Financial Regulation in China: 2000 till Now

Posted: December 22nd, 2022

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Financial Regulation in China: 2000 till Now

The 16^th National Congress of the Communist Party of China (CPC), held in 2002, proposed plans to improve the living standards across the country by 2020 and identified the fiscal system as a reform target.[1] As part of the continuing improvements in the socialist market economy system, which is a hybrid of a central-planning and market-driven economic system, the financial sector reforms aimed at enhancing the equal access to basic public services, liberalizing markets in the industrial, agricultural and services sectors, and increasing participation in the global economy. Besides, the government became keen on attracting foreign investments to spur economic growth. China’s accession into the World Trade Organization (WTO) in 2001 integrated its financial systems and economy with the rest of the world, advancing the market liberalization reforms. Moreover, policy and rule-making were to be enhanced by cooperating with the Asian Development Bank, the World Bank, and other international financial organizations, to help adopt global best practices.[2]

The new millennium brought fresh opportunities for fiscal reform in China. However, the transformation of the People’s Republic of China (PRC) began as far back as 1949 and has been progressing at a steady pace ever since. Following the nationalization of all capitalist institutions and companies in 1950, the country established the People’s Bank of China (PBC) as the only bank in the country.[3] Established on December 1, 1948 the PBC served as the central bank and the commercial bank of the country, controlling 93 % of China’s financial assets and undertaking all the financial transactions, including the financing of the physical production plans in the country.[4] The Huabei Bank, the Beihai Bank, and the Xibei Farmer Bank were consolidated giving birth to formation of People’s Bank of China (PBC). However, in 1978, major structural reforms were initiated and the Chinese administration separated the PBC from the finance ministry to increase its autonomy and delegated certain commercial banking activities to three state-owned banks.[5] These included the Agricultural Bank of China (ABC) to deal with rural banking, Bank of China (BOC) to handle foreign trade and investments, and the People’s Construction Bank of China (PCPB) to deal with the fixed investments in the manufacturing sector. Moreover, the Industrial Commercial Bank of China (ICBC) was set up in 1984, and given full independence manage all industrial and commercial banking matters, while the PBC operated as a full fledged central bank.[6] Further developments in the 1980s included the rapid growth of financial institutions outside the four large state-owned banks, including regional banks for the rural and urban sectors, and non-banking institutions like the Trust and Investment Corporations (TICs).[7] The 1990s saw the move to form the stock market, allowing businesses raise more funds from the public. Consequently, the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) were established to handle stocks and bonds transactions.[8] Altogether, there were several initiatives undertaken by the Chinese government to liberalize the economy before 2000. However, this opening up of the economy was undertaken under the strict control of the Chinese central government.

In the post-2000 era, the Chinese government reduced its regulatory grip on the financial sector by ceding some of its authority to provincial and local governments. Alternative financial channels opened up at the provincial and local levels to improve access to financial services outside the mainstream financial structure. In addition, the government continues to regulate the financial sector by establishing several supervisory authorities. The People’s Bank of China (PBC), which is the central bank, is responsible for monetary policy and financial stability. The PBC is supported by the China Banking Regulatory Commission (CBRC) as the banking regulator. Although these organizations have some autonomy, they largely implement the decisions of the National People’s Congress. As such, the Chinese government continues to control the banking sector and capital markets, particularly the large Chinese banks, distorting the economy.[9] Altogether, the government assumed a facilitative role rather than being the dominant player in the economy, although, in recent times, it has been clawing back some of its control.[10] The reforms journey of the financial sector in China has been extensive yielding mixed results in the economy. The government has largely pursued a proactive, expansionary financial policy, despite the interference by financial crises in 1997 and 2007.[11] However, according to Jain, China continues to pursue its narrowly defined national interests using rule-based and principle-based approaches.[12] The understanding of the financial reforms in China from 2000 to date is important in analyzing the success and challenges of integrating China’s financial sector into the global financial system.

The banking system in China

The banking sector is an important component of a financial system and the Chinese banking system is particularly unique when compared to its Western counterparts. Despite having a longstanding history dating back to the Song Dynasty of the 10^th century and having undergone significant changes since China became a republic in 1949, the banking system is still controlled significantly by the government.[13] Specifically, the communist party through the National Congress provides the policy directions to the banking sector aimed at achieving preset political and economic goals. People’s Bank of China (PBC) is charged with isuing policy directions as the central bank, while the China Banking and Insurance Regulatory Commission (CBIRC) carries out the role of banking supervisory and regulatory body. The safety of deposits and loan guarantees are assured by the government through the insurance arm of the CBIRC. State-owned entities (SOEs) enjoy protections from Financial Assets Management Companies (AMC), which cushions them against habitual loans defaulters.

The banking institutions are categorized by their ownership structure, business focus, and operational areas. For instance, the big four banks, which are state-owned, provide banking services to large state-owned enterprises in specific sectors, which differentiates them from other banks in the country. Although the shares of these financial institutions are publicly traded on the stock market and thus can be considered to be public organizations, their operations are geared towards the enabling of the achievement of the political and economic plans of the government though giving access to huge amounts of capital to the SOEs. Their nonperforming loans are bought by AMCs, protecting them from bankruptcy.[14] Also, there are policy banks such as the Export-Import Bank of China (EXIM) and China Development Bank (CDB), which concentrate on financing state and other economic and trade development projects conceived by the government. Established in 1994, policy banks took over the state-directed financing previously provided by the big four banks. Then there are the foreign-sponsored state banks, which are formed from joint ventures between foreign banks and the PBC to decrease the financial stress of Chinese financial institutions [1] . Lastly, there are commercial banks that focus on financial services in urban and rural areas such as Trust and Investment Corporations (TICs), city commercial banks and country banks. However, it is important to note the big four banks have the most government control and protection compared to other commercial banks in the country.[15] Moreover, the Chinese banking system is different from its worldwide counterparts because their main priority is to facilitate government organizations.[16] In addition, although the central bank oversees the health of the banking and financial sector in the country, the high concentration of its powers has been diluted over time, while its autonomy has increased considerably, albeit under the direction of the Communist Party.

Reasons for the regulation of the financial sector

With increased liberalization of the Chinese economy and continued improvement of the socialist market economy system, the vulnerability of the economy had increased. The Asian crisis of 1997 and the financial crisis of 2007, the rapid growth of the economy and large FDI inflows exposed the financial sector to risks, which threatened the country’s economic health.[17] Moreover, accession to the WTO had opened up the sector to global forces in an environment lacking sufficient regulatory frameworks.[18]

The financial crisis that affected China’s position, its growth, and capital inflows

Financial crises can adversely affect national economies, erode the attractiveness of a country and its products in the international market and stifle investments, thus undermining economic growth and development. The two financial crises in 1997 and 2007 affected china and instigated financial reforms to insulate the economy from external turbulences.

The financial crises in the banking and capital market sectors that swept across the Asian economies in 1997 raised concerns in the Chinese government. The twin crisis threatened to undermine the impressive economic growth and stifle inbound capital flow from investors, which contributed significantly to this growth. Since China shared many structural problems with the economies in the region, there were concerns that the crisis would spill over into the country. The structural problems included weak regulations and commercial bank supervision of the central bank, bank-dominated financial system, excessive lending, and huge nonperforming loans.[19]

Prior to the Asian crisis, China enjoyed a robust and favorable financial position because of its low international debt, surpluses in its current account and strong reserves. Internally, the government enjoyed public confidence because of the non-convertible Renminbi and capital controls that prevented the conversion of savings into foreign currency, and the belief that the government would bail out the state-owned banks if a crisis ensued.[20] However, the Asian crisis and the 2007 financial crisis dented the reputation of the economy and threatened its position as a rising and formidable economic power globally.[21]

Specifically, the Asian crisis reduced the Chinese exports to the region. Already, the annual export growth rate fell from 33.1 % in 1994 to 2.5 % in 1998.[22] Regional countries devalued their currencies and experienced reductions in GDP, which made Chinese exports expensive. Considering that the Asian market took up about 40 % of China’s total exports, the crisis reduced exports in the regional market.[23] Negative export growth rates were registered in 1998 and 1999, at -1.5 and -3.8 %, respectively.[24] The combined effects from the liberalization efforts in state-owned enterprises (SOEs) allowing them to fire employees to manage their high indebtedness and poor performance alongside the panic surrounding exports during the crisis, motivated the financial reforms. Also, foreign direct investments (FDIs) play a pivotal role in the growth and globalization efforts of the country. Besides, regional economies receive capital inflows courtesy of China’s success. As such, China was the most attractive destination for FDI.[25] The crisis reduced the attractiveness of China due to concerns about the spillover effects on the Chinese economy. The loss of investor confidence slowed the growth of new FDIs.

The financial crisis of 2007 also had effects that instigated further financial reforms in China. The crisis endangered the capital markets in the country and threatened to undo the gains in economic growth. For instance, some state-owned enterprises suffered huge losses worth over 11 billion Renminbi from trading in derivative products through foreign banks.[26] Moreover, during this crisis, the economic growth rate reduced from 14.2 % in 2007 to 9.2 % in 2009.[27] Likewise, the fivefold stock market boom between 2005 and 2007 was reversed when over two-thirds of the market value was erased.[28] Also, China’s net FDIs fell from 143.06 billion dollars to 70.32 billion dollars between 2007 and 2009, before rebounding to 124.93 billion dollars in 2010.[29] Altogether, these changes reduced the demand for China’s exports. They undermined the optimism about China’s stock market, and the risk attitudes and economic outlook about the country.

Industry requirement to address procyclicality and strengthen the resilience of the financial sector

Economic cycles are the fluctuation an economy experiences between periods of expansion (growth) and contraction (recession). The downward and upward movement of gross domestic product occurs over a long-term growth period. However, the downward spiral can be mitigated through a robust economic system. However, while procyclicality is a regular occurrence in economic systems, its fluctuation can be controlled by robust and effective financial systems that accommodate changing credit demands during economic cycles.[30] China and other emerging economies have weak bank risk management and supervision structures that can exacerbate procyclicality.[31] Moreover, China’s banking sector has asymmetric procyclicality because the linkage between the growth of the economy and loans is more connected during the decline rather than the upward stage of the economic cycle.[32] The prolonged economic boom in China was partly influenced by the rapid development of the financial system in the 70s and 80s. However, its effects were negatively affected [2] by increased loan defaulting by institutional borrowers, with many banks suffering from bad debts. At the same time, the country had over-invested in capital projects that did not generate returns. Therefore, changes in the credit market conditions such as those presented by the financial crises could amplify a small shock in the Chinese economy. This worsened the detriments that the Chinese financial sector could experience from external crises, such as credit crunches, declines in GDP and economy contractions.[33] The second Basel Accord (Basel II) required that banks hold capital that is proportional to their risk exposure to protect against credit, operational, and market risks. Basel II recommended the methods for risk calculation and advised banks to adopt them to improve their risk management systems and resilience during financial turmoil. The third Basel Accord (Basel III) improved on the provisions in Basel III to seal the financial regulation loopholes exposed by the 2007 financial crisis, although its effects are yet to be ascertained.[34] But China lacked prudent macroeconomic regulatory measures to address procyclicality and clients lacked information about the banks and their products to enable them to make informed investment decisions. Therefore, China, as a member of the global financial system needed to undertake reforms that aligned its financial system to the Basel II and Basel III recommendations and protect it against amplified procyclicality.

Promotion of the separation of banking regulatory supervision and monetary policy

The People’s Bank of China (PBC) had dual functions prior to the year 2000, considering that the main focus of the financial sector was to spur economic growth internally. While this worked well for China’s context at the time, accession to the World Trading Organization would open up the Chinese economy to external competition and overburden PBC as a banking regulator and a monetary policymaker.[35] Specifically, in the early 2000s, banks in China had accumulated huge bad loans requiring enormous bailouts from the government through the PBC. Also, opening up of the country to foreign investors was expected to increase the penetration of banking services to the rural and western areas of the country that hand long been underserved. Moreover, a robust monetary policy was required to enable China to participate in the global economic arena after accession into the WTO. To avoid the inefficiencies emanating from the dual role of PBC and to meet the huge workload related to regulation and monetary policy development, the regulatory supervision function needed to be delegated to an independent third-party authority. The interaction between macro and micro policies presented efficiency challenges to PBC. That way, the PBC would focus on the monetary policy formulation as a central bank, while the banking regulator would concentrate on regulating the changing the financial sector environment in the country.

The need to regulate and license foreign entities and enhance local incorporation

The accession to the WTO and increasing capital inflows from international investors increased the presence of foreign firms in the country. Moreover, the privatization of some of the state-owned enterprises increased the private sector participation in the Chinese economy.[36] Although the government was pursuing the privatization of some of its investments in industrial, agricultural and services sectors, the participation of the Chinese private sector remained low. [3] Besides, new foreign entrants into the Chinese financial market needed to be encouraged to invest in areas other than those in the eastern, highly urbanized region. The entrants also needed to be encouraged to incorporate locally rather than establishing branches, which were harder to supervise.[37] These changes found a lack in the regulatory framework for licensing and incorporating foreign companies, thus necessitating regulatory formulation.

Strategies used to regulate the financial sector

The Chinese government used various strategies to regulate the financial sector, which was endangered by rising debt, opaque and unethical business practices, and undercapitalization. A four-tier strategy is used in the regulatory framework. The first-tier comprises of laws formulated by the NPC. The second, third and fourth-tiers comprise of regulations developed by the CBRC and implanted as policies, rules, notices and guidance, and window guidance, respectively.

Legislation by the National People’s Congress

The 16^th the National People’s Congress (NPC) introduced a raft of legislation to regulate the financial sector in the country. The Laws of the People’s Republic of China Banking Regulation of 2003 sought to improve banking regulation and supervision, standardize the supervisory process in banking, protect the interests of investors and depositors, and prevent and mitigate financial risks. The law authorized the formation of the China Banking Regulatory Commission (CBRC) in 2003. This effectively removed the banking regulatory function from the PBC, leaving it to concentrate on the monetary policy. In the same year, the NPC enacted the Laws of the People’s Republic of China Commercial Banks to guide the regulation of the commercial bank sector.[38]

In 2006, during the 6^th session of the standing committee of 10th NPC, amendments to the Banking Supervision and Administration Law were enacted. This law sought to strengthen and regulate the activities of the supervision and administration in the banking sector, forestall banking risks, protect the rights and interest of depositors and other banking clients, and promote the advancement of the banking industry.[39] In addition, China’s regulations on Administration of Foreign-funded Banks was cleared in the same year by the State Council. This law advised on how the innovative banks funded by FDI inflows would be regulated.[40] In effect, although few, these law protected fair competition, demanded information sharing with the PBC, increased collaboration with foreign institutions, protected bank, and state secrets, and introduced an information system, among other reforms. Recently, the NPC restructured the banking regulators by merging CBRC with the China Insurance Regulatory Commission for form the China Banking and Insurance Regulatory Commission after 2018. This removes the silos deciding the banking and insurance sectors while reducing progressively the burden of bailouts on the government when banks collapse. [4]

Regulatory measures enacted by CBRC

The CBRC, as an authorized independent regulator of the banking industry in China, has instituted various regulatory measures since its inception in 2003. It oversees the banking sector in the country except that in the special administrative regions of Hong Kong and Macau. Besides, as a member of the Alliance for Financial Inclusion, the CBRC instituted various regulatory measures to promote financial inclusion. As such, its regulatory and supervisory roles require that the CBRC constantly monitor the entire financial sector and devise timely regulations to respond to the challenges of a rapidly-changing Chinese fiscal environment.

The CBRC uses policy, rules, notices, and guidance to perform its mandate. It also uses both the rules-based and principle-based regulatory approaches depending upon the need and context. However, it prefers the rules-based strategy, which indicates the longstanding command practice in Chinese leadership.[41] For instance, to prepare the financial sector for the entry and operations of foreign occasions [5] by joining the WTO, CBRC developed a local [6] incorporation policy. This policy aimed at incentivizing the local incorporation of foreign banks instead of the establishment of branches because they were easier to regulate and supervise [7] . This was a proactive policy that insulated the financial sector from the effects of the 2007 global financial crisis. However, this policy was abandoned in 2009 after being in operation for three years because CBRC changed its focus to county banking.

The raft of rules, notices, and guidance are numerous and prescriptive because they deal with day-to-day operations in the financial sector and should be responsive to the rapidly-changing fiscal environment. One such rule is the requirement of a lender trustee payment scheme if a loan exceeded 5 million Renminbi or 5 % of the fixed asset value.[8] This rule aimed at regulating the loans for acquiring fixed assets and instructed in the evaluation of the applicant, assessment of risk, process of contracting, disbursement of the loan and monitoring of the outcome.[42]
[9]

Following the 2007 financial crisis, the CBRC advised banks to implement an internal rating-based approach to establish the credit of clients and their projects. However, the CBRC provided three methodologies and encouraged banks to use advanced approaches. The regulatory body used a principle-based approach by not prescribing a specific credit rating method, leaving banks to choose the approach that best fitted their circumstances. Likewise, the implementation measures on administrative licensing items relating to foreign financial institutions demonstrated a principle-based self-regulatory strategy. Similarly, the guidelines on financial innovation of commercial banks targeted similar items. Although they guide the conduct of the derivatives business, the regulations do not define the scope of the derivatives. This provides avenues for product innovation and marketing. However, the CBRC required an application for banking products whose approval would be effected on a case-by-case basis.[43]

Other actions by the CBRC included the 75-percent loan-to-deposit ratio to safeguard liquidity while controlling the loan size, rules on auto loans to vet the eligibility of a borrower, appointment of a competent bank director to stem incompetence and encourage appropriate behavior. To nurture the growth and quality of local banks, CBRC employs paternalistic regulation. For example, customer authentication aimed at reducing operational risks, although its effect was discouraging foreign banks from outcompeting local banks while allowing the local firms to learn from their foreign counterparts.

Window guidance measures

Window guidance is an advisory mechanism of issuing loans to firms by local and foreign banks as authorized by the central bank of a country, influencing the amount of credit circulating in an economy. Its informal nature and lack of legal enforceability complicate its application because it exposes banks to loan default when they extend credit beyond their limit, thus increasing the chances of bankruptcy. Window guidance in China informs banks of the intentions of the regulators, prepares to guide opinions and signals impending risks to the financial institutions.[44] In China, the CBRC and the PBC collaborate in issuing window guidance with the PBC focusing on monetary policy issues, while CBRC attends to regulatory and supervisory issues in the financial sector.

Monetary policymaking was influenced by the central bank lending before 2000, with the interest on central bank credit guiding the interest rates in the broader economy. This is because the local banking products were loan-based.[45] However, the role of the central bank lending as the primary monetary policy tool was overburdened by reserve requirements, repurchase agreements, and open market operations. The CBRC supervises the PBCs window guidance by dealing with credit risk issues such as the pace of lending and lending details.[46] [10] However recently, the importance of central bank lending has resurged.

The CBRC issued window guidance as well. For instance, in 2003, the CBRC advised 11 commercial banks not to advance loans to sectors deemed to misappropriate the credit. To forestall the aftermath and spillovers from the global financial crisis, the CBRC advised banks to control the size of loans to prevent them from entering the capital and real estate markets. This loan management notice was discussed with individual banks to determine the proper loan size to be effected, accommodating the different bank contexts. The loan-to-deposit ratio and the asset size were used to determine the loan size cap.[47] These measures were accompanied by loaning quotas that the CBRC communicated monthly.[48] [11]

Window guidance is channeled to banks through telephone conversations and face-to-face meetings.[49] As such, they are often difficult to enforce because are not legally binding and often lack punitive measures to guarantee their implementation. However, PBC uses targeted transactions and penalty deposits. Window guidance is an effective tool for monitoring financial activity because they allow regular consultations between the bank and the regulators. Therefore, problems can be identified early and rectified before they contaminate the financial system.

Major financial reforms in China

China had planned to liberalize its capital account by the year 2000 before the interruptions of the Asian financial crisis.[50] Capital market liberalization, the managed floating exchange rate regime and the tightening of P2P lending controls characterize the major financial reforms in China since 2000.

Capital Account Liberalization

The capital account reflects the capital inflows and outflows in a country, informs about the foreign assets and liabilities, and reveals the level of international transactions by a country. Capital account liberalization is part of an overall liberalization strategy in response to globalization that helps in liberalizing short-term capital inflows and outflows in a country through prudent economic policies.[51] Ideally, it should improve the efficiency of capital allocation from wealthy nations to developing economies.[52] Although still in the industrializing path, China has used this rationale to guide its liberalization agenda to leverage capital outflows. However, although the liberalization process resumed after the financial crises, the Chinese authorities continue to closely control the capital account to guard against foreign exchange markets volatility, capital outflows and foreign currency reserves reduction.

The exchange rate regime

China undertook several reforms in its exchange rate regime to improve monetary policy and facilitate participation in the global market while securing national interests. Currency exchange rates influence the level of international trade of a country and the participation in the global free-market economy. The choice of the exchange rate regime influences the resilience of an economy to global market volatilities, countries can choose between the fixed, floating and pegged float exchange regimes.

In the continued embracing of the socialist market economy, China abandoned the dual exchange system by unifying the regime in 1994 [12] . It pegged the Renminbi against the dollar and managed its flexibility using a tight 0.25-percent band.[53] The currency basket comprised the dollar, yen, euro and won as the main currencies and Australian, Canadian and Singapore dollars, Russian rouble, Malaysian ringgit, and Thai baht as the secondary currencies. However, the weightings of this currency mix remain undisclosed. Between 2007 and 2010, the managed exchange rate was suspended for two years to stabilize the Renminbi during the 2007 financial crisis by using the dollar peg. The managed exchange rate regime was resumed in 2010, with the authorities promising to enhance the exchange rate flexibility. However recently, China has been experimenting with the use of the Renminbi as a mode of payment for import and exports, effectively reducing its reliance on the dollar.

Tightening control over P2P lending

The P2P industry was informal and unregulated, engaged in traditional banking services, exposed lenders and borrowers to risks and provided an avenue for illegal transitions prior to the reforms. Peer-to-peer (P2P) lending in China has grown significantly courtesy of the technological advancements and exclusion of many Chinese from mainstream banking services. Since the establishment of Paipaidai as the first unsecured P2P lending platform, providers increased to 1500 by the end of 2014.[54] This growth is facilitated by the gap created by the exclusion of the small and medium enterprises, and individuals from mainstream banking channels. The few state-owned commercial banks (SOCBs) focus on financing government-related borrowers and large state-owned enterprises (SOEs). In turn, informal financiers such as family, friend and business acquaintances fund the micro, small and medium enterprises.[55] Therefore, the influx of P2P platforms found an unregulated environment. Consequently, loan defaults increased and irregular practices prevailed threatening a credit crisis, thus prompting the central bank to tighten P2P lending. Moreover, the high number of informal banks and hybrid wealth-management firms exposed the banking industry to financial risks and exploited the public. [13]

The government introduced a guidance policy in 2015 to regulate online financial transactions. The aim of the policy is to encourage investment and growth while regulating the transactions. Internet lenders were to set up third-party depository systems with qualified banking institutions to channel transactions and secure lenders and borrowers. The CBRC was appointed as the supervisory agency in the P2P lending industry. In addition, the size of non-bank payments for individual accounts not linked to qualified banking institutions was restricted to prevent illegal financial transactions. Besides, P2P was required to share credit data with PBC through the Credit Registry Center (CRC).[56] Other regulations included the requirement for minimum .registered capital, outlawing of capital pooling and loan guarantees, and having experienced managers and credit-risk management teams.[57] These controls helped formalize the internet lending industry while delineating it from traditional banking. They blocked the avenues for illicit financial transactions and protected the borrowers and lenders. They also provided credit information to the central bank, improving its monitoring capacity. [14]

Improved bank governance and internal controls

The banking sector in China continues to be highly regulated by the government, with the four major state-owned banks transacting most of the country’s business. This has helped reduce the effects and promptly recover the banking sector and economy from the 2007 international financial instability compared to the shocks of the 1997 crisis.[58] In 2016, the PBC and CBRC issued directives requiring banks to improve governance and tighten internal controls to prevent corruption, embezzlement of funds and assets, and illicit financial transactions (Putnis 125). Rules-based regulations characterize the command-and-control mechanisms used, with detailed prescriptions and defined penalties being articulated clearly to enforce compliance and conformity. Importantly, the regulator set standards for banking leadership based on qualification, experience and compliance record (Putnis 121). Moreover, corporate governance, risk control capacity and managerial experience were to be influenced by foreign equity participation, which facilitated knowledge transfer.[59] With time, it is expected that the crop of financial professionals and corporate leaders would be ready to take up the locally incorporated companies, further expanding the Chinese economy and bolstering its international position.

Conclusion

China is committed to reforming its financial sector to facilitate its continued economic growth and improve its position as a global economic power. Despite the impressive growth in the years before 2000, the country began experiencing reductions in the pace of development. China’s leadership identified the financial sector as a target for reforms because the banking system was no longer effective in advancing the economy in the new millennium. After a series of piecemeal reforms that saw the country become an attractive destination of FDI inflows and huge exporter in the region and the world, mismanagement and corruption crept in and threatened to undo the economic progress.[60] Moreover, the country needed to prepare its regulatory and supervisory environment in readiness to the expected influx of foreign investors and foreign-owned companies after accession into the WTO. The country prepared for these changes by incentivizing the private sector being identified as important in preparing local firms for post-WTO competition and knowledge transfer from foreign firms. The government divested from some small and poorly-performing SOEs to spur private sector investment and offload the debt-ridden firms. State-owned enterprises in the industrial, agricultural and services sectors were targeted for privatization. Besides, internet banking had increased exponentially without a sufficient operational framework. Indeed, there was a need to create a fair competition environment that was safe and sound for the banking industry, which could endear public confidence and could protect depositor and consumer interests.

Therefore, China revamped its regulatory and supervisory agency by splitting the monetary policy and regulatory functions. The People’s Bank of China, which performed both roles, was relieved of its supervisory duties by carving out the China Banking Regulatory Commission as the financial sector regulator, leaving PBC to focus on central banking. With these structures ready, the directions and laws of the 16^th National Congress of the Communist Party of China could be implemented.

The reforms were executed in a four-tier approach comprising of laws by the NPC, regulatory policies by the CBRC, rules, notices, and guidance by the CBRC, and window guidance measures by the PBC and CBRC. The PBC instituted monetary policy reforms by focusing on the capital account and exchange rate regime, while the CBRC addressed the regulatory issues associated with lending particularly in the emerging internet finance industry, governance, and internal controls. The reforms focused on facilitating the entry and operations of foreign banks, making exports competitive in the global market, opening up credit lines for rural investments, attracting for FDI inflows, improving the resilience of the financial sector against external shocks and liberalizing the financial industry to support the socialist market economy system. Indeed, the Asian crisis of 1997 and the global finial crisis of 2007 not only exposed the vulnerabilities in China’s economy and financial sector but also invigorated the reform efforts to insulate the sector from economic shocks.

A combination of rules-based and principle-based mechanisms were used to institute the reforms and ensure compliance. Command-control and self-regulation supplement the implementation strategies. This cocktail of strategies allowed the liberalization agenda to be advanced alongside the pursuance of national interests. The reforms are not complete and continue to evolve as China learns to domesticate global practices.

The rapid reforms undertaken by the Chinese administration have managed to modernize the country’s banking system in a matter of decades. The modernization achieved is far ahead of the growth achieved by other countries over the centuries. However, despite spurring accelerated economic growth, the slow evolution of the financial system is evidence of the reservation to pursue a free market economy due to the conservative political ideologies of the country’s leadership. So far, the financial system has managed to support foreign trade and investment-led economy, despite its close supervision by the government. The growth of the banking sector led by the big four state-owned banks, numerous regional banking, and nonbanking institutions, and the two capital markets are evidence of the financial sector reforms. Apart from the progress in financial institutions, individuals now have better access to financial services as well. However, there are still not enough incentives for the private sector to fuel the next phase of development. In addition, the financial system is not resilient enough to sustain external shocks, is susceptible to numerous risks, and is not suitable for propelling domestic consumption and supporting innovation and service-driven economy. The next phase of financial sector reforms should focus on risk reduction, resilience building and private sector incentives, which remain unaccomplished by the current reforms.

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[1]

Try to be more explicit regarding why the financial institutions are becoming a part of the industry.

[2]

Please try to use easier language.

[3]

the participation of the Chinese private sector remained low. (As opposed to foreign? Please clarify)

[4]

Clarify this… my professor said he doesn’t understand.

[5]

What occasions?

[6]