The Taiwan Banker

In November, the State Council of the People's Republic of China established the Financial Stability and Development Committee, which is a milestone for China's financial supervisory system. The establishment of this committee followed China's 5th National Financial Work Conference in July and the release on July 25 of a report on financial stability. The Chinese government is implementing financial reform in a multi-tiered and systematic manner. Beijing's deleveraging policies have already had a positive impact on China's financial market. In the past, China had three supervisory bodies in charge of regulating business activities: the China Banking Regulatory Commission, China Insurance Regulatory Commission and China Securities Regulatory Commission. Yet recently, there has been more integration of business scopes within the industry, such as the combination of a financial holding company with a firm from a different sector. This can have a significant effect on financial markets. For instance, in June 2012, Pingan Insurance acquired Shenzhen Development Bank. From 2004, Beijing began gradually loosening restrictions on banks investing in insurance and securities. In the past 6-7 years, there has been a clear trend: Banks sell their own companies' fund products and directly provide funding for fund management companies. The banks are also used as a key sales channel for these financial products. Most of the profits from sales of the products go to the banks. Beginning integrated industry supervision in the financial sector With the financial sector active across different industries, leveraging has increased, attracting the attention of the Chinese authorities. Ballooning debt is a major concern for Beijing, given its aggravation of systemic risk not only within the Chinese financial system but also in other sectors. With this in mind, Beijing founded the Financial Stability and Development Committee. In fact, China's financial regulators began worrying about systemic risk in the financial system about 5-6 years ago. Since then, there have been numerous meetings among leaders of the financial industry to discuss how to manage the problem. Today, while some companies do not appear to be financial holding companies (they aren't named as such), they actually function as holding companies given their business scope that spans different industries. Thus, in July, at the 5th National Financial Work Conference, Beijing outlined "Two Missions" and "Four Principles," as well as establishing the Financial Stability and Development Committee. China's regulators have insisted that the China Banking Regulatory Commission, China Insurance Regulatory Commission and China Securities Regulatory Commission will remain independent - they will not be merged with the new committee. Yet by creating the new committee and giving it national-level regulatory powers, Beijing is in practice integrating the three regulatory bodies with the new supervisory body. The Financial Stability and Development Committee will have a number of main tasks. According to an official Chinese government statement, the committee will be responsible for "deliberating major reform and development programs for the financial sector, coordinating financial reform, development and regulation, coordinating issues concerning monetary policy, and coordinating the making of financial policies and related fiscal and industrial policies." Further, the committee will analyze international and domestic financial situations, address global financial risks, and conduct policy research on systemic risk prevention and treatment and financial stability.Toward the functional supervision model In addition, the Financial Stability and Development Committee will be tasked with overseeing the regulation of the booming digital finance sector, such as peer-to-peer lending, e-commerce and mobile payments. The fact that Beijing will confer this large responsibility on the committee shows that the new supervisory body will have substantial powers. Ultimately, the Financial Stability and Development Committee will help balance China's financial supervisory system both vertically and horizontally. By integrating the supervisory responsibilities of the three existing financial supervisory commissions, the new committee will improve the efficacy of financial regulation in China. The new committee will have oversight over such segments of the financial sector as wealth management, real estate, retail and lending. To be sure, China's financial regulation will benefit from this effort, given the negative impact of shadow banking on China's finance sector. There is likely an excessive amount of bad debt in the financial system, but because much of it is tied to shadow banking, it is difficult to quantify the extent of the problem. What we do know for sure is that lots of bad debt aggravates systemic risk in the Chinese financial system. Focus energy on deleveragingMeanwhile, China's financial regulators have been busy deleveraging for the past 18 months in a bid to eliminate risks that could derail stable economic development. Prior to the deleveraging campaign, credit growth had been extremely fast across different segments of China's financial sector, including peer-to-peer lending, mortgage loans and shadow banks' derivative products. As a result, China's entire financial system became excessively leveraged. With that in mind, Beijing's deleveraging efforts have borne fruit: Some analysts say that the M2 (money supply) annual growth rate has fallen from 15% to 7%. However, other experts believe that it's actually higher because of the volume of mobile payments in China, which are quickly replacing cash as a favorite form of payment. If that's true, then M2 should be measured in mobile payments. Still, it is certain that Beijing's deleveraging efforts have been successful in reducing the growth rate of the money supply. China's financial regulators thought that quantitative easing encouraged overly rapid credit growth, and so their response has been to tighten the money supply in a bid to reduce systemic financial risk. Looking at the many different indicators of deleveraging, including bonds, peer-to-peer lending, leasing companies, non-credit loans business, (biao wai business) and investment guarantee companies, internet wealth management companies' loan, and equities, it's clear that the tightening money supply has had an effect on the financial system. For instance the yield rate on Chinese government bonds has risen significantly; on 10-year bonds, it is now above 4%, the highest point in recent years. This shows us that credit growth is slowing. Further, 2/3 of China's peer-to-peer lending companies have shut down in the past 18 months. There were previously more than 5,000 firms; now there are just 2,000. Constrained credit growth has hit these companies hard, yet for the overall China financial market, the effect is positive and healthy. Previously, credit was too loose, aggravating the risk of bad debt. Mitigate the side effects of reform Additionally, it is worth mentioning that it is also very advisable for the mainland financial supervisory authorities to take vigorous measures to prevent negative side effects during the reform process. At the same time, it is also very advisable that the measures include "targeted reserve-requirement ratio cuts" and "targeted rate cuts." These two measures are intended to mitigate the potentially harmful effects of deleveraging and tightened capital controls on small and medium-size enterprises. This is a priority for the Chinese government, as these firms' health is important for China's overall economic health. China's financial regulators found that during quantitative easing, it was too easy for large companies to access credit. In fact, quite a bit of capital was accumulating within certain industries without entering the real economy. Yet it's important for the financial sector to provide funding to small and medium-size companies, not just big companies. With that in mind, China's financial regulator implemented two measures: targeted reserve-requirement ratio cuts and targeted rate cuts.In the case of targeted reserve-requirement ratio cuts, Beijing decided that if banks lend to SMEs, when the related loan business reaches a certain scale, the banks can be rewarded with a lower deposit reserve rate. The targeted reserve-requirement ratio cuts were announced in September and will come into force in January, so banks had the time in between to reach the target set by China's financial regulator. China's Financial Stability and Development Committee were also established to improve the implementation of financial policies. In recent years, Beijing has found that policies promulgated by the top financial regulators have not always been implemented on the local level. Local governments have found many ways around them. China's 5th National Financial Work Conference emphasized strengthening the Chinese Communist Party's control over the financial sector with slogans such as "The Party supervises the finance sector" and "Insist on the center of the Party having united leadership on finance." These slogans show that the Chinese Communist Party's control over the financial sector is bound to expand. The Party not only drafts key financial policies in Beijing, it requires that local governments implement those policies resolutely. Local governments will not be permitted to deviate from the course set forth by Beijing. The Party supervises the finance sector" - this is for sure With the principle "The Party supervises the finance sector" now promulgated, China will be able to resolve its debt problems gradually - including among P2P lenders, shadow banks, and local governments. These problems became so severe in the first place because of local government negligence or even malfeasance; only strong leadership from the center can rectify the situation. In the past few decades, there has been a saying about the Chinese economy: "Once you open up, there will be market disorder. Once there is disorder, there will be tighter control. Once there is tighter control, market reforms die!" That's why this time Beijing is tightening control gradually - to mitigate the impact that the tightening will have on certain vulnerable entities. This report highlights prudent management of the financial sector to minimize systemic risk. Prudent management includes improving regulatory capabilities, strengthening financial regulatory coordination, coordinating the monitoring of systemically important financial institutions, overseeing financial holding companies and important financial infrastructure, and promoting the establishment of standardized asset management products. To be sure, financial reform in China will have some adverse effects on the Chinese economy and capital markets, yet overall, results should be positive. (organized by Liu Shuning).