## cr17358 — People’s Republic of China: Financial Sector Stability Assessment (FSAP) ## Source details **Canonical URL:** [cr17358 — People’s Republic of China: Financial Sector Stability Assessment (FSAP)](https://www.imf.org/-/media/files/publications/cr/2017/cr17358.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17358.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17358.pdf.json) --- ### Executive summary and financial system overview - China is undergoing a prolonged economic transformation from an export- and investment-based model to one based on services and consumption. - Bank assets have increased to 300 percent of GDP. - Financial assets grew from 263 percent of GDP to more than 467 percent in 2016. - At end-2016, bank assets amounted to nearly 310 percent of GDP. - Equity and bond markets are the second and third largest in the world, respectively; the insurance industry is growing fast. - Credit-to-GDP ratio is about 25 percent above the long-term trend (credit gap ≈ 25 percent of GDP). - Corporate debt reached 165 percent of GDP (end-2015). - Household debt rose by 15 percentage points of GDP over the past five years; household debt (percent of GDP) series: 2012: 29.6; 2013: 33.0; 2014: 35.4; 2015: 38.2; 2016: 44.2; 2017: 46.4; 2018: 48.9; 2019: 51.6; 2020: 54.4; 2021: 57.4; 2022: 60.8. - Return on assets in 2016: Q2 was 1.1 percent. ### Credit growth, asset quality, and opaque risk transfer - Credit growth has vastly exceeded GDP growth; financial innovation and regulatory arbitrage have shifted risk into off-balance-sheet vehicles and NBFIs. - Major financial engineering practices identified: - Trust loans, securitization, Asset Management Plans (AMPs), entrusted lending, investment receivables, and debt-equity swaps. - Reported NPL ratio rose from about 1 percent in 2013 to 1.7 percent in 2017: Q2. - Special mention loans peaked at 4.1 percent of loans in 2016: Q3 and stood at 3.8 percent. - Provisions against NPLs declined from 290 percent in early 2013 to about 180 percent. - Off-balance-sheet WMPs are large and concentrated: bank-sponsored WMPs for medium-sized JSBs and CCBs are 25 percent and 17 percent of total assets, respectively. - Stress test coverage: 33 banks with RMB 171 trillion in total assets and RMB 20 trillion in off-balance sheet WMPs; these 33 banks account for 74 percent of assets in the banking system. ### Stress testing, scenarios, and solvency results - Severely adverse macro scenario: - Real GDP declines by two standard deviations relative to the baseline over a two-year horizon (a cumulative 7.3 percentage points over 2017–18). - NPL ratio rises to 9.1 percent in 2018 (from 1.5 percent for the 33 tested banks baseline). - Assumed relaxation of provisioning coverage ratio from 150 percent to 50 percent in the severe scenario. - Solvency outcomes (selected): - Aggregate CET1 capital ratio declines to 7.2 percent from 10.3 percent under the severely adverse scenario. - For the 33 tested banks, CET1 ratio falls by 4.2 percentage points under the severely adverse scenario. - Capital shortfall for the 33 tested banks amounts to 2.5 percent of GDP. - Overall, 27 out of 33 banks are undercapitalized relative to at least one minimum requirement; 23 banks fall below the 7 percent CET1 threshold. - WMP-support shock assumption and impact: - Purchasing 25 percent of sponsored off-balance sheet WMPs at face value, with recovery values of 40 percent, produces an additional system-wide CET1 capital fall equivalent to 4.5 percent of GDP. - Liquidity stress-test results (number of banks failing out of 33): - Overnight: 0 - 2d-7d: 0 - 8d-30d: 4 - 31d-90d: 7 - 91d-1y: 7 - Liquidity metrics: - Ratio of interbank funding to total funding: 11 percent in 2010; 17 percent in 2016; 22 percent for JSB and CCBs. - Average repo tenor: 2.7 days (down from 4.2 days at end-2010). - Liquid assets have accounted for about 20 percent of total assets since 2013. ### Macroprudential framework, institutional reform, and sequencing - Key institutional proposals: - Create a Financial Stability Sub-Committee (FSS-C) with sole function of preserving financial stability; FSS-C to report to the Financial Stability and Development Committee (FSDC). - FSS-C to be advisory; macroprudential tools remain with PBC and supervisors. - PBC to serve as secretariat, with interagency working groups and adequate resourcing. - Macroprudential toolkit and calibration: - Trigger the countercyclical capital buffer (CCyB); CCyB initial target: 0.5–1.0 percent of risk-weighted assets over the coming 12 months. - D-SIB charge: phase in 0.25 to 1 percent by end-2019 (bucket approach). - Note: 2.5 percent is the maximum CCyB level under Chinese regulation and for mandatory reciprocation by other BCBS members. - Sequencing to lift implicit guarantees — recommended preconditions: - Strengthen loan classification and disclosure requirements for non-guaranteed investment products. - Require FIs compensating investors for non-guaranteed products to hold equivalent capital and liquidity buffers. - Raise capital requirements and lengthen maturities to reduce run risk. - Establish insolvency and debtor workout regimes; clarify government support for SOEs. - Reduce property market interventions and local government dependence on land-sale revenue. - Build FI liquidity buffers; strengthen social safety nets and consumer protection. ### Regulation, supervision, and critical agency gaps - High degree of compliance with international standards, but three critical common gaps: - Lack of independence of regulatory agencies. - Insufficient resources: headquarter staffing unchanged while sector doubled; headquarter staff counts: PBC: 750; CBRC: 600; CSRC: 730. - Inadequate interagency coordination and systemic risk analysis. - Microprudential priorities for banks: - Enhance group and consolidated supervision; identify ultimate beneficial owners. - Eliminate use of collateral in loan classification; classify all loans overdue by more than 90 days as nonperforming. - Enforce “look-through” principle for investment products and AMPs. - Increase LCR coverage for interbank products and off-balance-sheet WMPs; extend LCR to smaller banks. - Enhance regulatory reporting to collect granular supervisory data on banks’ investment holdings and provisioning. - Functional oversight: - Move toward a functional overlay so similar products issued by differing financial firms are supervised and regulated similarly. - Harmonize regulation of AMPs/WMPs and improve disclosure; prohibit specifying expected returns in WMP prospectuses. ### Shadow banking, fintech, and market structure - Drivers of nonbank growth: search for yield, regulatory arbitrage, demand for credit at regional level. - Fintech highlights: - Peer-to-peer lending stock doubled in 2016 (to about 0.5 percent of banking sector assets). - Yu’E Bao assets: RMB 1.4 trillion (June 2017), accounting for one quarter of the total size of the money market in China. - Authorities have begun to draw fintech within regulatory perimeter; some crypto trading banned. - Recommendations: - Strengthen legal, regulatory, and supervisory frameworks for fintech. - Ensure bankruptcy remoteness and legal clarity of CIS and WMPs; clarify ownership and investors’ claims. - Improve credit registry to capture indebtedness to nonbanks (including P2P). ### FMIs, repo market, and operational resilience - FMI landscape: multiple payment, clearing and settlement systems; high membership overlap (80 percent futures exchanges overlap; >50 percent overlap in CCDC and Shanghai Clearing House). - Recommendations for FMIs: - CSDC to adopt full delivery-versus-payment. - Strengthen implementation of PFMI and legal framework for finality, netting, collateral remoteness, and insolvency protection. - Consider extending central bank services and emergency liquidity against collateral to systemically important FMIs (subject to legislative change). - Repo market vulnerabilities and suggested reforms: - Apply additional haircuts and haircut methodology tied to liquidation days. - Require minimum monthly turnover for eligible repo collateral. - Gradually exclude retail investors from repo market. - Encourage CSDC internal ratings and move toward true repo with title transfer where appropriate. - Cover repo collateral under fast-track arrangements outside formal insolvency. ### Crisis management, resolution, and safety nets - Current practice has relied on official financial support irrespective of systemic importance, fostering moral hazard. - Key recommendations: - Develop a special resolution regime for banks and systemically important insurers; expand administrative powers to resolve banks and insurance companies. - Establish a formal emergency liquidity assistance framework for the PBC with strict conditions (solvency, collateral, penalty rates, repayment plan). - Limit triggers for government-led crisis response to systemic cases that may require public resources. - Use protection fund resources only after licenses are withdrawn and not for rehabilitating failing firms or protecting shareholders. - Ensure shareholders and unprotected creditors bear losses before safety nets are used; clarify hierarchy of claims and bail-in powers. - AMCs and bad-debt resolution: - AMCs remain dominant disposal channel; re-think balance between rapid disposal and operational recovery/restructuring. - Encourage debt-to-equity swaps where part of broader operational restructuring; strengthen out-of-court enforcement options and bankruptcy experience. ### Key risks, likelihoods, and impacts (Risk Assessment Matrix — selected) - Risk 1: Shift in perceived implicit guarantees → Likelihood: High; Impact on Financial Stability: High. - Risk 2: Break in short-term intermediation chains → Likelihood: High; Impact on Financial Stability: Medium. - Risk 3: Sustained decline in asset prices (Tier 1 housing) → Likelihood: Medium; Impact on Financial Stability: High. - Risk 4: Disorderly corporate deleveraging → Likelihood: Medium; Impact on Financial Stability: High. - Risk 5 (external): Rise in protectionism → Likelihood: Medium; Impact on Financial Stability: High. - Risk 6 (external): Sharp rise in global rates or risk premia → Likelihood: Medium; Impact on Financial Stability: Medium. ### Selected macrofinancial projections and statistics (exact series as reported) - Real GDP (annual percent change, base=2015): 2012: 7.9; 2013: 7.8; 2014: 7.3; 2015: 6.9; 2016: 6.7; 2017: 6.8; 2018: 6.5; 2019: 6.3; 2020: 6.2; 2021: 6.0; 2022: 5.8. - Total social financing (percent change): 2012: 19.1; 2013: 17.5; 2014: 14.3; 2015: 12.4; 2016: 12.9; 2017: 10.9; 2018: 11.4; 2019: 12.2; 2020: 11.2; 2021: 10.5; 2022: 9.9. - Total social financing (percent of GDP): 2012: 169.0; 2013: 180.0; 2014: 189.8; 2015: 197.6; 2016: 209.0; 2017: 213.2; 2018: 218.9; 2019: 226.6; 2020: 232.4; 2021: 237.3; 2022: 241.7. - Nonfinancial corporate domestic debt (percent of GDP): 2012: 105.0; 2013: 109.3; 2014: 113.0; 2015: 119.4; 2016: 128.1; 2017: 134.9; 2018: 139.1; 2019: 141.5; 2020: 142.4; 2021: 142.3; 2022: 141.6. - Gross official reserves (in billions of U.S. dollars): 2012: 3,388; 2013: 3,880; 2014: 3,899; 2015: 3,406; 2016: 3,098; 2017: 2,930; 2018: 2,876; 2019: 2,823; 2020: 2,751; 2021: 2,655; 2022: 2,533. - Regulatory capital (Regulatory Capital to Risk-Weighted Assets): 2013: 12.2; 2014: 13.2; 2015: Q2: 13; 2015: Q4: 13.5; 2016: Q2: 13.1. - Regulatory Tier 1 Capital to Risk-Weighted Assets: 2013: 9.9; 2014: 10.8; 2015: Q2: 10.8; 2015: Q4: 11.3; 2016: Q2: 11.1. - Non-performing Loans to Total Gross Loans: 2013: 1; 2014: 1.2; 2015: Q2: 1.5; 2015: Q4: 1.7; 2016: Q2: 1.7. - Liquid Assets to Total Assets: 2013: 21.2; 2014: 19.9; 2015: Q2: 19.7; 2015: Q4: 21.1; 2016: Q2: 21.6. ### Policy priorities (selected, with stated priorities where provided) - De-emphasize high GDP growth projections in national plans that motivate setting high-growth targets at the local level. Priority: H, NT. - Create FSS-C to preserve financial stability; strengthen cooperation and granular data sharing. Priority: H, NT. - Trigger CCyB and review banks’ capital requirements; consider targeted and substantial increases in capital. Priority: H, NT. - Amend laws to strengthen operational and budgetary autonomy of the PBC and regulatory agencies; increase resources. Priority: H, MT. - Tighten loan classification: classify all loans overdue more than 90 days as nonperforming; eliminate use of collateral in loan classification. Priority: H, MT. - Ensure bankruptcy remoteness and legal clarity for CIS/WMPs; prohibit specifying expected returns in WMP prospectuses. Priority: H, MT (legal change) and H, NT (disclosure). - Adopt full delivery-versus-payment at the CSDC; strengthen PFMI implementation and FMI legal certainty. Priority: H, NT / H, MT. - Develop special resolution regime for banks and systemically important insurers; formalize emergency liquidity framework for PBC. Priority: H, MT. - Mandate enhanced CDD for domestic politically-exposed persons on a risk-sensitive basis and ensure self-laundering is prosecuted as a stand-alone offense. Priority: M. *Source: PREFACE; Executive Summary; selected chapters and annexes, Financial Sector Stability Assessment — People’s Republic of China (IMF), cr17358.* ### PREFACE _________________________________________________________________________________________ 6 ### PREFACE ### Engagement and meetings - The mission met with senior leaders and officials from: - People’s Bank of China (PBC) - China Banking Regulatory Commission (CBRC) - China Securities Regulatory Commission (CSRC) - China Insurance Regulatory Commission (CIRC) - National Development and Reform Commission - Ministry of Finance (MoF) - Ministry of Human Resources and Social Security - State Administration of Foreign Exchange (SAFE) - Legislative Affairs Office of the State Council - National Bureau of Statistics (NBS) - The mission also met with representatives from financial institutions (FIs), industry organizations, academics, and the private sector. - FSAP meetings were held at the national level and in cities including Changchun, Chengdu, Chongqing, Fuzhou, Guangzhou, Hangzhou, Shanghai, Shenzhen, Shijiazhuang, Wenzhou, and Hong Kong SAR. ### Acknowledgements and cooperation - The IMF and World Bank FSAP team expressed deepest gratitude to the authorities for: - Impeccable preparation - Constructive dialogue - Excellent cooperation - Substantive contributions to the FSAP process - The PBC, CBRC, CIRC, and CSRC provided: - Answers to hundreds of questions - Translation of innumerable pages of regulation and legislation - Patient responses to questions and clarifications - Special appreciation noted for the FSAP offices of the PBC and the regulatory agencies for responsiveness in organizing and facilitating meetings. ### Scope of the FSAP and limitations - The Financial Sector Stability Assessment (FSAP) assesses risks and development prospects of the financial system and provides recommendations to improve stability and facilitate development. - The scope is broad but does not cover all topics related to the financial sector. - Topics not addressed in this FSAP but covered in the IMF’s annual Article IV Consultation reports (most recent: IMF Country Report 17/247) include: - The conduct and stance of monetary policy - Capital account and exchange rate liberalization - Reform and governance of state-owned enterprises (SOEs) - Reforms in social safety nets ### Document structure highlights (selected) - Executive Summary - Macrofinancial Context (Macroeconomic Context; The Financial System) - Risk Assessment (including “The Economic Transition and Financial Stability”, “Complexity of the Financial System and Risks”, “Investment, Guarantees, and Bubbles”, “The Macroeconomic Policy Challenge”, “The Macrofinancial Regulatory Challenge”) - Overarching Policy Recommendations (Systemic Risk Oversight and Macroprudential Policy) - Oversight: Independence, Coordination, and Resources of Agencies - Microprudential Oversight (Modernizing the Bank Supervisory Framework; Consolidated Supervision and FHCs; Asset Quality and Credit Risk; Supervision of Securities Markets; Insurance; Supervision of FMIs; AML/CFT) - Crisis Management (Crisis Prevention and Preparedness; Resolution Powers and Approaches) - Financial Safety Nets; Resolution of Bad Debts; Development and Access - Boxes, Figures, Tables, and Annexes (including Risk Assessment Matrix; Stress Testing Assumptions; Size and Growth of FIs; Selected Economic and Financial Indicators; Financial System Structure; Implementation 2011 FSAP Recommendations) ### Glossary (selected acronyms preserved exactly as presented) - AMCs Asset Management Companies - AML/CFT Anti-Money Laundering/Combating the Financing of Terrorism - AMP Assets Management Plan - BCBS Basel Committee on Banking Supervision - BCP Basel Core Principles for Effective Banking Supervision - CBRC China Banking Regulatory Commission - CCB City Commercial Bank - CCDC China Central Depository and Clearing Corporation - CCPs Central Counterparties - CCyB Counter-cyclical capital buffer - CET1 Common equity tier 1 capital - CIS Collective Investment Schemes - CIRC China Insurance Regulatory Commission - C-ROSS China Risk-Oriented Solvency System for insurers - CSDC China Securities Depository and Clearing Corporation Limited - CSRC China Securities Regulatory Commission - DNFBP Designated nonfinancial businesses and professions - D-SIB Domestic Systemically Important Bank - ELA Emergency Lending Assistance - FHCs Financial Holding Companies - FIs Financial institutions - FMIs Financial Market Infrastructures - FSAP Financial Sector Assessment Program - FSS-C Financial Stability Sub-Committee - FSB Financial Stability Board - G-SIB Globally Systemically Important Bank - G-SIFI Globally Systemically Important Financial Institution - G-SII Globally Systemically Important Insurer - JMC Financial Regulatory Coordination Joint Ministerial Committee - JSB Joint-Stock Banks - LCR Liquidity coverage ratio - LGFV Local Government Financing Vehicle - LTV Loan-to-value ratio - MoF Ministry of Finance - MPA Macroprudential Assessment - NBFI Nonbank Financial Institution - NBS National Bureau of Statistics - NPLs Nonperforming Loans - NSCAs Nonstandard Credit Assets - PBC People’s Bank of China - PFMI CPSS-IOSCO Principles for FMIs - RMB Chinese renminbi - SAFE State Administration of Foreign Exchange - SOEs State-Owned Enterprises - WMPs Wealth Management Products *Source: PREFACE, Financial Sector Stability Assessment — People’s Republic of China (IMF).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Overview - Since the 2011 FSAP, China’s economic growth has continued; China is undertaking a necessary but prolonged economic transformation from an export- and investment-based model to one based on services and consumption. - The financial system has facilitated high growth and a sharp decline in poverty; it now reaches most of the population and permeates virtually all aspects of economic activity. - The financial sector’s role must shift from channeling high savings at low cost to strategic sectors toward facilitating a demand-driven system in which markets increasingly allocate resources and the consequences of risk-taking are well-understood and accepted. ### Financial system structure and interconnectedness - Bank assets have increased to 300 percent of GDP. - Equity and bond markets are the second and third largest in the world, respectively. - The insurance industry is growing fast. - Medium- and smaller-sized banks have grown rapidly; wealth management products (WMPs), short-term wholesale funding, and nonstandard credit assets (NSCAs) have become significant. - Some corporate borrowings appear to be migrating to nonbank financial institutions (NBFIs), some opaque and highly interconnected—including to banks—through common ownership or financing and distribution channels. - Much proliferation in entities and products appears driven by regulatory arbitrage. ### Credit growth, debt overhang, and asset quality - The credit-to-GDP ratio is now about 25 percent above the long-term trend. - Corporate debt has reached 165 percent of GDP. - Household debt has risen by 15 percentage points of GDP over the past five years. - Household debt, while still low, is increasingly linked to asset-price speculation. - The buildup of credit in traditional sectors has coincided with a slowdown of productivity growth and pressures on asset quality. - Low reported nonperforming loan (NPL) ratios may understate credit quality problems because banks have exposures to opaque NSCAs and retain risk on off-balance-sheet products. - Banks often aggressively write-off and dispose of problem assets to state-owned asset management companies (AMCs), while operational restructuring of distressed but potentially viable corporates is rare and timely exit of unviable corporates is even rarer. ### Policy tensions and implications for stability - Monetary and fiscal policies have been expansionary in recent years to support employment and growth. - Pressures to keep non-viable firms open—particularly at the local government level—conflict with financial stability objectives and contribute to credit expansion. - Widespread perceptions of implicit guarantees: banks often compensate retail investors for losses, and lenders assume loss-making SOEs or financial intermediaries will be bailed out. - Planned further progress in exchange rate and capital account liberalization will be difficult in the near term as liberalization could exacerbate run-risk on financial intermediaries. - Three underlying causes of risks remain insufficiently addressed: - The overriding objective at local government level to achieve high growth rates that encourages credit expansion. - Complexity and opacity of the financial system, reflecting rapid growth and regulatory arbitrage, which undermine authorities’ ability to measure asset quality and assess risk. - Existence of implicit guarantees encouraging moral hazard and excessive risk taking. ### Authorities’ response - Authorities, including at the highest level, have made financial stability a top priority; in April 2017 President Xi noted financial security is an important part of national security. - Many recommendations from the 2011 FSAP have been addressed, particularly on improving microprudential supervision. - Authorities responded positively to FSAP findings and recommendations during FSAP meetings. ### Key recommendations and priorities (selected highlights) - Macroeconomic - De-emphasize high GDP growth projections in national plans that motivate setting high-growth targets at the local level. Priority: H, NT. - Systemic risk and macroprudential policy - Create a new Financial Stability Sub-Committee (FSS-C) with the sole function of preserving financial stability. Priority: H, NT. - Establish robust mechanisms for cooperation, coordination, and exchange of information—including granular financial data—with domestic and foreign safety-net participants. Priority: H, NT. - Trigger the countercyclical capital buffer, and review banks’ capital requirements with a view to a targeted—and in some cases substantial—increase in capital. Priority: H, NT. - Amend primary laws to strengthen operational and budgetary autonomy of the People’s Bank of China (PBC) and the regulatory agencies, and increase their resources. Priority: H, MT. - Address data gaps that impede systemic risk monitoring and effective financial regulation and supervision. Priority: H, MT. - Regulation and supervision: banks - Enhance group risk supervision and the ability to supervise banking and wider financial groups, as well as ownership structures, including the identification of ultimate beneficial owners. Priority: H, MT. - Eliminate the use of collateral in loan classification, constrain banks’ ability to roll-over credit to non-small and medium enterprise corporate borrowers, and classify all loans overdue by more than 90 days as nonperforming. Priority: H, MT. - Strengthen enforcement of the “look-through” principle. Priority: M. - Increase liquidity coverage ratio (LCR) coverage for interbank products and for off-balance-sheet WMPs. Priority: M. - Enhance regulatory reporting requirements to collect more granular supervisory data on banks’ investment holdings and provisioning. Priority: M. - Stress testing and systemic assessment - Substantially enhance and systematize data and information sharing across the three regulatory agencies and the PBC for stress testing and systemic risk assessment purposes; use more granular supervisory data in stress tests. Priority: H, MT. - Expand coverage of nonbanks and interconnections significantly for systemic risk assessment, developing and integrating stress testing of collective investment schemes (CIS). Priority: M. - Shadow banking, implicit guarantees, and securities markets - Make legal and regulatory changes to ensure the bankruptcy remoteness of CIS, including WMPs, in the event of insolvency of the manager or the custodian. Priority: H, MT. - Move towards eliminating limits on lending to specific sectors, conditional on eliminating implicit guarantees. Priority: M. - Improve disclosure of CIS; prohibit specifying expected returns in the prospectus of WMPs. Priority: H, NT. - Introduce a functional overlay to supervision to ensure similar products issued by differing financial firms are supervised and regulated similarly. Priority: H, MT. - FMIs and liquidity - Adopt full delivery-versus-payment in the China Securities Depository and Clearing Corporation (CSDC). Priority: H, NT. - Strengthen resilience of FMIs through full implementation of the CPSS-IOSCO Principles and strengthening of the legal framework. Priority: H, MT. - Tighten eligibility and enhance haircut methodology for repo collateral. Priority: M. - Crisis management and resolution - Triggers for activating a government-led crisis response should be more clearly defined and limited to systemic cases that may require public resources. Priority: H, NT. - Develop a special resolution regime for banks and systemically important insurance companies. Priority: H, MT. - Develop a formal framework for emergency liquidity assistance by the PBC. Priority: H, MT. - AML/CFT and financial inclusion - Mandate enhanced customer due diligence (CDD) for domestic politically-exposed persons on a risk-sensitive basis. Priority: M. - Ensure that self-laundering is more effectively investigated and prosecuted as a stand-alone offense. Priority: M. - Enhance the legal, regulatory, and supervisory frameworks for fintech. Priority: M. ### Regulatory and supervisory assessment - Overall high degree of compliance with international standards across banking, insurance, and securities sectors, but three critical gaps common to agencies: - Lack of independence. - Insufficient resources for supervising a large and increasingly complex financial sector. - Inadequate interagency coordination and systemic risk analysis. - These gaps have been fundamental contributors to the build-up of financial risks. - Regulators do take swift and coordinated action when distress arises in specific markets or institutions. - Recommendation: Regulators should reinforce the primacy of financial stability over development objectives; establish an FSS-C reporting to the Financial Stability and Development Committee (FSDC), comprising the PBC and the three regulatory agencies, with technical capacity to regularly monitor systemic risk and recommend macroprudential actions; this body should be accountable via the FSDC to the State Council. ### Capital, asset quality, liquidity, and supervisory measures - Even though the banking system meets Basel requirements, a targeted increase in capital is warranted to: - Absorb potential losses during the economic transition as credit tightens and implicit guarantees are removed. - Better reflect potential underestimation of risks from complex and opaque transactions. - More capital is particularly justified for the largest banks because of systemic importance and interconnectedness; stress tests suggest vulnerabilities in a significant number of mid-tier banks. - Loan classification should be tightened; enforce the “look-through” principle; include SOEs under large exposure limits; government guarantees should be removed or made explicit. - Liquidity and maturity mismatch mitigation measures: - Review haircuts for repo collateral to account for pricing and liquidity uncertainties. - Increase liquidity coverage ratio for interbank products and off-balance-sheet WMPs marketed by banks. - Strengthen supervision and legal basis of financial market infrastructures to ensure full delivery-versus-payment and settlement finality. ### Other areas for further progress - Strengthen the crisis management framework, notably by establishing a special resolution regime. - Enhance availability and quality of financial sector data; establish a comprehensive legal framework for data protection. - Develop an oversight framework for digital finance that balances innovation with safety and soundness. - Reexamine the broad and expanding mandates of policy banks. - Deepen capital markets by developing a solid institutional investor base to build resilience. - Address remaining deficiencies in the AML/CFT framework, including enhancing transparency of legal persons, applying enhanced CDD on a risk-sensitive basis, ensuring self-laundering is effectively investigated and prosecuted as a stand-alone offence, and extending preventive measures to cover nonfinancial businesses and professions. _People’s Republic of China: EXECUTIVE SUMMARY (FSAP) — cr17358_ ### 3. Saving rates remain elevated and in constant search for high-yielding returns. Capital ### 3. Saving rates remain elevated and in constant search for high-yielding returns. Capital ### Elevated saving rates, capital controls, and market effects - Capital controls restrict opportunities to invest abroad. - The large pool of investible funds—along with implicit guarantees—pushes down term yields and leads to risk-seeking behavior. - Savers’ preference for investments over lower-yielding deposits has increased, contributing to credit growth outstripping bank deposit growth. - Banks and other financial intermediaries have responded to tightened controls with the creation of a range of complex and opaque instruments that place riskier activities in off-balance sheet vehicles or in NBFIs. ### Financial innovation, credit growth, and leverage build-up - Financial market liberalization, rapid credit growth, and the high savings rate have proved fertile ground for financial innovation, but also for risks and a buildup of leverage. - There is a large and growing debt overhang from borrowing by weak corporates and local government entities, and overleveraged NBFIs. - Wholesale and short-term market funding has grown in importance. - Credit growth has vastly exceeded GDP growth, as interest rate and prudential controls have been circumvented by continuous financial innovation. - These on- and off-balance sheet channels of intermediation entail strong connections within the banking system, and between banks and NBFIs such as trust, insurance, securities, and AMCs. ### Major regulatory and supervisory achievements since the last FSAP in 2011 (Box 1) - The monetary and macroprudential policy frameworks have been upgraded: - PBC deregulation of the floor for the lending rates and the cap for deposit interest rates in July 2013 and October 2015, respectively. - Interagency cooperation enhanced in addressing macroprudential risks and strengthening systemic risk monitoring. - A deposit insurance system was established with the implementation of the Deposit Insurance Regulations on May 1, 2015. - The Basel III regulatory framework has been implemented: - Since 2010, the China Banking Regulatory Commission (CBRC) has issued rules and regulations implementing Basel III standards on capital, leverage ratio, and liquidity. - In 2017, the CBRC conducted examinations targeting inter-bank finance, wealth management and off-balance-sheet activities. - Investor protection has been enhanced: - Strengthened CSRC suitability requirements, investor rights, and investor education program. - CSRC actions after 2015 volatility to curb excess leverage, some jointly with other public authorities. - A sound framework for growth of the insurance industry is being put in place: - C-ROSS rules issued in February 2015; C-ROSS entered into force on January 1, 2016. ### Growth, size, and composition of the financial system - Financial assets grew from 263 percent of GDP to more than 467 percent in 2016. - At end-2016, bank assets amounted to nearly 310 percent of GDP. - Within the banking sector, growth has been driven by joint stock, city, and rural commercial banks; the assets of the four large state-owned banks have remained stable as a share of GDP. - NBFIs, from insurance companies to trust companies, continue to grow rapidly. - Loans account for under half of bank assets (40 percent when the Big Four banks are excluded). - For many medium-sized banks, the investment portfolio now accounts for half of total assets. - Wealth Management Products (WMPs) were pioneered by banks to satisfy savers’ search for yield; asset management products issued by securities firms are regulated and supervised differently from otherwise similar products issued by banks. - Liabilities increasingly have a wholesale structure; growth of small- and medium-sized banks and NBFIs has been financed to an important extent by short-term interbank credit and structures such as WMPs. - By 2016: Q2 return on assets was 1.1 percent for banks. ### Comparative features of China’s financial landscape - China remains bank-dominated. Credit to GDP exceeds the benchmarks by wide margins. - The bond market is the world’s third largest but remains a relatively small source of finance for the private corporate sector. - The equity market is large and volatile; retail investors account for the majority of trades. - Insurance companies have only recently grown in size and activity. - Mutual funds have grown rapidly, boosted by tightening of regulation in WMPs, but remain underdeveloped. - Pension funds remain the least-developed traditional NBFI despite tax incentives and China’s very high savings rate. - Non-traditional savings and investment products, including trusts and WMPs, cannot be benchmarked given their unique Chinese characteristics. ### State ownership, control, and implications for pricing and competition - The financial system is characterized by a high degree of government ownership and control. - The Big Four are majority state-owned; local governments have important ownership stakes in lower tier banks and often exercise control. - Local government-affiliated entities own nonbank subsidiaries and other intermediaries such as AMCs, though these holdings are rarely transparent. - The state controls a large share of insurance companies, trusts, and securities companies, as well as the financial sector's largest borrowers. - Potential conflicts of interest between the state as controlling or major shareholder and as regulator limit market-based risk pricing and efficient credit allocation. ### Risk assessment and pressures - Key questions organizing concerns: - A. What are the implications for systemic risk of maintaining current levels of GDP and credit growth? - B. What are the threats to financial stability from a dynamic and increasingly complex financial sector? - C. Can sequenced reforms help mitigate social stability risks if implicit guarantees are removed? - Credit intensity has increased; over the past 10 years, the credit to GDP ratio has risen above its long-run trend, and this “credit gap” now reaches about 25 percent of GDP (BIS). - By end-2015, corporate debt amounted to 165 percent of GDP. - In 2016, private corporations issued less than RMB 700 billion of bonds, while bank lending to private corporations rose by RMB 5 trillion. - Household home ownership in China has been high, at over 90 percent. - Much of the new household debt since 2015 has been in housing loans; average LTV on new mortgages was estimated at about 40 percent in 2016. - Financial innovation has been used to circumvent LTV rules (e.g., consumer credit and peer-to-peer services to finance mortgage down-payments). - Data gaps (e.g., consistent debt-service-to-income and debt-to-income information) preclude an accurate analysis of systemic risk, but debt-at-risk estimates indicate vulnerabilities in the real estate sector. - The credit to GDP gap level is very high by international comparison and already above levels consistent with a high probability of financial distress. - The average regulatory capital ratio in 2016: Q2 was 13.1 percent (11.1 percent Tier 1 capital). - Liquidity: liquid assets have accounted for about 20 percent of total assets since 2013; liquid liabilities slightly less than half of total liabilities. - Within average metrics, large publicly owned banks have conservative business models offset by weaker positions concentrated in many middle- and small-sized banks. - The banking system has minimal foreign currency lending or deposits; gross open positions are only about 3 percent of capital. *People’s Republic of China — International Monetary Fund* ### 21. Credit quality has been deteriorating and other risks are rising, but data gaps preclude a ### cr17358 - 21. Credit quality has been deteriorating and other risks are rising, but data gaps preclude a ### Credit quality and provisioning - Reported NPL ratio increased from about 1 percent in 2013 to 1.7 percent in 2017: Q2 as banks have aggressively disposed nonperforming loans (NPLs) through write-offs and large volumes of asset sales, and—to a limited extent—recovery. - Special mention loans—“the category above NPLs”—peaked at 4.1 percent of loans in 2016: Q3 and now stand at 3.8 percent. - Banks’ provisions against NPLs declined from 290 percent in early 2013 to about 180 percent. - Despite the introduction of the “look-through” principle, risk weights on some banks' investment products appear to be too low, and the credit risk of some loans is underestimated. - Lack of sufficiently granular data prevented a quantitative assessment of some credit risks by the FSAP mission. ### Off-balance sheet WMPs, exposures, and possible impact - Off-balance sheet wealth management products (WMPs) represent a significant risk to capital; they are not guaranteed, but banks almost always compensate retail investors for principal losses. - In a stress scenario, the costs to banks of supporting WMPs could be substantial and could, in case of a run, place the liquidity position of some banks under strain. - The stress tests cover 33 banks with RMB 171 trillion in total assets and RMB 20 trillion in off-balance sheet WMPs. ### Stress-test scenarios and key macro assumptions - Severely adverse scenario (described in Annex II) combines domestic and external shocks: - Real GDP declines by two standard deviations relative to the baseline over a two-year horizon (a cumulative 7.3 percentage points over 2017–18). - As a consequence of macroeconomic conditions and partial migration of special-mention loans (SMLs), the NPL ratio rises sharply to 9.1 percent in 2018. - Assumed relaxation of the required provisioning coverage ratio (from 150 percent to 50 percent in the severe scenario) offsets a significant part of the credit losses. ### Stress-test results — solvency and capital - Aggregate system-wide impact: - Aggregate CET1 capital ratio in the system declines to 7.2 percent from 10.3 percent under the severely adverse scenario. - For the 33 tested banks, under the severely adverse scenario the NPL ratio rises sharply from 1.5 percent to 9.1 percent and the CET1 ratio for these banks would fall by 4.2 percentage points. - Capital shortfall for the 33 tested banks amounts to 2.5 percent of GDP. - Coverage of undercapitalization: - Overall, 27 out of 33 banks included in the tests are undercapitalized relative to at least one of the minimum requirements (which include the capital conservation buffer). - The number of banks that fall below the 7 percent CET1 capital threshold (also including the capital conservation buffer) is 23. - Solvency table (in percent) - Baseline (2016) Common Equity Tier 1 Capital Ratio: Aggregate 10.3; Big 4 11.8; Large 9.3; Medium 8.2; City 9.0; Rural 10.0 - Severely Adverse Scenario (2017) Common Equity Tier 1 Capital Ratio: Aggregate 7.2; Big 4 9.9; Large 5.7; Medium 3.0; City 3.3; Rural 7.0 - Baseline and Severely Adverse entries for Tier 1, Total Capital, and Leverage Ratio are provided in the source for each bank group. ### Bank-sponsored WMPs and additional capital impact - Bank-sponsored off-balance sheet WMPs are particularly large at medium-sized joint-stock banks (JSBs) and city commercial banks (CCBs): 25 percent and 17 percent of total assets, respectively. - Stress-test assumption: purchasing 25 percent of sponsored off-balance sheet WMPs at face value, with recovery values of 40 percent. - Result: significant system-wide additional fall in CET1 capital, equivalent to 4.5 percent of GDP (under the assessed scenario and assumptions). ### Liquidity stress tests and funding pressures - Many small- and medium-sized banks increasingly rely on short-term funding, including overnight interbank and repo. - Ratio of interbank funding to total funding: 11 percent in 2010, 17 percent in 2016, and 22 percent for JSB and CCBs. - Average repo tenor is 2.7 days, down from 4.2 days at end-2010. - Liquidity stress-test methodology: cash-flow based maturity ladder analysis (top-down) using supervisory data, capturing outflows, inflows, and available buffers; key assumption that banks could use securities as collateral to obtain liquidity through standard PBC facilities; only when banks had no eligible collateral to access PBC facilities would they fail the test. - Liquidity test results — number of banks (out of 33) that fail the test: - Overnight: 0 - 2d-7d: 0 - 8d-30d: 4 - 31d-90d: 7 - 91d-1y: 7 - Findings: - Four banks would experience liquidity shortfalls within a 30-day period and three banks would have insufficient liquidity within a 90-day horizon, but liquidity positions at the Big Four banks are strong. - Even in substantial runoff of off-balance sheet WMPs and interbank products, most banks’ liquidity positions would remain strong given the wide range of collateral accepted by the PBC. - Bond market liquidity and rollover risks: - Most corporate bonds issued on the exchanges and the interbank market are held by shadow banking vehicles, and are often repo’d (using CSDC as a CCP) to add leverage. - In the interbank market, commercial paper, medium-term notes and enterprise bonds held by banks are mostly under hold-to-maturity accounts. - Lack of ratings differentiation—very few bonds rated below AA—reduces incentives to trade; rollover risks in the bond market are rising. ### Contagion, networks, and systemic linkages - Contagion (balance-sheet-based network) analysis: - The Big Four banks are the most systemically important in terms of triggering defaults of other banks. - Smaller banks risk higher losses in capital through interbank contagion. - Contagion analysis based on stock-market data: - Chinese banks are highly interconnected. - Joint-stock banks (JSBs) and city commercial banks (CCBs) are important net contributors to financial stress measured by volatility of equity returns’ co-movement. - NBFIs are increasingly relevant as sources and conduits of financial shocks; net spillovers from them to the banks are on the rise. - Financial market infrastructures (FMIs): - Membership of FMIs is highly clustered; about 80 percent of members of the futures exchanges belong to all the exchanges, while member overlap in CCDC and Shanghai Clearing House is more than 50 percent. - The largest eight banks are connected to all eight FMIs, constituting a wide-ranging source of vulnerability. ### Potential fiscal and second-round amplification - Direct recapitalization need identified in the stress tests is 2.5 percent of GDP for the 33 tested banks. - Deleveraging and second-round effects could amplify fiscal and re-capitalization costs: - Reduction in capital buffers and provisioning coverage ratios under the adverse scenario could lead banks to be unable or unwilling to sustain the current pace of credit growth. - Consequent deleveraging could lead to a slowdown in output growth stronger than assumed in the scenario—with the fiscal impact possibly exceeding the direct recapitalization needs for the banking system by a wide margin. - From 2011 to 2016, commercial banks used RMB 1.4 trillion to absorb NPLs—about half the current level of provisions. ### Complexity of the financial system, nonbank growth, and regulatory issues - Drivers of nonbank sector growth: - Demand for credit to support high GDP growth, especially at the regional level. - Rapid growth in demand for high-yield investment products. - Stronger oversight of the banking sector relative to the nonbank sector leading to regulatory arbitrage. - Nonbank sector features and links to banks: - Trusts, insurance companies, securities firms, and fund management companies have an increasing share in the system, while banks remain linked to almost all this activity. - Banks and NBFIs repackage loans to weak corporate sectors into complex, often structured, financial products sold to investment vehicles. - Pricing of risk is distorted by incentives to transfer credit risk from loan books and by the lack of clarity on whether banks stand behind off-balance sheet vehicles they sponsor or create. - Local government financing and indirect borrowing: - Borrowing by local governments has grown by some 25 percent a year since 2007—2.5 times as fast as central government borrowing. - Local government financing vehicles (LGFVs) help circumvent rules against direct borrowing; a 2015 budget law aims at preventing LGFVs from borrowing from banks, but the flow of new LGFV borrowing has not yet been replaced by municipal bonds. - Fintech and regulatory perimeter: - In 2016, the stock of peer-to-peer lending doubled (though only to about 0.5 percent of the banking sector assets). - Yu’E Bao, a money market fund established in 2013 by Alipay, had assets of RMB 1.4 trillion (June 2017) and accounts for a quarter of the total size of the money market in China. - Authorities have begun drawing fintech within the regulatory perimeter: requiring lending products sold by internet firms to be supervised by the China Bank Regulatory Commission (CBRC) and securities products by the CSRC; the State Council launched an overhaul of internet finance oversight in 2016. - China has recently banned the trading of cryptocurrencies. *International Monetary Fund — PEOPLE’S REPUBLIC OF CHINA (Excerpt from FSAP chapter).* ### Box 3. Financial Engineering of Credit Risk in China ### Box 3. Financial Engineering of Credit Risk in China ### Financial engineering strategies used to move credit risk - Banks have developed strategies for moving assets out of their loan books, while retaining some risks, to create capital headroom for new lending. These strategies include: - Trust loans: A bank channels funds from investors via a Wealth Management Product (WMP) into a trust product. The trust can then lend (sometimes with implicit credit enhancement by the bank or a local government) to a troubled company, allowing it to pay off a bank loan. - Securitization: Banks can securitize packages of loans and keep the senior tranche as an investment product. These carry high ratings and thus have minimal capital requirements (and no provisioning), and sell the mezzanine and equity tranches to off-balance sheet WMPs. - Asset management plans (AMPs): Similar to WMPs but issued by a wide range of NBFIs, AMPs can buy nonstandard credit assets (NSCAs) sold by banks with funds raised from investors, often brought in by banks. A regulatory clampdown in 2016 reduced the amount of leverage they could take on. - Entrusted lending: Intercompany loans are largely within conglomerates, but sometimes between unrelated firms. Companies, particularly SOEs, borrow from banks and on-lend to a troubled company, brokered by the bank, often with the provision of informal credit enhancement. - Securitization with Chinese characteristics: Investment receivables on banks’ balance sheets are investment products often composed of other financial products. These can include trust beneficiary rights—the income flows from trust products; targeted AMPs; or securitized products. CBRC supervisory rules apply a “look-through” principle for capital and liquidity held against these products, but this is difficult to enforce. - Debt-equity swaps: Direct bank holdings of equity are not permitted, except as allowed by the State. One such exception has recently been granted for debt/equity swaps (some of which have buyback options). ### Contagion and interconnectedness - Increasingly complex linkages across financial intermediaries: - Banks have large contingent exposures to products they sponsor, as well as indirect exposure to bonds and equities (and real estate) as collateral. - Insurance companies have also diversified, holding complex financial products on balance sheets. They also sell products that contain a substantial investment component. - Complex structures have emerged, with corporate groups—not necessarily under financial holding companies (FHCs)—owning banks, as well as insurance, securities, trust, and fund management companies. - Financial Market Infrastructures (FMIs) and membership concentrations: - China’s large number of FMIs are highly interconnected. Eight Chinese banks, among the largest in the country, have a membership in all eight of China’s FMIs. This high interconnectivity suggests that losses following a financial or operational failure at an FMI or member could quickly spread through the financial system if proper safeguards are not in place. - Stress-test and spillover findings: - Stress tests suggest direct spillover effects through the interbank market are relatively limited, but connections to G-SIBs are substantial. - Analysis indicates that mid-tier and small Chinese banks are a key recipient of shocks from G-SIBs (the Big Four banks and G-SIBs in other countries). - Global spillovers and channels: - A financial sector shock would reduce domestic demand, giving a contractionary impulse to the global economy via lower commodity prices, reduced import demand, and lower outward investment. - Cross-border capital flows are substantial, despite capital controls, and have been rising. - Recipients of spillovers: Commodity exporters mostly receive credit or FDI from China, while advanced economies tend to see portfolio and long-term asset flows. Spillovers are largest to countries, such as ASEAN, with strong trade links to China. - Asset prices: A financial shock in China that led to lower GDP growth would impact global asset and commodity prices, largely via shifts in risk aversion and commodity prices. - Chinese G-SIFIs: The Big Four banks are active internationally, and Chinese banks have become important creditors in many countries in sub-Saharan Africa and the Caribbean. Crisis Management Groups and recovery and resolution plans are in place for all five of China’s G-SIFIs; resolvability assessments and cross-border cooperation agreements are in progress. ### Investment behavior, perceived guarantees, and market volatility - Implicit guarantees and market structure: - Much of the financial system, from local government and SOE debt to bank-issued investment vehicles, is seen by investors as being ultimately guaranteed by the central government. Implicit guarantees, combined with a high saving rate, the predominance of retail investors, restrictions on capital outflows, and a paucity of long-term investment products have led to periodic volatility in asset markets. - Leverage in financial markets raises the probability of a serious dislocation. - Retail investor dominance and market effects: - Investment in standard assets managed by institutional investors is estimated to be roughly RMB 20–25 trillion (about one-third of GDP) for 2016. - Retail investors hold 30 percent of A-share stocks, but account for three-quarters of turnover. - The dominance of retail investors—especially in an equity market where free float is relatively small—affects market behavior and raises volatility. - Ways perceptions of implicit guarantees operate: - Investment products: Financial institutions (FIs) have frequently honored liabilities of non-guaranteed products that they have marketed (most notably, bank-sponsored WMPs). - Domestic rating agencies: Ratings of large SOE bonds are very close to sovereign levels. Local governments use vehicles such as LGFVs and Government Guided Funds to channel funds to projects; these products are almost all rated AAA by domestic rating agencies, implying a full government backstop. - Asset markets and policy response: Authorities’ actions to stabilize markets (e.g., measures taken in mid-2015 and early 2016) have at times implied a preference for setting floors under asset markets. In late 2016, counterparty risk concerns led to a freezing of part of the money market, and policy banks lent to NBFIs to address the immediate liquidity shortage. - Liquidity support: In times of market dislocation, the PBC as well as some policy banks have supported markets to preclude large downward price movements. - Protection funds: Criteria for using existing safety nets—different kinds of protection funds—are not fully clear, giving rise to moral hazard. - Real estate as collateral and localized dynamics: - Real estate, both commercial and residential, is the most common form of collateral in China, accounting for two-thirds of the collateral underlying banks’ loan books. - Local governments control the supply of land for development and depend largely on the proceeds for revenue; they manage supply to ensure revenue flows, contributing to homeowners’ expectations of limited price falls. - Housing market heterogeneity: In Tier 1 cities, both house prices and price inflation are high; in smaller cities, particularly in less-developed areas, prices are significantly lower and more stable. ### The macroeconomic policy challenge - Reducing excessive credit expansion and the debt overhang requires de-emphasizing high GDP projections in national plans that motivate setting high growth targets at the regional and local levels. - Political economy and incentives: - Credit growth is seen by local governments as essential to maintaining employment and social stability, and by central authorities as a tool for responding to negative shocks. - Supervisory crackdowns create incentives for financial innovation to finance firms despite lack of viability. - Role of interest rates and structural reform: - Higher interest rates—justified if core inflation continues to tick up—could help reduce excess credit demand and financial risks. - Authorities are aiming to move the focus from headline GDP growth to the quality of economic development, advancing supply-side structural reforms, encouraging corporate mergers and restructuring, promoting the exit of zombie firms, and addressing high leverage. - Requirements to slow medium-term credit growth: - Reforming non-viable SOEs and allowing failure. - Strengthening the social safety net to reduce social costs of higher unemployment. - Measures needed: identification of companies in long-term difficulties; insolvency reform; initiatives to organize corporate debt restructuring for viable but overindebted firms; facilitating market entry of private firms. - Central policy changes must be accompanied by aligning incentives of local governments, notably by improving social safety nets. ### Macrofinancial regulatory challenge and supervisory gaps - Authorities’ actions and improvements: - Authorities are aware of financial stability risks and have tightened rules on complex financial products. - CBRC and PBC have tightened rules on complex financial products; CBRC has stepped up scrutiny of NPLs; CSRC has overhauled systemic risk monitoring; CIRC has reined in reliance on short-term products among small- and medium-sized insurers. - Coordinated efforts: PBC and CBRC have worked together to reduce WMP risks and proposed regulations on asset management business across jurisdictions. - Progress since the 2011 FSAP: The vast majority of the recommendations of the 2011 FSAP have either been largely or fully addressed. - Remaining regulatory architecture weaknesses: - Supervision is conducted almost exclusively on an institutional rather than a functional basis, leaving substantial gaps where supervisors have different emphases. - Investment products sponsored by banks (many, but not all, WMPs fall under the CIS rubric) and insurance companies are not directly supervised by the CSRC. - Regulatory measures can spur new instruments and regulatory arbitrage (example: the 2013 CBRC limit on NSCAs in WMPs spurred trust beneficiary receipts and AMPs by NBFIs). - Incentives that perpetuate credit migration into the shadows: - Internal NPL targets set by bank managers encourage moving credit risk away from the loan book before payments are missed. - Employment practices hold loan officers accountable for NPLs even when loans were granted under bank rules. - Guidelines for on balance-sheet credit to certain sectors, such as overcapacity industries, and local government pressure encourage lending by NBFIs. - Importance of sequencing: - The complexity of challenges underscores the need for careful consideration of impacts and spillovers of individual reform measures on wider financial stability. Sequencing of reforms is essential to mitigate unintended, adverse consequences. ### Overarching policy recommendations (systemic risk oversight and macroprudential policy) - Improvements and tools: - Since the last FSAP, China's framework for monitoring and responding to systemic risk has been tested and improved. - Macroprudential tools were key to the successful containment of risks related to rising housing prices in 2012–13. - The Joint Ministerial Committee (JMC) was created in 2013 to facilitate policy coordination among the PBC and three regulatory commissions. - The authorities are creating a uniform data platform to facilitate inter-agency information sharing. Various agencies have created new macroprudential tools and improved stability monitoring. - Remaining challenges highlighted: - Regulatory gaps: Understanding of systemic risks may be weak when no regulator has a clear mandate to supervise new or cross-sectoral products. - Weak coordination mechanism: The JMC focuses on coordination of specific regulatory policies rather than collaborating on systemic risk analysis. Decisions on technical or nonsystemic issues are sometimes elevated too rapidly to the State Council rather than decided by the JMC. - Conflicting objectives: Regulators in principle give priority to their financial stability mandate over growth goals, but gaps and weaknesses in coordination may mean insufficient account is taken of the impact of growth on financial stability in areas that fall under another regulatory agency or outside the regulatory perimeter. *Source: Box 3. Financial Engineering of Credit Risk in China (excerpt).* ### 55. A more effective macroprudential policy-making structure is needed. A recently ### 55. A more effective macroprudential policy-making structure is needed. ### Institutional reform: FSDC, FSS-C, and governance - A recently announced high-level interagency committee under the State Council—the Financial Stability and Development Committee (FSDC)—could be a positive step; details are yet to be disclosed, except that the PBC will perform a secretariat role. - The FSDC includes both a financial stability and a development mandate; the highest level of authorities should be able to consider these two objectives together. - Recommendation: create a separate body with the sole mandate of ensuring financial stability (proposed name: FSS-C). - FSS-C members should have joint accountability to the FSDC and, thus, to the State Council. - A separate sub-committee on development could also be created to support sound economic and financial market development. - The FSS-C should be a permanent body, meet regularly and frequently (often quarterly elsewhere, but China’s fast-evolving system suggests more frequent meetings may be needed), and regularly discuss joint assessment of macroprudential risks. - The FSS-C would be supported by interagency working groups at technical staff level, permanent or ad hoc depending on topic, and would require adequate (additional) resourcing of the PBC and the regulatory agencies. ### Role and remit of the FSS-C - The FSS-C should be an advisory rather than an executive body; macroprudential tools should remain in the hands of relevant supervisory agencies and the PBC. - The FSS-C should coordinate and recommend the use of macroprudential tools; supervisory agencies should take its recommendations into account in formulating and activating policies. - The full range of tools—covering systemic credit, liquidity, and foreign exchange risks—should be available for the FSS-C to recommend. ### Systemic risk analysis, stress testing, and data sharing - Regular systemic risk analysis should be undertaken collaboratively across PBC and regulatory agencies; presently systemic risk analysis is performed on a sectoral basis with no institution conducting comprehensive cross-sectoral or macrofinancial risk monitoring. - The PBC secretariat, including staff seconded from other regulatory institutions, would prepare meeting agendas and briefing materials, and ensure regular functioning of the FSS-C and working groups. - Stress testing framework shortcomings and recommended enhancements: - Current stress testing falls short of being a useful input into macroprudential policy decisions. - More detailed information is needed, including on: bank-specific loan portfolios; securities portfolios; various categories of investment products and their underlying assets; different types of interbank exposures (within banking system and vis-à-vis nonbanks); asset and maturity structures of bank-sponsored off-balance sheet WMPs. - Data and information sharing across the three regulatory agencies and the PBC needs to be substantially enhanced and systematized for stress testing and systemic risk assessment. - Stress test coverage should be expanded to include NBFIs—such as insurance companies and AMCs—and integrated into the broader risk assessment framework. - Analytical capacity within stress testing teams should be enhanced significantly to adopt new techniques and capture evolving systemic risks; interagency coordination is important. ### Sequencing reforms: implicit guarantees and mitigation measures (Box 4) - Dismantling implicit guarantees is necessary but poses risks (retail investor withdrawals, short-term repo runs, undermining solvency). - Implementing the following reforms before lifting implicit guarantees could mitigate risks: - Strengthen oversight through more rigorous loan classification criteria; stronger and uniform disclosure requirements for non-guaranteed investment products; require FIs that compensate investors for non-guaranteed products to hold the same capital and liquidity buffers as for on-balance sheet products. - Raise capital requirements (see Box 6). - Lengthen maturities and reduce reliance on short-term wholesale funding to reduce creditor run risk. - Establish more efficient insolvency and debtor workout regimes; central and local government should clarify the extent to which they will stand behind SOEs. - Reduce property market interventions to address overinvestment and underpricing of real estate risk; reduce local government dependence on land-sale revenue so interventions can be limited to macroprudential measures. - Build liquidity buffers at FIs; in the longer run, consumer education and strong consumer protection rules should bolster resilience. - Develop a more comprehensive social safety net (portable pension system, “hukou” reform) to allow unprofitable companies to shut down and facilitate structural transformation. ### Macroprudential policy in the real estate market (Box 5) - The counter-cyclical capital buffer (CCyB) is an important instrument; the FSS-C could review it regularly and propose activation. - The PBC's macroprudential assessment (MPA) has been useful but its purpose and structure should be reviewed: - MPA currently monitors seven categories of financial stability indicators (recently broadened to cover off-balance sheet credit expansion) on a bank-by-bank basis. - MPA assessments involve PBC discretion; currently MPA is used to determine access to PBC facilities and remuneration of reserves—MPA results should not determine access to PBC facilities. - The MPA purpose should be reviewed and clarified, structure simplified, and methodology published. - Any macroprudential action recommended on MPA basis should be discussed by the proposed FSS-C for action by individual regulators. - Liquidity and product-level measures: - Tighter liquidity requirements are warranted on macroprudential grounds; LCR should be extended to smaller banks; rules on asset allocation and redemption should be tightened; valuation rules revised. - Data gaps and interagency information sharing: - Priorities: (i) better granular data on banks’ investments and interbank exposures; (ii) empower the FSS-C to require institutions (including nonfinancial institutions providing financial services) to report data related to financial stability; (iii) adopt common accounting standards across financial institutions. - Ongoing plans to develop a joint regulatory financial data platform should be prioritized. - Strengthen credit registry quality and scope by capturing individual indebtedness to nonbanks (such as P2P); centralize property market indicators across regions. - Property market policies should be standardized across municipalities; local-level committees (local governments and local PBC and CBRC offices) should be formalized and meet regularly using PBC risk analysis to ensure comparable treatment across cities. - Homebuyer leverage and rising share of high-LTV mortgages are concerns; refinements to calibration of housing measures—e.g., stressed interest rate assumptions in debt-service-to-income limits—would be useful. ### Bank capital: recommendation and calibration (paragraphs 64 and Box 6) - Recommendation: targeted increase in bank capital during the current economic transition. - Rationale: risks are high and uncertain despite Basel III minimum compliance; build additional buffers—activate CCyB and domestic systemically important bank (D-SIB) charge now. - Suggested sequencing and calibration (Box 6): - Gradual raising of requirements, with partial introduction of CCyB and D-SIB charges from 2018, presumption of full implementation of the D-SIB charge by end-2019. - CCyB: targeting a CCyB to be applied to all banks and set at 0.5–1.0 percent risk-weighted assets over the coming 12 months may be an appropriate initial step, with subsequent changes reflecting developments. - D-SIB charge: finalize D-SIB methodology and implement framework; the ‘bucket approach’ could see a 0.25 to 1 percent D-SIB charge phased in by end-2019, in addition to other regulatory measures. - Consider country-specific capital adjustments (“uncertainty and transition buffer”) or Basel tailoring to reflect domestic conditions. - Enhanced supervisory review (Pillar 2) will raise risk density and require higher capital even without changing regulatory ratios. - Compliance channels: raising capital in markets; development of other capital instruments; temporary reduction in excess capital and increased profit retention; Big Four and others will implement TLAC requirements in coming years. ### Oversight: independence, coordination, and resources (paragraphs 61–63) - Overall assessment: high degree of compliance with international standards but critical gaps remain. - Three critical gaps common across regulatory agencies: - Empower regulatory agencies over time to take independent decisions and increase budget autonomy to ensure supervisory decisions cannot be overruled, secure staff tenure, and prioritize safety and soundness mandates over growth/employment/market development considerations. Supportive legal reform with broad consultation is recommended. - Shift coordination from ex post discussion to ex ante collaboration on data sharing, risk assessment, curtailing regulatory arbitrage, and crisis preparedness; improve coordination within agencies via the proposed FSS-C; adopt functional oversight of similar products and services. - Substantially increase resources: staff count at headquarters of the PBC and regulatory agencies has not risen in 10 years while the financial sector has doubled in size; regulators cannot hire or reallocate staff without prior government approval. - Headquarter staffing noted as small and unchanged: PBC: 750; CBRC: 600; CSRC: 730. - Increased resources are needed for onsite supervision intensity, supervision of complex groups and innovative products, and retention of highly qualified staff. - Increase budget autonomy—within a given budget envelope—is essential. *Source: cr17358 - IMF staff report excerpt on macroprudential policy-making, institutional reform, stress testing, capital buffers, and regulatory resources.* ### 2.5 percent is the maximum CCyB level under the Chinese regulation and for mandatory reciprocation by other BCBS members ### 2.5 percent is the maximum CCyB level under the Chinese regulation and for mandatory reciprocation by other BCBS members ### Asset quality reviews and troubled exposures - Asset quality reviews could provide greater clarity about troubled exposures once regulatory gaps and the status of implicit guarantees are addressed. - Reviews should target banks most at risk given regional and sectoral exposures and include: - a comprehensive and independent assessment including the investment book; - verification whether transfers of assets have been conducted at arms’ length. - Targeted examinations and stress tests on credit risk, which the CBRC already conducts, can indicate which FIs are most exposed. - Planning for reviews should start early to clarify the authorities’ objectives. ### Nonbank finance — product controls and remaining incentives - Achievements: - Separate accounting for WMPs; limiting leverage in bond funds; ceilings on WMP holdings of NSCAs; and other measures have reduced riskiness of these products. - Remaining weaknesses and recommended measures: - Underlying incentives for banks and NBFIs to originate and sell risky assets remain unaddressed. - Suggested measures include: - Ease limits on lending to infrastructure, construction and real estate, and overcapacity sectors, but only after implicit guarantees are lifted, pressures to lend are reduced, and lending decisions are made on a market basis. - Shift enhanced regulatory scrutiny of banks towards credit and risk management policies and practices; banks report a perceived trigger point for intensified scrutiny if NPLs reach 2 percent. - Focus on compliance with lending policies instead of loan performance; holding loan officers personally accountable can encourage rolling over loans and shifting risky borrowing off-balance sheet. - Move local government incentives further away from headline growth and pressures to invest in infrastructure funded by shadow banking credit; facilitated by a more comprehensive social safety net. - Increase investors’ awareness of risks in high-return assets via financial literacy as part of eliminating implicit guarantees. - Other reforms related to consolidated supervision, credit risk, and supervision of securities are discussed under microprudential oversight. ### Legal clarity for investment products - Legal and regulatory changes are required to ensure the bankruptcy remoteness of CIS, including WMPs, if the manager or custodian becomes insolvent. - Ownership of assets in most investment products is ambiguous, including whether investors have a separate claim on the issuing financial firm. - Stand-alone legal identity and balance sheets for these products would facilitate risk pricing and clarity. ### Liquidity risks and repo market vulnerabilities - LCR reforms should be considered to reflect rising liquidity risks; current implementation is compliant with Basel but is a minimum standard. - Stress testing implies current buffers for off-balance sheet WMPs could be too small. - Run-off rates for WMPs under the LCR should be raised to levels commensurate with other retail products. - Run-off rates for interbank liabilities should be reconsidered, particularly the allocation between operational and non-operational deposits. - About one-third of collateral in the exchange-traded repo market is corporate bonds with largely inactive secondary markets and insufficient depth to cope with modest liquidation (see ¶28). - Risks in the repo market could amplify downward pressure on prices from rising defaults and deleveraging, provoking fire sales, a downward spiral in asset prices, and contagion across financial markets; stability of the CSDC could be jeopardized. - Provision of liquidity by policy banks to NBFIs during stress creates moral hazard and discourages NBFIs from holding sufficient liquid assets. - Recommended repo market reforms: - Apply additional haircuts, for example based on the number of days to liquidate a holding. - Require securities to meet a minimum monthly turnover requirement to be eligible for repo. - Gradually exclude retail investors from trading in the repo market. - Encourage the CSDC to develop internal ratings to enhance risk differentiation. - Address legal risk of conveying collateral by pledge, possibly moving toward true repo with title transfer. - Cover repo collateral under a fast track-type arrangement that places it outside the formal insolvency process. - Ensure participants can use set-off (netting) in insolvency. - Liquidity pressures leading to runs on banks or asset markets can be associated with capital outflows and exchange rate pressures. - Liquidity support in the stress test scenario would be somewhat smaller than current PBC lending to commercial banks and, in principle, could be offset by reducing other loans without expanding the PBC’s balance sheet; however, the long maturity of most existing loans would require interim liquidity-management measures. - Advance planning for such scenarios could be part of crisis preparedness planning. ### Microprudential oversight — banking supervision - The CBRC has maintained momentum and progress in almost all aspects of banking supervision; recent organizational reforms in 2015 will support its supervisory mandate. - Vulnerabilities remain that require more attention and intervention. - Gaps and priority areas: - Group supervision: ensure banks can identify and manage risky interactions across complex groups; rationalize corporate governance regulation into a single coherent legislative instrument. - Risk concentrations: strengthen regulations on large and related-party exposures; exemptions related to common local government ownership represent significant concentration and governance risks. - Loan classification and credit risks: current loan classification standards appear insufficiently robust given mounting borrower challenges in traditional and overcapacity industries. - Framework for D-SIBs needs higher priority despite implementation of international standards for the largest banks. - Smaller banks may receive inadequate oversight despite often riskier profiles; liquidity risk, interest rate risk in the banking book, and increased and better quality audit oversight warrant greater attention. ### Consolidated supervision and FHCs - Complex cross-sectoral groups present significant challenges; there is no standard approach to FHC structure or regulation. - Coordination through the JMC has improved but detailed information exchange and cooperation at the group level have been insufficient. - Disclosure of ultimate beneficial ownership is deficient, complicating compliance with capital adequacy, large exposure, and related-party transaction regulations. - Lack of powers of approval or pre-notification for changes of control or structure of groups including banks is a major shortcoming; CBRC currently has ex post information gathering and intervention powers but needs to be informed and able to act before changes take place that could result in unfit shareholders gaining control or compromising safety and soundness. ### Asset quality and credit risk — limitations of the NPL ratio and transparency measures - The NPL ratio may understate system-wide credit quality problems due to: - Loan book: certain small- and medium-sized banks have large amounts of loans that are 90-days past due (dpd) but are not classified as NPLs; rollover of overdue credit and generating repayments using bridge loans by other (sometimes connected) lenders are observed. - Investment book: some banks have moved credit assets into their investment book to circumvent credit quotas and restrictions or to reduce capital charges and loss provisions. - Off-balance sheet exposures: indications exist that some banks have transferred assets off-balance sheet but retained credit risk through financial engineering and implicit guarantees. - Measures needed to increase credit risk transparency: - Classify “90 days past due” loans as NPLs, consistent with the 2016 Basel Committee’s guidelines on NPLs. - Determine loan classification by cash flow rather than collateral; current guidelines allow overdue loans with sufficient collateral or guarantees to be categorized as “Special Mention” or even performing. - Reduce implicit guarantees for SOEs through clearer definitions of acceptable guarantees and lending practices, and by issuing formal guidance or risk alerts to detect and reduce rolling over of loans to weak SOEs. - Develop comprehensive CBRC guidance on credit risk management to prevent circumvention of piecemeal rules. - Improve risk pricing through greater focus on internal credit ratings and increased competition and market access for foreign credit ratings agencies. ### Supervision of securities markets - CSRC initiatives in the last three years have aimed at protecting retail investors, strengthening systemic risk monitoring, and taking a firmer stance on enforcement. - CBRC has strengthened the regulatory framework for WMPs by introducing stronger distribution and sales rules, requiring full segregation and separate accounting for each WMP, and imposing stricter rules on eligible investments. - The regulatory framework and supervisory program for securities markets is largely compliant with IOSCO Principles. - Key challenges and recommendations: - Harmonize regulation of similar products, prioritizing asset management services; implement existing agreements on harmonizing regulation of activities and products subject to multiple regulatory regimes. - Develop uniform regulatory rules for asset management products and draft regulation on credit rating services. - Improve disclosure requirements to ensure investors receive comparable information across products and prohibit publication of expected returns in WMP prospectuses. - Eliminate or more strongly regulate money-market funds’ use of amortized costs and stable net asset value practices. - Consider developing harmonized regulations for asset-backed securities. - Continue and deepen the recent strengthening in enforcement policy; eliminate gaps and inconsistencies in descriptions of misconduct and increase levels of fines and penalties for administrative and criminal offenses. - Ensure systemic risk monitoring provides a holistic view of securities markets and their interconnectedness with the rest of the financial sector; implement information sharing, identification, and monitoring of systemic risk via the proposed FSS-C. ### Insurance sector supervision - Insurance sector growth has been very rapid and is expected to continue, increasing supervisory challenges. - CIRC has undertaken far-reaching reforms and reached a high level of compliance with the Insurance Core Principles. - China Risk-Oriented Solvency Standards (C-ROSS) implemented in 2016 create risk-based solvency standards and a framework for in-depth assessment of insurers’ risk management. - CIRC is the lead supervisor for a G-SII and is preparing a regime for domestic SIIs; enforcement powers and an insurance guarantee scheme exist to support orderly exit. - Recommendations for CIRC: - Further develop C-ROSS, plan for a more market-oriented valuation basis, expand the role of supervisory judgment, and keep investment limits under review while improving insurance-sector risk management standards. - Review and communicate solvency control levels, including the point above the minimum requirement where CIRC will intervene and below which no insurer may continue in business. - Address liquidity risks where insurers sell high volumes of short-term savings products while investing in illiquid assets such as real estate and WMPs; consider actions to curb unusual liquidity risks or excessive declines in the duration of liabilities. - Enhance crisis management and preparedness frameworks for larger insurance groups, building on recovery and resolution planning for the one G-SII. - Review consumer protection risks, including mis-selling of complex products, and fill gaps in disclosure requirements and supervision of intermediaries. - Develop plans for fully risk-based supervision that consolidate issues and actions for each insurer. *International Monetary Fund — PEOPLE’S REPUBLIC OF CHINA (cr17358)* ### 89. China’s landscape for FMIs is one of the largest and most complex in the world. It ### 89. China’s landscape for FMIs is one of the largest and most complex in the world. ### FMI landscape and systemic importance - Consists of a range of payment, clearing and settlement systems, including several interbank payment systems, securities settlement systems, and CCPs. - Many systems have high volumes by international comparison and are systemically important at a national level. - Disruptions, both operational and financial, in one of these FMIs may significantly impact the economy. - The landscape is changing, with the establishment of: - a cross-border interbank payment system, - a CCP for over-the-counter derivatives, - development of innovative products (for example in the area of internet payments). ### Adoption of PFMI and implementation - Adoption of the PFMI in 2013 and establishment of an interagency platform to assess FMIs (the “PFMI Office”) are important achievements. - Full implementation of the principles by FMIs is the next step and is expected to enhance resilience and stability. - The level of implementation of the requirements varies greatly among the different systems. - FMIs and their overseers are encouraged to actively reform risk management practices. - Notably, the CSDC should adopt full delivery versus payment and modernize its credit and liquidity risk management. ### Legal basis for FMI supervision - The legal basis for FMI supervision needs to be strengthened; various initiatives are underway. - Main vulnerability: lack of a statutory framework for futures markets, which could hamper CSRC’s power to enforce change where needed. - When new cross-sector products are developed—such as in the over-the-counter derivatives markets—gaps or overlaps in regulation may appear. - Authorities’ initiatives to strengthen the supervisory framework include development of the ‘China Financial Infrastructure Supervisory Rules,’ drafting of a comprehensive Futures Market Law, amendments to the Securities Law, and drafting of a dedicated National Payment System Law. ### Finality, netting, and statutory certainty - Weaknesses exist in the legal framework for FMIs regarding finality and netting of transactions. - Recommendation: enact a comprehensive statute, or otherwise adopt statutory provisions, to achieve a high degree of legal certainty for all relevant material aspects covering FMIs. - Key legal provisions to provide: - recognition of settlement finality in the event of insolvency of a participant, - recognition of multilateral netting, - provisions for bankruptcy remoteness of pledged collateral, - prescriptions to overcome any zero-hour rules. ### Cyber risk and coordination - Cyber risk identified by authorities as an important topic for FMIs. - A cyber security law was issued in 2016. - “Cyberspace at the Administration of China,” a body under the State Council, conducts cyber security tests at a national level. - With the promulgation of the cyber security law, cooperation between the PBC, CSRC, and FMIs may further improve insights and contribute to awareness and assessments of cyber risks. - Joint crisis coordination mechanisms and testing of crisis communication protocols can further improve management and monitoring of these risks. ### Central bank services to strengthen resilience - Resilience can be strengthened through provision of central bank services to all solvent, systemically important FMIs. - The PBC currently provides settlement services to CCDC and Shanghai Clearing House. - It may consider extending these services to the CSDC and other CCPs. - Although private-sector liquidity must constitute the first line of defense for FMIs, extreme circumstances may render these insufficient or unavailable. - Providing solvent FMIs with access to emergency central bank liquidity, against collateral, ensures they can continue to make payments and thereby maintain market stability. - The provision of central bank accounts would reduce FMIs’ exposure to commercial banks. - Note: legislative change or specific State Council approval would be required to provide such services. ### AML/CFT progress and gaps - China was removed from the Financial Action Task Force enhanced follow-up process in 2012, following substantial reform. - The AML/CFT legislative and regulatory framework has been significantly enhanced since the 2007 Mutual Evaluation Report: - money laundering criminalized, - all terrorist financing offenses covered, - securities and insurance sectors brought into China’s AML/CFT regime. - Remaining measures required to bring the legal framework into compliance with international standards include mandating enhanced CDD(CDD) for domestic politically-exposed persons on a risk-sensitive basis. - CDD and suspicious transaction reporting rules are now largely in line with international standards, except for designated nonfinancial businesses and professions (DNFBPs). - China has ratified the United Nations Convention against Corruption and incorporated it into the legal framework. - As concealing the proceeds of one’s own crime is viewed as an extension of the predicate offense, laundering is not sanctioned as an independent action. - Full and comprehensive availability of information on ownership and control of legal persons, in line with the FATF Recommendations, is needed. ### AML/CFT supervisory and enforcement recommendations - Group-wide supervision and cooperation mechanisms should be developed. - The PBC is developing a risk-based approach to AML/CFT supervision by requiring institutions to undertake self-assessments and by developing its own methodology for prioritizing institutions. - An increased focus on group-wide risk should be a supervisory priority and there is scope for regulatory agencies to strengthen their cooperation. - Stronger sanctions for breaches of AML/CFT obligations should be considered. - Specific going-forward recommendations: - Ensure that self-laundering is more effectively investigated and prosecuted as a stand-alone offense. - Mandate enhanced CDD for domestic politically exposed persons on a risk-sensitive basis. - Ensure that the arrangements to record and maintain data on beneficial ownership are effective. - Extend preventive measures to DNFBPs. - Strengthen cooperation across all AML/CFT supervisory authorities. ### Crisis management: overview and need for reform - Authorities have relied on official financial support to manage failing FIs, regardless of systemic importance of the firm; this encourages moral hazard. - The size of the financial sector suggests this approach may no longer be viable because resources needed would be much larger than in the past. - Establishing a framework that allows FIs to fail—and requires shareholders, creditors, and investors to bear the costs of those failures while mitigating financial stability risks—is a key part of the transition. - Reforms needed to repurpose the existing crisis management framework and to facilitate operation of a special resolution regime. ### Crisis prevention and preparedness - Some elements of an effective institutional framework are in place: - regulatory agencies and the PBC have emergency-response frameworks that include monitoring and early warning systems, indicator-based action plans, and reporting rules for timely communication. - At the discretion of the relevant regulatory commission or the PBC, serious matters are escalated to the State Council, which can activate the Financial Crisis Response Group. - In practice, nonsystemic problems are elevated rapidly to government level; policy decisions may be skewed towards addressing social rather than financial stability. - Local governments have explicit statutory responsibilities to resolve risks posed by FIs in their jurisdiction and may convene interagency responses to minor incidents. - Recommendations to strengthen preparedness: - Limit triggers for activating a government-led crisis response to systemic cases where public resources may be required. - Design crisis management strategy and execution with technical advice of safety net members in conformity with their mandates and preserving regulatory autonomy. - PBC and regulatory agencies should conduct inter-agency crisis simulation exercises and update emergency-response frameworks as needed. - Consider establishing a dedicated forum for contingency planning and technical-level coordination for crisis management. ### Supervisory action and forward-looking assessments - Regulators should be able to request corrective actions based on forward-looking assessments. - Regulatory commissions have comprehensive early warning indicator systems and powers to request corrective actions and impose sanctions. - Limited scope exists for supervisors to act on forward-looking assessments; delayed supervisory actions can worsen financial conditions and reduce recovery values. - Authorities have requested recovery plans for the five G-SIFIs, in line with FSB requirements; CBRC and CIRC plan to extend these requirements to domestic systemically-important banks and insurance companies. - FSB guidance on recovery and resolution planning should be adapted to Chinese circumstances, with local requirements and guidance developed accordingly. ### Resolution powers and approaches - Ability to address problems of overindebted, unviable borrowers is key for effective supervision; requires political willingness to restructure overindebted sectors, including operational restructuring of viable corporates and exit of nonviable ones. - Further work needed to align approaches with the Key Attributes of Effective Resolution Regimes. - Bankruptcy law applies to FIs but has been rarely used; current approach aims to turn weak FIs into stronger ones to protect shareholders and creditors, often led by local governments and sometimes using public sector resources. - International good practice contrasts by imposing losses on shareholders and unprotected creditors, facilitating orderly exit of non-viable firms, relying on deposit insurance to protect depositors up to insured limits, and minimizing use of public funds. - Recommendations to accelerate reforms: - Expand administrative powers to resolve banks and insurance companies and put in place a special resolution regime for banks and systemic NBFIs. - Legal changes to empower an administrative authority to require recognition of losses in accordance with a clearly established hierarchy of claims and apply a broad set of powers in resolution. - Ensure resolution actions are not subject to stay or reversal in court, with redress limited to monetary compensation if authorities are at fault. - Resolution powers should include ability to transfer part of the business or shares to a healthy firm or bridge institution, and bail-in powers. - Adequate arrangements exist—in the absence of financial stability concerns—for application of the bankruptcy law to NBFIs, including requirements for the relevant authority to serve as “gatekeeper” for commencement of bankruptcy proceedings. ### Financial safety nets and moral hazard - Formal financial safety nets consist of: - (i) the deposit insurance fund; - (ii) the insurance protection fund; - (iii) the securities investor protection fund; - (iv) the recently established protection fund for trust companies; - (v) PBC liquidity assistance. - Beyond these, state financial assets have been used—including resources of the China Finance Corporation, a margin lender that provided substantial market support in response to the 2015 disruptions. - Current application of the safety net: - does not require a distinction between insolvency and illiquidity; - there is no clear test of systemic importance; - there is no means to ensure shareholders and unprotected creditors bear losses before safety nets are used, or that costs to safety nets are minimized. - Recommendations: - Use protection fund resources only after licenses are withdrawn and to provide appropriate protection for selected classes of creditors. - Prevent use of protection fund resources for rehabilitating failing firms and protecting shareholders. - Make and enforce a clear distinction between protected deposits and other investments to erode perceptions of implicit guarantees. - Limit protections in the trust and securities sector to cases of fraud or misappropriation of assets, not for recapitalization or liquidity support. - If public funds are required in systemic situations, they should be provided by the government with appropriate safeguards. - Emergency liquidity assistance should be provided only by the PBC. ### Emergency liquidity and procedural framework - Funding for commercial banks outside normal monetary operations should be available only under a specific emergency liquidity arrangement, subject to strict conditions. - Absence of a clear solvency requirement or supervisory opinion for institutions applying to the PBC for liquidity support may foster market perceptions that insolvency procedures will not be enforced, generating moral hazard. - A much stronger procedural framework is required, based on key principles, including that support is provided: - (i) at the discretion of the PBC; - (ii) to solvent, viable institutions; - (iii) against collateral and at penalty rates; - (iv) through triggering intensified supervisory measures; - (v) on provision of a clear repayment plan. - Illiquidity constitutes adequate grounds for resolution, and support should only be provided based on an analysis of systemic risks that would justify putting public funds at risk. - Note: Under current law, the PBC may only provide liquidity to NBFIs with the approval of the State Council. ### Resolution of bad debts and AMCs - Current setup with a dominant role for the four nationwide AMCs, created in 1999, facilitates disposal of problem bank assets. - AMCs bid for the loans and mostly offload NPLs through re-sale. - AMCs have re-sold most of the acquired NPLs, while restructuring loans to companies that are potentially viable. - Authorities have taken steps to improve the functioning of the AMC-based disposal channel and to diversify disposal options. - Initiatives to expand range of resolution options include pilots for NPL securitization and debt relief for distressed borrowers (for instance, setting up creditor committees to support deleveraging via debt-to-equity swaps). ### Rethink on disposal vs. recovery and restructuring - Structural slowdown and rebalancing of the economy call for a rethink of approaches that favor rapid disposal instead of recovery and restructuring. - In absence of thorough operational restructuring for distressed but potentially viable corporate borrowers—and timely exit for unviable ones—losses will mount and potentially salvageable economic activity will erode. - Recovery and restructurings are currently discouraged by aspects of the legal and regulatory framework and its implementation. - Collateral enforcement reportedly works well in large cities, but is less efficient elsewhere—sometimes due to social implications. - There are few formal re-organization and liquidation cases, no out-of-court enforcement, and limited bankruptcy experience. - Recent regulatory encouragement for creditors to pursue debt-to-equity swaps appears to focus too much on financial restructuring and may end up capitalizing losses in overcapacity sectors, rather than being part of effective operational restructuring of distressed corporations. *PEOPLE’S REPUBLIC OF CHINA — INTERNATIONAL MONETARY FUND (cr17358 excerpt).* ### 112. Many countries have formulated special programs to deal with SOE debt, but the ### cr17358 - 112. Many countries have formulated special programs to deal with SOE debt, but the ### SOE debt and regionally led programs - Policymakers at the regional level may lack sufficiently strong incentives to push for meaningful operational restructuring as a quid pro quo for financial restructuring. - Regional policymakers may lack resources for social programs designed to cushion the impact of restructuring and relocation of displaced workers. ### Development and access (financial sector focus) - Policy direction: - As part of the economic transition, the government has urged FIs to adjust their lending practices with greater emphasis on households, micro and small enterprises, and labor-intensive industry. - Policy banks: - The policy banks’ mandates should be further reviewed. - They have recently experienced another round of fast asset growth with substantially expanded mandates domestically and overseas, raising questions about their additionality vis-à-vis commercial sources of financing, and the economic impact of their interventions. - The broad range of mandates reflects a mix of short-term growth-stabilizing strategies (centered around infrastructure and construction projects) and longer-term development priorities. - Recommendation: The government should further clarify and define the mandates of the policy banks to ensure that they supplement and catalyze commercial financing, and to prevent excessive expansion of their business scope. - Financial inclusion progress and challenges: - China has made significant progress in financial inclusion: high levels of account penetration, savings, and usage of payments services have been achieved. - Remaining challenges include providing a wider range of financial services, in particular credit and insurance products, to individuals and micro and small enterprises that are technically banked, but still underserved. - Financial literacy needs improvement, in particular in rural areas where investors are more likely to be misled by the promise of high returns from risky or fraudulent schemes. - Market-based approach: - A market-based approach based on improving the legal and regulatory framework would be the most sustainable way to improve access. - Caution: Quantitative targets on physical outlets and the number of loans disbursed (and an emphasis on keeping interest rates low) contradict the principle of commercial sustainability and can—as an unintended consequence—set the stage for an unsustainable buildup of debt among mostly low-income households and small and medium enterprises, adversely impacting financial stability. - Fintech: - The expansion of fintech bodes well for financial inclusion, but presents challenges for regulation and supervision. - Fintech achievements: reached hundreds of millions of consumers with new financial products, including investment vehicles for consumers without bank accounts, a cashless and disintermediated payments system, and loans to households and SMEs without sufficient credit history. - Risks noted: authorities have already banned some P2P lending (used to evade housing down payment requirements); the size and rapid growth of money market funds under management by fintech firms means they could eventually pose systemic risks. - Recommendation: The legal, regulatory, and supervisory framework for fintech should continue to be strengthened to provide legal clarity and manage risks, allowing for healthy growth. ### Risk Assessment Matrix — Realization of domestic risks (sources 1–4) - Risk 1: A shift in the perceived value of implicit guarantees leads to a sharp increase in risk premia. - Likelihood: High - Impact on Financial Stability: High - Key implications: - Repricing of risk across the system. - Rolling over short-term funding would become more expensive or impossible. - Mortgage rates could rise, leading to falling prices in oversupplied regions. - Demand would fall for investment products; FIs could suffer mark-to-market losses. - Risk 2: A break in complex and short-term financial intermediation chains leads to a systemic liquidity crunch. - Likelihood: High - Impact on Financial Stability: Medium - Key implications: - Dislocation to short-term funding markets could lead to substantial liquidity shortages, particularly at medium-sized banks. - Wholesale funding has risen rapidly; stress in smaller banks could be triggered by corporate defaults (Risk 4), concerns on collateral valuation, or a shift in expectations of implicit guarantees (Risk 1). - Outflows from WMPs and other off-balance sheet investment products could rise if risk premia rose (Risks 1 and 5). - Banks may for reputational reasons bail out off-balance sheet products, depressing profitability and straining liquidity. - The PBC would respond with ELA to banks (and potentially to nonbanks), but banks would suffer losses, and a dislocation to sectors dependent on wholesale funding could be substantial. - Risk 3: A sustained decline in asset prices—most dangerously Tier 1 housing—leads to a decline in confidence and investment, potentially encouraging capital outflows. - Likelihood: Medium - Impact on Financial Stability: High - Key implications: - Rising importance of mortgage finance raises the risk of larger bank losses if housing prices fall. - While loan-to-value (LTV) ratios are relatively low, a large fall in housing prices could lead to losses. - Loss in land value underlying corporate lending would depress real estate investment. - Capital outflows could be large if other markets are also seen as overvalued (linked to Risk 5). - Risk 4: Disorderly corporate deleveraging leads to a loss of confidence in the domestic economy, leading to credit losses at banks. - Likelihood: Medium - Impact on Financial Stability: High - Key implications: - The pace of SOE debt creation appears unsustainable. - If new credit to unprofitable enterprises were cut off, defaults could trigger losses on bank loans, WMPs and securities products, and other debt products—with credit losses cascading across a complex and interconnected financial system. - Uncertainty about local governments stepping in, or the central government as second backstop, could further depress investor sentiment, harm liquidity (Risk 2), reduce credit to the economy, and lead to capital outflows (see Risk 3). ### Risk Assessment Matrix — Realization of external risks (sources 5–6) - Risk 5: Rise in protectionism in large economies could reverse international trade integration and policy coordination, weighing on global growth. - Likelihood: Medium - Impact on Financial Stability: High - Key implications: - China, as the world’s largest trading nation, would be heavily affected. - Slower-than-expected external demand would result from diminished confidence, investment, and growth in partner economies. - Exchange rate pressure would be likely, which could fuel possible capital outflows. - Lower domestic growth would exacerbate credit risks, with a negative impact on bank profitability and capitalization. - Risk 6: Sharp rise in global rates or relative risk premia leads to net capital outflows. - Likelihood: Medium - Impact on Financial Stability: Medium - Key implications: - Investors expect PBC to follow rises in global rates, but PBC could opt to keep policy loose and tighten capital controls. - A shift in retail investors’ assessment of domestic (Risks 1−4) and foreign investment prospects could lead to substantial capital outflows. - Tighter capital controls are difficult to sustain over time; reserve losses and pressure on the RMB would grow. - Tighter controls and rising outflows could dent domestic confidence, depress asset prices, and slow growth. ### Annex II — Stress testing assumptions (summary) - Coverage and data: - Tests covered 33 banks that account for 74 percent of assets in the banking system and were based on selected supervisory data. - Bank categorization (33 banks divided into five categories): - The Big Four banks: Agricultural Bank of China, Bank of China, China Construction Bank, and Industrial and Commercial Bank of China. - Large: Five joint stock banks with assets over RMB 5 trillion, Bank of Communications, China Development Bank, and China Postal Bank. - Medium: Seven joint stock banks with assets below RMB 5 trillion. - City Commercial Banks (9). - Rural Banks (5). - Types of stress tests: - Solvency: - Macroeconomic scenarios assessed impact of combined external and domestic shocks that result in cumulative declines of GDP equivalent to 1 and 2 standard deviations relative to the baseline over a two-year horizon (2017–18). - Sensitivity analysis assessed vulnerabilities to individual shocks. - Tests assessed impact on banks’ solvency and liquidity of potential actions aimed at covering shortfalls in their sponsored off-balance sheet WMPs. - Liquidity: - Assessed resilience to strong shocks characterized by reductions in funding that vary by type, and funding using a maturity ladder analysis. - To cover resulting liquidity gaps, banks must liquidate assets at a loss. - Banks could use securities as collateral to obtain liquidity through the standard liquidity facilities of the PBC. - Only when banks had no eligible collateral to access the standard facilities would banks fail the test. - Contagion: - Network stress test based on bank-by-bank balance-sheet information follows Espinosa-Vega and Solé (2010). - Analysis uses a matrix of bilateral bank-to-bank exposures including interbank assets and liabilities as well as on- and off-balance sheet WMPs issued and invested by each bank. - Market-data based contagion stress test uses data on daily volatility of equity returns and follows the methodology developed by Diebold and Yilmaz (2014). - Note on exclusions: - China’s three policy banks account for 10 percent of system assets. They are growing rapidly, and focus on infrastructure and construction projects, some of which appears to substitute for fiscal expenditure. However, as they are not deposit financed, and with business models different from those of commercial banks, they were not included in the stress tests. ### Selected key statistics and projections (exact values as reported) - Stress test coverage: 33 banks that account for 74 percent of assets in the banking system. - Policy banks share of system assets: 10 percent. - National accounts and macro projections (selected series, annual percentage change unless otherwise indicated): - Real GDP (base=2015): 2012: 7.9; 2013: 7.8; 2014: 7.3; 2015: 6.9; 2016: 6.7; 2017: 6.8; 2018: 6.5; 2019: 6.3; 2020: 6.2; 2021: 6.0; 2022: 5.8. - Total domestic demand: 7.9; 8.1; 7.2; 7.2; 7.4; 6.9; 6.9; 6.7; 6.6; 6.3; 5.9 (2012–2022). - Consumption: 8.7; 7.2; 7.2; 8.3; 8.4; 8.0; 7.9; 7.4; 7.0; 6.6; 6.2 (2012–2022). - Investment: 7.1; 9.1; 7.1; 6.1; 6.3; 5.7; 5.6; 5.8; 6.0; 5.8; 5.6 (2012–2022). - Macrofinancial indicators (selected): - Total social financing (percent change): 19.1; 17.5; 14.3; 12.4; 12.9; 10.9; 11.4; 12.2; 11.2; 10.5; 9.9 (2012–2022). - Total social financing (in percent of GDP): 169.0; 180.0; 189.8; 197.6; 209.0; 213.2; 218.9; 226.6; 232.4; 237.3; 241.7 (2012–2022). - Household debt (percent of GDP): 29.6; 33.0; 35.4; 38.2; 44.2; 46.4; 48.9; 51.6; 54.4; 57.4; 60.8 (2012–2022). - Domestic credit to the private sector (percent of GDP): 134.6; 142.3; 148.5; 157.6; 172.3; 181.4; 188.0; 193.1; 196.8; 199.7; 202.5 (2012–2022). - Nonfinancial corporate domestic debt (percent of GDP): 105.0; 109.3; 113.0; 119.4; 128.1; 134.9; 139.1; 141.5; 142.4; 142.3; 141.6 (2012–2022). - Gross official reserves (in billions of U.S. dollars): 3,388; 3,880; 3,899; 3,406; 3,098; 2,930; 2,876; 2,823; 2,751; 2,655; 2,533 (2012–2022). - Fiscal and balance indicators: - Net lending/borrowing (percent of GDP): -0.3; -0.8; -0.9; -2.8; -3.7; -3.7; -3.7; -3.9; -4.0; -4.1; -4.2 (2012–2022). - Revenue (percent of GDP): 27.8; 27.7; 28.1; 28.5; 28.2; 27.5; 27.5; 27.4; 27.1; 27.0; 26.8 (2012–2022). - Expenditure (percent of GDP): 28.1; 28.5; 29.0; 31.3; 31.9; 31.2; 31.2; 31.2; 31.1; 31.1; 31.0 (2012–2022). - Official government debt (narrow definition, percent of GDP): 15.5; 16.0; 38.6; 36.4; 36.6; 37.5; 38.5; 39.4; 40.4; 41.3; 42.4 (2012–2022). - Memo items: - Nominal GDP (in billions of renminbi): 54,099; 59,696; 64,718; 69,911; 74,631; 81,133; 88,029; 95,444; 103,468; 111,984; 120,795 (2012–2022). - Augmented debt (percent of GDP): /44.1; 48.1; 52.3; 56.6; 62.2; 68.2; 73.5; 78.3; 83.5; 88.0; 91.8 (2012–2022). *Source: IMF staff report excerpts as provided in the supplied content.* ### Annex IV. Table 2. China: Core Financial Stability Indicators for Deposit Takers ### Annex IV. Table 2. China: Core Financial Stability Indicators for Deposit Takers ### Regulatory capital and asset-quality indicators - Regulatory Capital to Risk-Weighted Assets: - 2013: 12.2 - 2014: 13.2 - 2015: Q2: 13 - 2015: Q4: 13.5 - 2016: Q2: 13.1 - Regulatory Tier 1 Capital to Risk-Weighted Assets: - 2013: 9.9 - 2014: 10.8 - 2015: Q2: 10.8 - 2015: Q4: 11.3 - 2016: Q2: 11.1 - Non-performing Loans Net of Provisions to Capital: - 2013: -11.6 - 2014: -9.8 - 2015: Q2: -8.9 - 2015: Q4: -7.9 - 2016: Q2: -7.9 - Non-performing Loans to Total Gross Loans: - 2013: 1 - 2014: 1.2 - 2015: Q2: 1.5 - 2015: Q4: 1.7 - 2016: Q2: 1.7 ### Sectoral distribution of total loans (shares, percent) - Residents: - 2013: 99.4 - 2014: 99 - 2015: Q2: 98.9 - 2015: Q4: 98.9 - 2016: Q2: 98.9 - Deposit-takers: - 2013: 11.2 - 2014: 8.8 - 2015: Q2: 8.6 - 2015: Q4: 7.1 - 2016: Q2: 3.4 - Central bank: - 2013: 0.4 - 2014: 0 - 2015: Q2: 0 - 2015: Q4: 0 - 2016: Q2: 0 - Other financial corporations: - 2013: 3.7 - 2014: 3.7 - 2015: Q2: 3.7 - 2015: Q4: 4.3 - 2016: Q2: 4.6 - General government: - 2013: - - 2014: - - 2015: Q2: - - 2015: Q4: - - 2016: Q2: - - Nonfinancial corporations: - 2013: 59.6 - 2014: 60 - 2015: Q2: 59.4 - 2015: Q4: 58.6 - 2016: Q2: 59.5 - Other domestic sectors: - 2013: 24.5 - 2014: 26.6 - 2015: Q2: 27.1 - 2015: Q4: 28.9 - 2016: Q2: 31.4 - Nonresidents: - 2013: 0.6 - 2014: 1 - 2015: Q2: 1.1 - 2015: Q4: 1.1 - 2016: Q2: 1.1 ### Profitability and income structure - Return on Assets: - 2013: 1.3 - 2014: 1.2 - 2015: Q2: 1.2 - 2015: Q4: 1.1 - 2016: Q2: 1.1 - Return on Equity: - 2013: 19.2 - 2014: 17.6 - 2015: Q2: 17.3 - 2015: Q4: 15 - 2016: Q2: 15.2 - Interest Margin to Gross Income: - 2013: 78.9 - 2014: 78.5 - 2015: Q2: 75.4 - 2015: Q4: 76.3 - 2016: Q2: 74.3 - Non-interest Expenses to Gross Income: - 2013: 32.9 - 2014: 31.6 - 2015: Q2: 27.2 - 2015: Q4: 30.6 - 2016: Q2: 26.7 ### Liquidity and foreign-exchange exposures - Liquid Assets to Total Assets (Liquid Asset Ratio): - 2013: 21.2 - 2014: 19.9 - 2015: Q2: 19.7 - 2015: Q4: 21.1 - 2016: Q2: 21.6 - Liquid Assets to Short Term Liabilities: - 2013: 44 - 2014: 46.4 - 2015: Q2: 46.2 - 2015: Q4: 48 - 2016: Q2: 48.1 - Net Open Position in Foreign Exchange to Capital: - 2013: 3.7 - 2014: 3.5 - 2015: Q2: 3 - 2015: Q4: 3.7 - 2016: Q2: 3.1 ### Notes - Source: Financial Soundness Indicators, International Monetary Fund (2016). - (-) Indicates that a figure is zero. - (...) Indicates a lack of statistical data that can be reported or calculated from underlying observations. *Annex IV. Table 2. China: Core Financial Stability Indicators for Deposit Takers* ### 29. Completing the reform of the Postal Savings Bank by optimization ### 29. Completing the reform of the Postal Savings Bank by optimization of the ownership structure, marketization, and the establishment of effective corporate governance. ### Authorities’ statement and engagement with the FSAP - Statement by Zhongxia Jin, Executive Director for People's Republic of China, November 10, 2017. - Authorities thank the FSAP team for their work and welcome the FSAP update as an opportunity to examine the health and soundness of China’s financial system. - The FSAP staff conducted more than 500 meetings and stress tests using confidential regulatory data. - Acknowledgement that the stress test under extreme scenarios shows strong resilience of China’s financial system: - The four largest commercial banks are sufficiently capitalized even under extreme scenarios. - Medium sized commercial banks may face some liquidity stress and a significant erosion in capital, but they will all remain solvent. - Authorities note the central bank will not allow liquidity stress to trigger systemic financial risks and that the newly established deposit insurance system will address insolvency effectively. - Thanks expressed to Ratna Sahay, Simon Gray, and the entire FSAP team. ### Recent openness and reform measures announced by authorities - Relaxation of foreign ownership limits across several financial sectors: - Foreign firms will be allowed to raise their shares in securities ventures and fund managers to 51 percent. - Foreign ownership limits will be removed three years after the new rule takes effect for securities ventures and fund managers. - The cap on life insurers will be lifted to 51 percent after three years and will be removed after five years. - Non-discriminatory ownership limit rules will be applied on equity investment in Chinese banks (private banks excluded) and financial asset management companies. - Authorities expect increased competition and improved efficiency in the medium and long term from these measures. ### Macro-financial context and leverage - Since the last FSAP in 2011, the financial sector has developed rapidly with reforms and opening up supporting growth and transformation. - Shift in policy emphasis from quantity to quality and efficiency of growth, following the 19th CCP Congress; GDP growth now set as a forecast based on estimated potential growth. - China’s inflation rate is now lower than 2 percent under current GDP growth. - Credit gap observations: - The “credit gap” is acknowledged as deserving attention but characterized as to some extent counter cyclical and recently narrowed. - Growth picked up since late 2016 and monetary policy shifted to a more neutral stance; overall leverage growth in 2016 slowed. - Leverage of the corporate sector has dropped since the third quarter of 2016. - Discussion on composition of corporate debt and local government contingent liabilities: - Official public sector’s debt over GDP is 40 percent. - Total leverage ratio in China is 260 percent of GDP, which authorities state is lower than most advanced countries and comparable with many emerging market economies. - Clarification that perception of implicit government guarantee for SOEs does not have legal basis; precedent cited of Guangdong International Trust & Investment Corp allowed to go bankrupt about 20 years ago. ### Exchange rate policy and external pressures - Authorities appreciate Fund support for exchange rate flexibility and stress the importance of risk management. - China has been moving toward a market-based exchange rate and greater exchange rate flexibility to achieve external and domestic balance and prevent financial risks. - Capital outflow pressure attributed largely to global economic and financial developments, particularly monetary policy adjustments in major economies. - China has applied market-based counter-cyclical macroprudential policies to mitigate potential financial risks. ### Regulatory framework and institutional reforms - Financial Work Conference (July 2017) decisions to enhance oversight: - Establishing the Financial Stability and Development Committee (FSDC). - Reinforcing the central bank’s mandate on macroprudential regulation/supervision and prevention of systemic risks. - Enhancing accountability of regulatory authorities. - Strengthening regulation on a consolidated basis through functional and behavioral regulation. - Macroprudential Assessment (MPA) framework by the People’s Bank of China: - Assesses banks’ key macroprudential indicators in a rule-based manner. - Process is transparent to both the central bank and banks assessed; banks are informed of outcomes. - Eligibility policy for accessing PBC facilities provides incentives for prudent bank operations. - Policy on remuneration of reserves has never been enforced in practice. ### Asset Management Products (AMPs) and regulatory harmonization - Authorities agree on function-based rather than institution-based regulation for similar products. - Regulatory actions in progress: - Formulating regulatory policy for AMPs to eliminate discrepancies across regulators. - AMPs will be subject to uniform regulatory standards, defined as off-balance sheet products with clear requirements of investor suitability and explicit removal of implicit guarantees. - Reinforcement of targeted macroprudential and functional regulation based on the “look-through” principle, with enhanced regulatory and statistical coordination. ### Nonperforming loans (NPLs), provisioning, and deposit insurance - Loan classification system in China is generally in line with international standards on prudential regulation and accounting. - Authorities and staff worked together to assess potential underestimation of NPLs; conclusion is that underestimation room is limited and shrinking. - Supervisory actions taken: - Reinforced monitoring of NPLs. - Tightened regulatory requirements on the investment book and off-balance sheet exposure. - Intensified on-site examination and punishment to contain illicit risk transfer. - Banks have reinforced provisioning and write-offs of NPLs in the past 5 years. - Deposit insurance scheme implemented in 2015, in compliance with international core principles on deposit insurance and disposal of financial institutions, providing a basis for market-based resolution. - Authorities note corporate sector profitability has improved significantly in the current year compared with last year. - In most cases, local government borrowings have been backed by long-term, cash-generating assets. ### Supervision of Financial Market Infrastructures (FMIs) - Progress toward implementing internationally accepted principles and practices of FMI supervision while tailoring practices to country specifics. - Example: China Securities Depository and Clearing Corporation Limited (CSDC) arrangements: - Risk and liquidity management framework secures payment one day after delivery of securities. - Includes a contingent plan to directly compensate unsettled payment with debtors’ securities holdings. - 100 percent margin requirement and comprehensive regulations for risk control. - Under extreme liquidity shortage scenarios: - CSDC can access liquidity through collateral management. - The central bank will provide ad hoc liquidity support to avoid liquidity shocks to clearing banks in extreme circumstances, while being cautious of moral hazard from using central bank clearing and liquidity facilities for securities transactions. ### Publication - Authorities have agreed to publish the FSSA report and the DAR report. *Source: Statement by Zhongxia Jin, Executive Director for People's Republic of China, November 10, 2017.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17358.pdf_