has adopted a clear set of accounting and auditing standards which are well advanced in the process of converging with the IFRS and IAS and which are of high and internationally accepted quality.”

174. After reading the Recommendations of the Report, we recognize that all of them are worthy of immense attention and some of the Recommendations have already been incorporated into our work plans. For example:

a. Regarding the regulator

175. With lessons drawn from the latest financial crisis, we identify with relevant Recommendations in the Report, such as strengthening regulatory coordination among different Regulators (i.e., the CSRC, the CBRC, and the CIRC), placing unregulated markets and products under regulation, allowing greater flexibility for the Regulator in terms of staffing and budget, clarifying relevant provisions to ensure that regulatory staff do not bear liability for the bona fide discharge of their functions and duties, etc. In response to these Recommendations, China’s regulatory authorities will take further measures to enhance the efficacy of the CBRC-CSRC-CIRC MOU to avoid potential regulatory gap. Meantime, China’s regulatory authorities are taking active measures that will cover the previously unregulated institutions and products (e.g., private equity funds). With regard to Recommendations to increase regulatory resources and to exempt staff from liability for the bona fide discharge of duties, the CSRC will further consult with relevant government agencies, as well as legislative and judicial authorities. We believe more regulatory resources that are proportionate to China’s political system, economic status and the overall income level of its financial industry will manage to satisfy the regulatory demand of an ever-expanding market.

b. Regarding SROs

176. We agree with the Report that the SROs will need to give continued attention and resources to their regulatory functions; and that the CSRC, SIPF, and SROs should increase their efforts to educate investors about the market and risk. We recognize that given the rapid growth of the Chinese capital market and in particular in listed companies and regulated entities, the functions of SROs need to be further tapped into. The CSRC will enhance its regulation of and communication with the SROs, and will seriously consider relevant Recommendation to conduct regular comprehensive onsite inspections of the stock exchanges.

177. However, we cannot agree with some Findings and Recommended Actions in the Report, which we think are misunderstandings and erroneous. We feel that such misunderstandings and errors are partly due to the lack of sufficient understanding of China’s capital market, its features and mechanisms; and partly due to the failure to acknowledge the remedies that have already been put in place, or perhaps to the lack of trust in the efficacy of existing mechanisms and measures. In some cases, the Report even denies, without sufficient proof that such regulatory practices are ineffective, some tried-and-trusted practices that are unique to the Chinese market. We would like to express our concerns.

c. Regarding enforcement

178. We do not think the Report has sufficiently reflected CSRC’s efforts and achievements in cracking down on illegal investment and insider-trading. In 2006, the Steering Group on Cracking Down upon Illegal Securities Activities was jointly established by the CSRC and Ministry of Public Security. With the aim to organize and coordinate domestic efforts in combating illegal securities activities, the work of this Steering Group has yielded visible results. In our daily work, the CSRC monitors various public news media including the internet, in order to timely detect clues of securities violations for prompt handling. In 2001, the CSRC enacted the Notice on Implementing an Incentive Mechanism for the Reporting of Illegal and Fraudulent Securities and Futures Trading, encouraging investors to blow whistles on illegal securities and futures activities. Pursuant to China’s securities laws, any securities or futures violation that exceeds RMB 300 thousand constitutes a crime, and shall be referred by the CSRC to public security authorities. To sum up, illegal investment activities akin to Ponzi schemes and boiler rooms have been effectively detected and punished.

d. Regarding intermediaries

179. The Report recommends that there should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake. The Report also recommends that “as the system of risk based net capital is relatively new, the CSRC should continue to monitor it carefully to ensure that it captures all relevant risks.” However, we believe that CSRC’s supervision of net capital is sufficient and appropriate. The risk-based net capital system, featured by off-site supervision and on-site inspection, and timely and effective regulatory measures taken against problematic intermediaries, has proved to capture risks very well. Moreover, ever since 2007, the CSRC has been continuously monitoring and assessing the net-capital based risk regulatory system via IT monitoring platforms, and requires regular stress-test thereof.

180. In recent years, the CSRC has made a series of improvement on market infrastructure, and the futures market has achieved a great progress. The monitoring system of the secured custody of futures margins has taken into full consideration of the characteristics of futures trading, and the status quo of the market. It has played a significant and indispensable role in securing a healthy and stable development of the futures market. We wish to share the experience of our innovative regulatory system with regulators from other countries, and to enhance financial regulation through strengthening communication.

e. Regarding accounting and auditing standards

181. We regret to say that we cannot identify with the Rating result of IOSCO Principle 16. In order to ensure high quality auditing for listed companies and other market players, the CSRC has established a qualification license system, allowing only accounting firms that have obtained the qualification license to perform auditing for listed companies and other market players. The CSRC conducts all-round regulation including onsite inspection to the accounting firms with relevant qualifications (currently 53 firms), listed companies and other major market players. Judging from the reality, the size and professional capability of accountants and auditors are enough to satisfy the needs of the capital market.

f. Conclusion

182. While we may not agree with everything the Report says, we fully agree with what the Assessors kindly reminded during one of our numerous meetings—that we should not take pride in the findings, nor rest on our past laurels. In this sense, the FSAP Assessment stands as a good chance for us to retrospect the past and take a prudent look into the future. After all, given the tremendous changes that the world is undergoing, China’s capital market is exposed to profound changes and challenges, both home and abroad, while its regulators are encountered with an increasingly complex market and ever-growing tasks of maintaining sound and steady growth. An incomplete list of the challenges that we are facing include issues such as how to further build and improve the market legal framework, enhance enforcement and deterrence, so as to better protect the lawful rights of investors; how to strengthen regulatory coordination and function-based regulation with regard to various wealth management products offered to the public, so as to minimize potential regulatory gaps; how to regulate the once unregulated markets and products, striking appropriate balance between financial innovation and regulation; how to prevent and resolve systemic risks, strengthen the oversight of cross-border capital flow and sound early warnings of risks from abroad; how to cultivate sophisticated investors and encourage institutional investors, etc. We recognize that they are but some of the challenges we are faced with, that call for our unremitting effort and commitment. As regulators of China’s capital market, we have a long and promising way ahead of us.

Annex IV: Observance of Financial Sector Standards and Codes—Assessment of Observance of CPPS Core Principles for Systemically Important Payment Systems: A Summary

A. Introduction

183. The assessment was conducted in June 2010. In addition to the 2001 CPSS-CPSIPS Report, the methodology used follows the Guidance Note for Assessing Observance of CPSIPS prepared by the IMF and the World Bank in collaboration with the Committee for Payment and Settlement System (CPSS) in August 2001.

184. The information used included all relevant laws, rules and procedures governing the systems, the abundant material available on the issue inside and outside the central bank.11 In addition, extensive discussions were held with regulators—PBC, MOF, CSRC, CBRC, and SAFE; several stakeholders in the Chinese Payments System, including the big four commercial banks, joint stock commercial banks, city commercial banks, policy banks, foreign banks, and rural banks,12 funds management companies, the card operator (China Union Pay), the China Foreign Exchange Trade Center (CFETC) and securities depositories—China Central Depository & Clearing Co., Ltd. (CCDC) and China Securities and Clearing Corporation Limited (SD&C). A self assessment by the PBC of the country’s SIPS with the CPSS Core Principles as well as of the central bank’s responsibilities in applying the Core Principles (CPs) was provided prior to the mission. The self-assessment was prepared by the PBC Payment and Settlement Department, in close consultation with the major stakeholders of the China National Payments System (CNPS).

B. Institutional and Market Structure

185. In recent years, the PBC has carried out a major and comprehensive reform of the CNPS. The PBC implemented the CNAPS, which consists of the HVPS and the Bulk Electronic Payment System (BEPS). The HVPS system currently operates in a tiered way (multi-entry point) with a national processing center (NPC) and 32 local processing centers (LCPs). The HVPS system is interconnected to many trading, payments, and securities settlement systems (SSS) to allow for central bank money settlement. In addition, there are numerous cheque clearing houses around the country administered by the PBC local offices or delegated to banks. China Union Pay (CUP) handles the clearance of cards transactions whose balances are settled in the HVPS. Also automated clearinghouses (ACHs) and other systems handle clearance and settlement for a variety of payment instruments.

186. The HVPS is a systemically important payment system, as it is the backbone of the national payments system in China. The HVPS handled transactions for a value of CY 804 trillion in 2009, approximately 24 times the GDP value. Thus, the HVPS is being assessed against the ten CPSIPS of the CPSS and the four responsibilities of the central banks in applying the CPSIPS. The BEPS is not currently a systemically important payment system. However, its importance for an efficient settlement of the interbank payment system is growing.

187. The cheque clearinghouses around the country also handle an important value of transactions. The gross value of cheques issued in 2009 reached a value of CY 248 trillion in 2009, about 7.4 times the GDP. However, of this amount, 350 million cheques are interbank cheques valued at about CY 62.5 trillion. This means that the majority of the cheques issued in the country are “on us” cheques. Also, ACHs handled CY 69 trillion in 2009, about two times the GDP, relatively important (though not major) for a big country like China. Thus, neither the cheque clearinghouses nor the ACHs have been considered systemically important in this assessment but their relative importance has been taken into consideration in the assessment of Responsibility B and C.

188. Regarding the use of payment instruments, China is evolving to a more intensive use of non-cash payment instruments, especially cards. The relationship of cash (M0) to GDP has been declining since the beginning of the 2000 from a level of 14.8 percent of GDP in 2000 to 11.2 percent in 2009. Bank cards issuance have been increasing at a high pace and approximately 2.07 billion had been issued at end-2009, of which 1.88 billion were debit cards. Bank cards have therefore become the primary non-cash payment instrument in China accounting for over 90 percent on the total non-cash volume in 2009.

189. Domestic foreign exchange (FX) transactions are mostly executed at the CFETC. The majority of participants settle their transactions bilaterally while 26 participants use a net clearing model and the CFETC acts as CCP at end-2010. Settlement of the CY leg occurs through the HVPS and settlement of the foreign currency leg with domestic settlement banks, at which participants hold FX accounts. The mission was not provided with complete data of the transactions cleared and settled through the multilateral arrangement nor has the PBC conducted an assessment of this payment system. However, in light of the nature of these transactions and the potential systemic importance of the system, the PBC is urged to assess the compliance of this system with international standards as soon as possible.

190. The China Domestic Foreign Currency Payment System (FCPS) was launched in April 2008 to handle the clearing and settlement of domestic foreign currency denominated transactions. The FCPS is a Real-Time Gross Settlement (RTGS) system and currently handles payment transactions in seven foreign currencies. The values settled in the system do not show a systemic importance of the system.

C. Payment Systems Oversight

191. PBC powers to oversee payment and settlement systems have a sound and clear legal basis, CSRC has overlapping oversight powers on the securities settlements. PBC oversight and regulatory powers over retail payments, interbank payments, securities settlements and related functions are recognized in the legal framework. These powers are articulated in the Article 4 of the “Peoples Bank of China law.” The securities commission also has oversight powers over securities settlements, including government securities, derived from Article 179 of the “Securities law.” A formal memorandum of understanding (MoU) defines general cooperation arrangements among the PBC, MOF and other authorities, such as the CSRC and the CBRC. There is no specific MoU defining the modus operandi of these authorities over payment and settlement systems, however, there have been frequent coordinated actions and regular meetings at the technical level.

192. The PBC carries out its oversight function over all payment arrangements in the country. In addition to overseeing the systemically important payment systems in the country, the PBC has played a catalyst role in reforming interbank payment arrangements in China. Recently, PBC oversight has been extended to nonbank payment service providers. However, the PBC has not issued a comprehensive document covering the objectives, scope, instruments and institutional arrangements of its oversight function as yet.

193. The PBC has implemented a data analysis platform to assist in its oversight activities. The Payment Management Information System (PMIS) gathers payment and settlement information from various systems including HVPS and BEPS. This system provides various standard analytical reports and various ad-hoc analysis features which assist PBC in its oversight activities. PMIS also enabled the PBC to monitor the liquidity position of the participants in real-time.

194. The PBC has not yet formally established any national payments council. The central bank has legal authority to establish a self-regulated China payments and clearing association, but it has not yet established one, although it is working on a project to create the China National Payment and Clearing Association.

195. The PBC, in cooperation with other authorities and relevant stakeholders, is working on a number of projects to further improve the safety and efficiency of the CNPS. They include: the launch of a “second generation” version of the CNAPS; a reform of key aspects of the legal and regulatory framework; and initiatives to further increase the penetration of retail payment services, in particular in rural areas and through the use of innovative channels and modalities.

D. Main Findings

196. The assessment team found the payment systems in China to be operated in a safe way. However, several improvement opportunities, summarized in Table below, were identified.

Table 20.

China: Recommended Actions to Improve Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPs

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E. Authorities’ Response

197. The Chinese authorities welcome and support the CPSS assessment as an opportunity for reflection and improvement for China payment and settlement system according to international standards. The assessment team has undertaken an excellent task, demonstrating high quality, professionalism, dedication and the ability to cut through complex issues in a constrained timeframe. The authorities appreciate the opportunity to provide the following comments.

198. Over the past decade, China has continuously pushed forward the development of China payment and settlement system, which constitute the backbone of China’s financial system. We have built a payment network consisting of the central bank inter-bank payment systems, the banking institutions’ internal payment system, the security settlement system, the FX settlement system, the bankcards payment system and other retail payment systems run by private sectors. Non-cash payment instruments have been widely used and met various payment requirements. Commercial drafts have been underwritten and transferred in an electronic way. Bankcards penetration ratio has been on a fast track and bankcards have been the most widely used payment instrument by Chinese residents. Online payment, mobile payment and telephone payment have been developing dramatically. The application of non-cash payment instruments has greatly facilitated economic production and civil life, reduced cash circulation and transaction costs. Payment providers have been diversified. These include the central bank, banking institutions, nonbanking institutions and securities settlement institutions as payment organizations. The payment services have been market-driven. Modern payment means have also found their way in rural areas. The pilot cross-border trade settlement in RMB has developed in an orderly way. The management system of bank settlement accounts has improved on a gradual basis. The PBC has promulgated regulations on bank settlement accounts and established the bank settlement account management system to implement regulations. At the same time, the PBC launched a nationwide identity authentication system of accounts with the Police Bureau to implement the “know your customer” scheme. The payment system oversight has been strengthened, with safety and efficiency as the priority. The PBC has also improved supervision techniques and realized the DVP mode in the bond market.

199. The Large Value Payment System (LVPS) run by the PBC has been designated as the systemically important payment system and has been assessed against the CPs. The assessment concluded that the system observes (observed or broadly observed) all the CPs except CPI (legal basis). The PBC pays high attentions to the assessment results and appreciates valuable recommendations of the IMF and the WB. In implementing the recommendations, the PBC has realized one point entry in CNAPS1, e.g., the treasury centralized booking system and China postal savings bank’s internal payment system have been connected to CNAPS1 from one point and settled their transactions with one account.

200. Measures will be taken to strengthen our legal foundation, management and supervision of China payment systems, so as to improve its practicality and efficiency in the future.

  • CP I legal Foundation. The PBC has been aware of the shortcomings in the legal framework, and has decided to draft a payment system act to avoid the effects of the “zero hour rule” and give the legal recognition of netting arrangements and settlement finality. But the process of establishing legislation will take time and may involve many authorities.

  • CP VIII Practicality and Efficiency. The PBC is launching the 2nd generation of CNAPS to increase efficiency and practicality. CNAPS2 will be designed to extend the opening hours of settlement to meet the needs of users in different areas and various financial markets.

  • CP X Governance. The PBC has decided to improve management, upgrade the payment system and conduct a regular drill of emergency procedures, with an aim to achieving full observance of the CPs.

201. Central Bank Responsibilities A, B, C, and D. The PBC fully agrees with the recommendations and will take proper measures to ensure full observances of all CPs. The PBC will clarify in detail its policy stance in the payment system oversight in a publicly available document, and extend its oversight over all payments and securities settlement systems, including the systemically important systems and retail payment systems. The PBC will assess the safety and efficiency of the CFETS and the ACHs with relevant international standards. Besides, the PBC is about to establish the China National Payment Association and strengthen cooperation with relevant authorities, foreign central banks and international organizations.

Annex V: Observance of Financial Sector Standards and Codes—Assessment of Observance of CPPS-IOSCO Recommendations for Securities Settlement Systems and Central Counterparties: A Summary

A. Introduction

202. This summary is based on the Recommendations of the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) for Recommendations for Securities Settlement Systems (RSSS) and the Recommendations of CPSS-IOSCO for Central Counterparties (RCCP). This assessment was conducted in September 2010.

203. The information used in the assessment included relevant laws, rules and procedures governing the systems, and other available material.13 In addition, extensive discussions were held with regulators and overseers: PBC, CSRC, SSE, SHFE, DCE, ZCE, CFFEX, CCDC, SD&C, SAC, CFA; several stakeholders, including banks and broker-dealers active on the SSE, SHFE, and the interbank bond market, participants of the CCDC and SD&C as well as banks that facilitate settlement and funds custody for corporate securities and futures. Three self assessments were prepared by the CCDC for the CCDC settlement system, by the SHFE for the SHFE clearing and settlement system and by the Department of Market Supervision of the CSRC for the SD&C clearing and settlement system. Other relevant information was derived by the assessment process for Systemically Important Payment Systems (SIPS).

204. The assessment was conducted on processes and functions as opposed to institutions. Given that the bonds are mostly traded over the counter (OTC), the processes relating to trades outside the stock exchange were also examined.

B. Institutional and Market Structure

205. The Securities Settlement Systems (SSS) in the PRC are organized around three different types of markets, which are the bond market, the corporate securities market and the futures market. The bond market comprises the interbank bond market, the exchange bond market, and the bank counter market. The interbank bond market is the most dominant market, with more than 97 percent of total bond trading volume. The two stock exchanges, the SSE and the SZSE, were established in 1990 and offer trading in the same type of securities, being shares, bonds, funds and warrants. Turnover on both stock exchanges is relatively high and has grown tremendously during the last decade. According to the World Federation of Stock Exchanges, as of 2009, the SSE ranks as the 3rd exchange worldwide in share trading with RMB 34 trillion, and the SZSE as the 6th with RMB 18 trillion. There are also three commodities exchanges: SHFE, DCE, and ZCE. The SHFE ranks as the 10th derivatives exchange worldwide, measured in number of contracts traded and the second largest commodity exchange. A CFFEX was established in 2006 as a joint venture of the SSE, SZSE, SHFE, DCE, and ZCE but still volume and value of transactions are relatively modest.

206. The CCDC is the SSS as well as the central securities depository (CSD) for bonds. It is the only institution entrusted by the MOF to be the depository for government securities. The CCDC was established in 1996 as a Government entity and since then it is regulated by the PBC and overseen by the PBC and MOF. In addition, the CBRC is in charge of the appointment of Executive Managers of CCDC. The CCDC settles bond transactions (spot, repo, forward) on a gross basis for both bonds and funds, though CCDC management under PBC guidance, is currently considering introducing also a netting facility. Securities are held at the end-investor level in most cases (98 percent). The CCDC book entry system is interconnected with the interbank trading system (operated by the China Foreign Exchange Trading System (CFETS)). Cash settlement takes place in the central bank HVPS. Settlement takes place on T+0 for most transactions (82.9 percent of total value settled in 2009). In addition to the commonly used delivery versus payment (DvP) settlement, CCDC allows for other settlement modalities, Payment after Delivery (PaD), Delivery after Payment (DaP) and Free of Payment (FoP).

207. The SD&C is the central counterparty (CCP), SSS, as well as the CSD for all instruments traded on the SSE and SZSE. The SD&C was established in 2001 and is jointly owned by the SSE (50 percent) and the SZSE (50 percent). Securities settlement arrangements for SSE and SZSE are based on front-end availability of securities and funds, otherwise transactions do not take place. Securities are held at the investor level detail in the SD&C while funds are kept through a system of third party custodian banks with the SD&C acting as the settlement agent.

208. The four futures exchanges have their own clearing and settlement departments, which offer the function of a CCP. Settlements can be either in cash (daily mark to market) as well as physical settlements (delivery on expiration). The exchanges operate a pre-margining system, that is, futures contracts can only be purchased under the premise of sufficient margin deposits. In addition to the pre-margining system the exchanges have established other risk management controls including: price limits, limits to speculative positions and large holders, compulsory closed-out of positions, a system of warning indicators, and settlement reserves. Cash settlement is effected through the accounts of five commercial “settlement” banks. The “settlement” banks only operate as custodians for margins and facilitators for transfers of funds with the futures exchanges conducting settlement functions. Also, the China Futures Margin Monitoring Center was established in 2006 as a non-profit company under the sponsorship of the three futures exchanges to guarantee the safety of futures margin.

209. The CCDC, SD&C, and SHFE/DCE/ZCE operate important securities and derivatives settlement systems both, due to the large volume and value of transactions (GDP comparison) and the fact that they support key financial sector markets (interbank bond market, stock exchanges and futures). Therefore, the CCDC and SD&C are being assessed below against the 19 RSSS and the SHFE is being assessed against the 15 RCCP. The SD&C operates as a CCP for most of the market transactions but given the “unique” features of its settlement process (front-end control of securities and funds) it is being assessed against the RSSS. The other two commodities futures exchanges, DCE and ZCE, follow very similar settlement procedures to the SHFE, thus, findings and recommendations for the SHFE are also applicable to DCE and ZCE.

C. Main Findings

210. The assessment team found the securities settlement systems in China to be operated in a safe way. However, several improvement opportunities, summarized in Tables 21, 22, and 23, were identified.

Table 21.

China: Recommended Actions to Improve Observance of CPSS-IOSCO RSSS—OTC Bonds Market-CCDC

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D. Main Recommendations

211. The assessment team found several improvement opportunities, summarized in the Table below:

Table 22.

China: Recommended Actions to Improve Observance of CPSS-IOSCO RSSS—Stock Exchange (SSE, SZSE)—SD&C

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Table 23.

Recommended Actions to Improve Observance of CPSS-IOSCO RCCP—SHFE

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E. Authorities’ Response

212. The PBC and CSRC appreciate the significant undertaking associated with the FSAP review by the IMF and the World Bank in a comprehensive assessment of the SD&C, CCDC, the SHFE against the CPSS-IOSCO RSSS and for Central Counterparties (RCCP). We would like to pay a high tribute to the great efforts made by all parties involved in the assessment process and the professionalism of the assessors as demonstrated. We recognize the positive and far-reaching influence the assessment has on the stability and effective regulation and oversight of SIPS, clearing and settlement systems.

213. The assessment well objectively reflects the status of the settlement system in China’s security market, bond market and futures market as well as the compliance of the SD&C and CCDC with the RSSS, the compliance of the SHFE with the RCCP. The PBC and CSRC will share and analyze the comments and recommendations in the assessment with the SD&C, CCDC and SHFE, and consider absorbing and adopting the comments and recommendations in the future. All relevant parties will work together to ensure that SSS in China can operate in a secure, efficient and transparent environment.

214. Meanwhile, the CSRC still holds reservations about certain parts of the assessment of SHFE on its compliance with the RCCP (i.e., Recommendation 1 and Recommendation 4), for the following reasons:

  • On the issue of legal basis. Regarding China’s legislative system, laws are promulgated by the National People’s Congress (NPC), and administrative regulations are issued by the SC. Administrative regulations constitute an important part of China’s legal system, providing legal basis for not only administrative regulation, but also the settlement of disputes and cases by judicial authorities. However, it is not an explicit clause after all. The Regulations on the Administration of Futures Trading, which is the administrative regulation governing futures trading, is the legal basis for China’s futures market. We do not believe legal gaps exist in China’s futures settlement system.

  • On the legal recognition of the use of dematerialized warehouse receipts as margin contributions. The use of standardized warehouse receipts as margin contributions is clearly stipulated in the Regulations on the Administration of Futures Trading, the Measures for the Administration of Futures Exchanges and the relevant business rules of futures exchanges. The Property Law also contains clearly-stated provisions on pledge right. In practice, the SHFE designates delivery warehouses to serve as the registration authority for the pledge of dematerialized warehouse receipts. There have never been any controversies or disputes in this regard.

215. The PBC holds reservations about certain parts of the assessment of CCDC on its compliance with the RSSS, i.e., Recommendation 1 and Recommendation 8. Since bond is a kind of security, the Securities Law applies to interbank bond market. Also the finality has legal certainty. The regulations issued by PBC indicates, “bond transaction settlement cannot be revoked once completed,” “the cash and bonds with the status of waiting for transfer in the settlement process and the collateral regarding to the settlement can only be used for completing the settlement and shall not be enforced compulsorily for other purposes.” The spirit and principles of the Securities Law apply to domestic securities market in China, including inter-bank bond market; despite that the Securities Law contains specific provisions more on the exchange market. Regulations promulgated by PBC, which are in accordance with the spirit and principles of the Securities Law and mainly applied to inter-bank bond market, are the special provisions in Chinese legislation system on securities. According to the Law on Legislation, regulations issued by PBC belong to broadly defined laws and have legal enforceability. Owing to these, inter-bank bond market has been operating smoothly and safely these years since its establishment.

216. The PBC, together with CCDC, will seriously analyze the opinions and suggestions raised in the Assessment Report and keep improving the depositary and settlement system of China’s inter-bank bond market.
1

McKinsey Global Institute, 2006, “Putting China’s Capital to Work: The Value of Financial System Reform.”

2

The aggregate quota for the 88 QDII participants was US$68.4 billion at end-2010, which accounted for about 0.6 percent of domestic deposits. Under the QFII, 106 foreign institutional investors shared the aggregate quota of US$ 19.7 billion at end-2010, which accounted for about 0.3 percent of domestic bond and equity market capitalization.

3

According to the FSAP team’s calculations, as of end-2006, the book value of the non-performing assets transferred to the AMCs amounted to about RMB2.6 trillion.

4

See Table 7 and Appendix I for the methodology.

5

The industries are (i) steel-making; (ii) cement, lime and plaster manufacturing; (iii) brick, stone and other building materials manufacturing; (iv) building construction; (v) furniture making; and (vi) household electrical apparatus manufacturing.

6

This section should be read along with Annexes I to V containing the Reports on the Observance of Financial Sector Standards and Codes.

7

These deviations are currently not material and are offset by the higher minimum requirement.

8

The June 2007 report is the latest available comprehensive AML/CFT assessment of China. For the full text, see http://www.fatf-gafi.org/infobycountry/0,3380,en_32250379_32236963_1_70342_43383847_1_1,00.html.

9

Two foreign shareholders other than American International Group (AIG) have 51 percent shareholdings reflecting special circumstances.

10

Participating business has a low guaranteed return and offers the opportunity for additional participation in emerging profits.

11

The China Payment System Development Reports, 2007, 2008, and 2009, prepared by the PBC Payment and Settlement Department were particularly relevant.

12

Bank of China (BoC), Industrial Commercial Bank of China (ICBC), China Construction Bank (CCB), Agricultural Bank of China (ABC), Bank of Beijing (BOB), China Development Bank (CDB), Bank of Communication, Shanghai Pudong Development Bank, Standard Chartered Bank, HSBC, Bank of East Asia (BOEA), JP Morgan-Chase, and Shandong United Rural Cooperative.

13

CSRC Annual Reports 2008 and 2009, CDC Annual Report of China’s Bond Market 2009, PBC responses on the FSAP questionnaire for payment systems and securities clearing and settlement; websites from CSRC, SSE, SZSE, SHFE, CDCC/Chinabond; and other relevant documents.

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Cover IMF Staff Country Reports
People's Republic of China: Financial System Stability Assessment
Author:
International Monetary Fund
Volume/Issue:
Volume 2011: Issue 321
Publisher:
International Monetary Fund
ISBN:
9781463924546
ISSN:
1934-7685
Pages:
126
DOI:
https://doi.org/10.5089/9781463924546.002
  • Figure 1.
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    Figure 1.

    China: Evolution of the Commercial Banking System

  • Figure 2.
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    Figure 2.

    China: Scale of Retail Lending in Selected Banking Systems, 2009

  • Figure 3.
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    Figure 3.

    China: Growth of Mortgage Lending

  • Figure 4.
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    Figure 4.

    China: Benchmark and Average Lending Rates

    (Percent)

  • Figure 5.
    View in gallery
    Figure 5.

    China: Distribution of Lending Rates

    (Multiples of Benchmark Rate)

  • Figure 6.
    View in gallery
    Figure 6.

    China: Residential Housing Prices and Mortgage Lending

  • Figure 7.
    View in gallery
    Figure 7.

    China: Bank Loans to the Real Estate Sector, Year-on-Year Changes

    (Percent)

  • Figure 8.
    View in gallery
    Figure 8.

    China: Share of Real Estate Sector Loans in Bank Loans

    (Percent)

  • Figure 9.
    View in gallery
    Figure 9.

    China: A Proxy for Loan-to-Value Ratio

    (Percent)

  • Table 3.
    View in gallery
    Table 3.

    China: Financial Sector Reforms—Selected Benchmarks

  • Figure 10.
    View in gallery
    Figure 10.

    China: Credit Intermediation, 2010

    (Percent of GDP)

  • Figure 11.
    View in gallery
    Figure 11.

    China: Commercial Banking System Structure by Assets, 2010

  • Figure 12.
    View in gallery
    Figure 12.

    China: Fixed Income Markets in Selected Countries, 2009

  • Figure 13.
    View in gallery
    Figure 13.

    China: RMB Deposits in Hong Kong SAR

  • Figure 14.
    View in gallery
    Figure 14.

    China: Market Capitalization of A, B, and H Shares (RMB billions)

  • Figure 15.
    View in gallery
    Figure 15.

    China: Hong Kong SAR Market Premium for Chinese Equity

  • Figure 16.
    View in gallery
    Figure 16.

    China: Loan Growth Rates

    (Year-on-Year; Percent)

  • Figure 17.
    View in gallery
    Figure 17.

    China: Levels and Incremental Growth of Bank Deposits

    (RMB trillions)

  • Figure 18.
    View in gallery
    Figure 18.

    China: Loans by Maturity

    (Percent)

  • Figure 19.
    View in gallery
    Figure 19.

    China: Nonperforming Loans to Total Loans

    (Percent)

  • Figure 20.
    View in gallery
    Figure 20.

    China: Depository Corporations’ Foreign Asset and Liability Positions

  • Figure 21.
    View in gallery
    Figure 21.

    China: Flow of Funds in the Interbank Market—Repos

    (RMB billions)

  • Figure 22.
    View in gallery
    Figure 22.

    China: Flow of Funds in the Interbank Market—Call Loans

    (RMB billions)

  • Figure 23.
    View in gallery
    Figure 23.

    China: Aggregate Credit Risk: Sensitivity Analysis

    (Percent)

  • Figure 24.
    View in gallery
    Figure 24.

    China: Credit Concentration: Real Estate Sensitivity Analysis,

    (Percent)

  • Figure 25.
    View in gallery
    Figure 25.

    China: Change in CAR: Credit Concentration: Real Estate—Alternative Approach, March 2010

    (Percentage point)

  • Figure 26.
    View in gallery
    Figure 26.

    Test for Banks’ Exposures to LGFPs, End-2009

  • Figure 27.
    View in gallery
    Figure 27.

    China: Interest Rate Risk: Banking Book, End-2009

    (Percentage point)

  • Figure 28.
    View in gallery
    Figure 28.

    China: Interest Rate Risk: Trading Accounts, End-2009

    (Percentage point)

  • Figure 29.
    View in gallery
    Figure 29.

    China: Direct Exchange Rate Risk, End-2009

    (Percentage point)

  • Figure 30.
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    Figure 30.

    China: Macro-scenario Results, End-2009

  • Table 8.
    View in gallery
    Table 8.

    China: Financial System Architecture

  • Figure 31.
    View in gallery
    Figure 31.

    China: Reliance on Real Estate Collateral in Bank Lending, 2007

  • Figure 32.
    View in gallery
    Figure 32.

    China: Each Public Sector Debt Issuer Dominates in a Different Maturity Segment, 2009

  • Figure 33.
    View in gallery
    Figure 33.

    China: Sequencing Financial Reforms

  • Figure 34.
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    Figure 34.

    China: Stress Testing Exercise: Three Pillars

Figure 1.

China: Evolution of the Commercial Banking System
Figure 2.

China: Scale of Retail Lending in Selected Banking Systems, 2009
Figure 3.

China: Growth of Mortgage Lending
Figure 4.

China: Benchmark and Average Lending Rates

(Percent)
Figure 5.

China: Distribution of Lending Rates

(Multiples of Benchmark Rate)
Figure 6.

China: Residential Housing Prices and Mortgage Lending
Figure 7.

China: Bank Loans to the Real Estate Sector, Year-on-Year Changes

(Percent)
Figure 8.

China: Share of Real Estate Sector Loans in Bank Loans

(Percent)
Figure 9.

China: A Proxy for Loan-to-Value Ratio

(Percent)
Table 3.

China: Financial Sector Reforms—Selected Benchmarks
Figure 10.

China: Credit Intermediation, 2010

(Percent of GDP)
Figure 11.

China: Commercial Banking System Structure by Assets, 2010
Figure 12.

China: Fixed Income Markets in Selected Countries, 2009
Figure 13.

China: RMB Deposits in Hong Kong SAR
Figure 14.

China: Market Capitalization of A, B, and H Shares (RMB billions)
Figure 15.

China: Hong Kong SAR Market Premium for Chinese Equity
Figure 16.

China: Loan Growth Rates

(Year-on-Year; Percent)
Figure 17.

China: Levels and Incremental Growth of Bank Deposits

(RMB trillions)
Figure 18.

China: Loans by Maturity

(Percent)
Figure 19.

China: Nonperforming Loans to Total Loans

(Percent)
Figure 20.

China: Depository Corporations’ Foreign Asset and Liability Positions
Figure 21.

China: Flow of Funds in the Interbank Market—Repos

(RMB billions)
Figure 22.

China: Flow of Funds in the Interbank Market—Call Loans

(RMB billions)
Figure 23.

China: Aggregate Credit Risk: Sensitivity Analysis

(Percent)
Figure 24.

China: Credit Concentration: Real Estate Sensitivity Analysis,

(Percent)
Figure 25.

China: Change in CAR: Credit Concentration: Real Estate—Alternative Approach, March 2010

(Percentage point)
Figure 26.

Test for Banks’ Exposures to LGFPs, End-2009
Figure 27.

China: Interest Rate Risk: Banking Book, End-2009

(Percentage point)
Figure 28.

China: Interest Rate Risk: Trading Accounts, End-2009

(Percentage point)
Figure 29.

China: Direct Exchange Rate Risk, End-2009

(Percentage point)
Figure 30.

China: Macro-scenario Results, End-2009
Table 8.

China: Financial System Architecture
Figure 31.

China: Reliance on Real Estate Collateral in Bank Lending, 2007
Figure 32.

China: Each Public Sector Debt Issuer Dominates in a Different Maturity Segment, 2009
Figure 33.

China: Sequencing Financial Reforms
Figure 34.

China: Stress Testing Exercise: Three Pillars