This year’s national “Two Sessions” unveiled a plan to overhaul departments of the State Council, with two major changes related to the financial regulatory system.
First, to establish the State Financial Regulatory Administration to replace the China Banking and Insurance Regulatory Commission (CBIRC). The new regulator will also take over day-to-day supervision of financial holding groups from the People’s Bank of China (PBOC), the country’s central bank. Second, to abolish the PBOC’s nine regional branches and restore provincial-level branches.
These changes will essentially reverse the financial sector reforms of the 1990s, which emulated the U.S. model.
The 1990s reforms focused on two aspects: ensuring the central bank’s independence to free it from the influence of other state departments and local governments; and adopting industry-based regulation by setting up independent regulatory bodies for different financial sectors.
Before the previous reforms, the PBOC was a massive organization responsible for formulating monetary policies and regulating all financial industries. But its headquarters often struggled to control money supply, as local bank branches were pressured by local governments to provide more liquidity. This indirectly forced the central bank to create more money, leading to mounting inflationary pressure and bad loans in the early 1990s.
As a result, the PBOC abolished all provincial branches in 1998 and replaced them with nine regional branches. The move effectively limited the influence of local governments on monetary policy. At the same time, monetary policy started to shift from the central bank’s direct guidance of loans to an indirect, price- and market-based approach.
Over the past two decades, the influence of local governments on the central bank’s policies has been substantially reduced. Therefore, there is no need to worry that the PBOC’s re-establishment of provincial branches would make room for localities to intervene in its policy formulation in the short term.
The re-establishment of provincial branches reflects efforts in adjusting the direction of the previous financial sector reforms, which aimed to achieve monetary control indirectly through interest rates and open market operations.
In recent years, the Chinese government hopes that banks can provide financial support to bolster the growth of specific industries through targeted policies. This requires closer cooperation between the PBOC’s credit and monetary policies and provincial governments, which will boost the clout of provincial branches and reduce the impact of regional branches. The re-establishment of provincial branches may imply that the role of direct loans and policy guidance in China’s monetary policy will be further strengthened.
In addition to restructuring the central bank, the financial institutional reforms of the 1990s and 2000s also decided to set up the China Banking Regulatory Commission (CBRC), the China Insurance Regulatory Commission (CIRC), and the China Securities Regulatory Commission (CSRC) to oversee banks, insurance firms and capital market participants, respectively. Yet as China’s capital market evolved, the boundaries between different financial institutions gradually blurred, creating room for regulatory arbitrage where firms tried to exploit regulatory loopholes to circumvent supervision.
Therefore, the CBRC and the CIRC merged into the CBIRC five years ago to regulate banks and insurance companies, with the PBOC overseeing financial holding companies.
However, this time, the CBIRC will be replaced by the State Financial Regulatory Administration, which will also take over the day-to-day oversight of financial holding companies from the PBOC, and investor protection from the CSRC. It will be in charge of local financial supervision as well. In fact, all financial sectors, except for the capital market, will be subject to supervision of the new regulator.
Meanwhile, the CSRC will be in charge of approving corporate bonds for all non-financial institutions, in addition to equity offering supervision. This is the right direction for regulatory reforms.
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The 1990s financial reforms, which emulated the U.S. model, did not achieve all the desired results. Meanwhile, the U.S. financial market structure dominated by Wall Street interests was seen by the Chinese government and scholars as failing to serve the real economy. The rapid development of financial innovation and the increasing complexity of financial products in the West have also become a major concern for Chinese officials.
In comparison, although China also faces risks in its own financial system, the government often acts as the largest shareholder of major financial institutions, giving it strong control over the financial market. This has limited the negative impact of sudden crises on China’s credit system and overall financial stability, making its financial market relatively stable compared to those of Western countries over the past decade or so. This is also an external factor driving the latest round of shake-ups.
Admittedly, the U.S. financial system that China emulated in the past reforms has its limitations, but China’s overhaul of commercial banks has been quite successful.
That said, over the past decade or so, the government has been increasingly involved in bank lending. It should be bank managers who decide whether to issue loans to specific projects or industries and the interest rates based on market changes. It is likely that a financial system lacking commercial independence will become a new source of financial risks.
Vincent Chan is a China strategist at investment advisory firm Aletheia Capital.
Contact translator Zhang Ziyu (ziyuzhang@caixin.com) and editor Bertrand Teo (bertrandteo@caixin.com)
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