## 1chnea2025001-print-pdf ## Source details **Canonical URL:** [1chnea2025001-print-pdf](https://www.imf.org/-/media/files/publications/cr/2025/english/1chnea2025001-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2025/english/1chnea2025001-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2025/english/1chnea2025001-print-pdf.pdf.json) --- ### Macrofinancial context and recent developments - Financial system size and structure: - Financial system has grown faster than the economy to over 450 percent of GDP, with banks dominant. - Bond and equity markets stand at 126 and 61 percent of GDP respectively. - Nonbank financial intermediaries: total assets under management estimated at 95 percent of GDP (down from 130 percent of GDP in 2017). - Five state-owned G-SIBs and one other large bank together account for around 42 percent of total banking system assets. - Cross-border exposures are limited; system is largely government-controlled and highly interconnected. - Institutional reforms since 2017: - Creation of the National Financial Regulatory Administration (NFRA) with oversight responsibility for banks, insurers, and other financial institutions. - Progress on legal, regulatory, and supervisory reforms noted, but further strengthening required. ### Elevated and rising financial stability risks - Overall assessment: - Financial stability risks are elevated and rising compared to the 2017 FSAP. - Financial risks related to LGFV and property sectors flagged in 2017 are materializing. - LGFV and property: - Property downturn and widening strains on highly leveraged LGFV are already negatively impacting financial institutions. - As of end-2023, outstanding LGFV debt was equivalent to 46 percent of GDP (staff estimate). - Figure 2: As of end-2023, LGFV debt amounted to 8 trillion USD (47 percent of GDP), 75 percent of which is held by banks. - Staff estimates suggest that 39-46 percent of LGFV debt needs restructuring to restore LGFV debt servicing capacity. - Manifestations: - Smaller banks with riskier business models have encountered difficulties. - Government-owned institutions and funds are used as ‘buyers of last resort’ and to intervene in financial markets to support asset prices. - Risks of partial/temporary solutions: - Relying on temporary or partial solutions will exacerbate misallocation of capital, mispricing of risk, and build-up of veiled losses with macroeconomic implications. ### Asset quality, loss recognition, and market price signals - Loss recognition and forbearance: - More timely loss recognition and greater reliance on market price signals recommended. - Nonperforming loan ratios have remained broadly stable and below 2 percent for several years, amid write-offs and asset disposals to AMCs at potentially inflated prices. - Forbearance measures and implicit government support increase legacy asset proportion and risk credit loss deferral. - Disclosure and market pricing: - Increased transparency on NPL inflows, transfer prices, AMC sale prices and recovery rates, IFRS 9 staging, collateral/LTV details, and interest-rate maturity ladders recommended. - Analytical finding: - Analysis suggests LGFV restructuring strategies predicated on interest rate relief have serious implications for bank earnings and future lending capacity while failing to restore LGFV repayment capacity. ### Bank capital, liquidity, stress testing, and contagion - Sample coverage: - Solvency stress tests used confidential data for 55 largest banks (assets > US$70 billion) covering close to 80 percent of banking sector assets. - Liquidity and interconnectedness analysis used data for 111 banks (assets > US$30 billion) covering 87 percent of commercial bank assets. - Solvency stress test results (55 banks, 3-year horizon to end-2026): - Baseline projection: aggregate CET1 rises to 11.9 percent of total RWA by 2026 (up from 10.7 percent in 2023). - Adverse scenario aggregate: CET1 falls by 3.7 percentage points relative to baseline and declines to 8.2 percent by end-2026. - Group outcomes: - G02 aggregate CET1 ratio: 9.7 percent by 2026. - G04 banks: Aggregate CET1 drops to 5.4 percent. - Bank shortfalls in adverse scenario: - 12 of 55 banks fail minimum CET1 (five in G03, six in G04, one in G05). - 31 banks fail full Pillar I capital requirements (four in G02, 11 in G03, 14 in G04, two in G05). - Aggregate shortfall magnitudes by end-2026: - Total CET1 shortfall against minimum CET1 requirements: 0.5 percent of RWA (or 0.7 percent of China’s GDP). - Total CET1 shortfall against Pillar I requirements: 1.8 percent of RWA (or 2.5 percent of China’s GDP). - Cost to restore CET1 and total capital ratios to initial levels: about 3.9 percent of China’s GDP. - Three-year cumulative credit impairments: 5.6 percent of starting RWA for the sample. - Liquidity stress test (111 banks): - Under baseline all banks meet LCR requirement; some banks vulnerable to sudden deposit withdrawals. - Retail, wholesale, and combined scenarios erode liquidity buffers—some city and rural commercial banks fall below regulatory requirement in retail scenario; some joint-stock and large banks vulnerable in wholesale/combined scenarios. - Cash-flow analysis anchors system-wide outflows to approximately 20 percent of total liabilities over a one year period; under adverse several joint-stock and city commercial banks experience small liquidity shortfalls beyond one month. - NSFR: all 111 banks meet the 100 percent requirement on average; joint-stock banks have lower NSFRs. - Interconnectedness and contagion: - Interbank network (111 banks) analysis shows large banks tend to be more contagious; exposures captured represent less than 10 percent of total inferred interbank exposures, so results are a lower bound. - Small intermediaries and regional banks are highly connected and can cause material contagion losses. - Data limitations: - Lack of granular, bank-specific data on LGFV exposures, IFRS 9 staging, collateral/LTV distributions, and interest-rate maturity ladders limits precision of stress tests and analyses. ### Local Government Financing Vehicles (LGFVs) — vulnerabilities and illustrative restructuring impacts - LGFV debt and holders: - Banks hold 75 percent of LGFV debt; asset management products hold another 16 percent. - FSAP assumed bank exposure to LGFV debt of US$6 trillion, mostly loans. - Staff illustrative coverage: sample of about 3,700 bond-issuing LGFVs and about 400 banks covering about 95 percent of banking sector assets. - Illustrative debt relief exercise findings: - LGFVs may require up to US$38 billion per year of interest reductions, or additional financial support. - Support needed to restore debt-servicing capacity where debt is perpetually rolled over could require debt relief up to US$1.24 trillion (approximately 7 percent of GDP). - If debt service includes principal repayments, costs would be larger. - Impact on banks: - If banks bear full burden of LGFV debt relief, capital depletion for sampled banks could reach around 2.9 percentage points in an extreme full write-down/no interest relief case. - Overlay results (interest reduction scenarios): - Additional impact on banks’ NII over year 2023 RWA from LGFV interest rate reduction: range from 25 to 31 basis points. - Respective impact on CET1 ranges from 11 to 27 basis points. - Sensitivity caveat: data on individual bank holders of LGFV debt not available; results are illustrative. ### Corporate, SME, and household vulnerabilities - Corporate sector: - Bank credit to nonfinancial corporates (including LGFV) amounted to 134 percent of GDP in 2023; corporate leverage around 38 percent. - Corporate debt in China was 134 percent of GDP in 2022 (excluding LGFV debt the figure remains 82 percent of GDP). - Firm-level PD analysis covered 11,300 firms (2013–2023); sectoral heterogeneity and greater corporate PDs under adverse scenarios identified. - SME lending sensitivity: cumulative total credit losses as proportion of RWA projected to rise by approximately 20 basis points for every 10 percent increase in SME lending under baseline; in adverse scenario the rise would be one percentage point higher. - Households: - Household debt reached 63.7 percent of GDP by end-2023. - Mortgage loans account for about half of all household debt. - Aggregate debt-to-assets for households around 9.1 percent. - Average debt service-to-income ratio (DSR) is 18.4 percent. - Debt concentration: 20 percent of households hold 60 percent of total debt. - Around 35 percent of total debt is held by households with a DSR over 40 percent; 12.8 percent of total debt is held by those with a DSR over 60 percent. ### Climate-related financial risks - Emissions and exposure: - China accounted for 30 percent of global CO2 emissions in 2021. - China is highly exposed to natural hazards (floods, typhoons, extreme temperatures). - Transition risk analysis (to 2040): - Three scenarios: "orderly", "disorderly", "disorderly-global". - Estimated impact on bank capital by 2040 relative to baseline: - Less than 1 percent of total RWA in the orderly scenario. - About 9 percent of total RWA in the disorderly-global scenario. - Physical risk analysis: - Floods and typhoons assessed across 31 provinces; eastern regions (accounting for over 26 percent of GDP) show largest increases in probability of potential economic damages and associated credit and market risks. - Recommendations: - Bolster regulators’ capacity for climate risk understanding and oversight; improve coordination, data collection, granular analysis, and climate information frameworks. ### Regulation, supervision, and data gaps; NFRA capacity and mandates - Supervision and regulatory recommendations: - Strengthen NFRA autonomy, resources, and staffing—priority: High; Timeframe: ST. - Clearly communicate and ensure primacy of NFRA’s safety and soundness objective over developmental objectives. - Transition toward more risk-based supervision; strengthen conglomerate supervision; tailor capital requirements through active use of Basel Pillar 2. - Phase out regulatory forbearance and asset classification exceptions. - Tighten regulation for payment services providers and differentiate standards across risk profiles (BigTech PSPs). - Capacity gaps: - Notable weaknesses in headcount, skills, tools, methodologies, and need for additional capacity for risk analysis and stress testing. - Need to strengthen data validation, broaden horizontal risk analysis, and centralize expertise through dedicated risk teams. - Macroprudential governance: - Strengthen systemic risk monitoring by creating a stress event dataset, back-testing indicators, and establishing a Macroprudential Policy Committee to include key agencies (PBC; Medium; MT). ### Financial safety net, resolution, insolvency, and DIF - Financial safety net weaknesses: - Current safety net fragmented, prone to inefficient decision-making, largely reliant on public funding, and not equipped for systemic distress. - Recommended actions: strengthen draft Financial Stability Law, designate independent lead resolution authority, build crisis management capabilities, and introduce an effective emergency liquidity assistance framework. - Deposit Insurance Fund (DIF): - DIF balance was US$8.8 billion as of end-2023 (down from US$17 billion at end-2019), well below target level of around US$224 billion. - Recommendations: - Limit DIF use strictly to insured deposit payouts and contributions to transfer strategies subject to a least-cost test. - Increase annual contributions to bridge gap to target level of 1.5 percent of covered deposits. - Explicit government backstop recommended in line with international good practices. - Corporate insolvency and AMCs: - Modernize Enterprise Bankruptcy Law and strengthen courts’ capacity and regulation of insolvency administrators. - Strengthen supervision, regulation, and transparency of AMCs; publicly disclose sale prices and recovery rates; open primary market beyond AMCs to enhance distressed-loan market. ### Key recommendations (selected, with priority and timeframes preserved) - Cross-cutting: - 1. Design and implement a medium-term comprehensive plan to address financial stability risks associated with LGFV debt overhang. — Multiple, High, I - 2. Take decisive steps to fully recognize expected losses on balance sheets of financial institutions and continue to move toward market-based pricing of financial assets. — Multiple, High, I - Systemic Risk Analysis: - 3. Strengthen analytical and stress testing capacity, supported by more granular data and specialist staff. — NFRA, PBC, High, ST - 4. Closely monitor growth of exposures to non-viable entities in bank balance sheets; switch to forward-looking systemic risk assessment. — NFRA, PBC, High, I - 5. Enhance analytical capacity for climate-related risks. — NFRA, PBC, Medium, MT - Macroprudential Policy Framework: - 6. Create a stress event dataset and establish a Macroprudential Policy Committee. — PBC, Medium, MT - Financial Sector Oversight: - 7. Expand NFRA’s autonomy and staffing. — NFRA, High, ST - 8. Ensure primacy of NFRA’s safety and soundness objective. — CSRC, NFRA, High, ST - 10. Enhance Supervisory Review Process and active use of Pillar 2. — NFRA, Medium, ST - 11. Enhance transparency by making granular bank financial soundness information public. — NFRA, PBC, High, MT - 12. Intensify oversight of smaller and high-risk banks. — NFRA, High, ST - Financial Safety Net and Resolution: - Refine and enact draft Financial Stability Law and designate/operationalize a dedicated lead resolution authority. — CDIC, NFRA, PBC; High; I/ST - Design and implement emergency liquidity assistance framework. — PBC; High; ST ### Macroeconomic and fiscal projections (select figures preserved exactly) - Real GDP (base=2015): - 2024: 4.8 - 2025: 4.6 - 2026: 4.5 - 2027: 4.2 - 2028: 3.8 - 2029: 3.5 - 2030: 3.4 - Consumer prices (average): - 2024: 0.3 - 2025: 0.8 - 2026: 1.3 - 2027: 1.7 - 2028: 1.8 - 2029: 1.9 - 2030: 2.0 - Non-financial corporate domestic debt (percent of GDP): - 2024: 121.1 - 2025: 125.5 - 2026: 127.1 - 2027: 128.9 - 2028: 131.1 - 2029: 133.7 - 2030: 136.5 - Household debt (percent of GDP): - 2024: 64.5 - 2025: 63.8 - 2026: 63.5 - 2027: 63.2 - 2028: 63.0 - 2029: 62.9 - 2030: 62.9 - General budgetary government net lending/borrowing (percent of GDP): - 2024: -7.9 - 2025: -8.3 - 2026: -8.2 - 2027: -7.7 - 2028: -7.8 - 2029: -7.8 - 2030: -7.8 - Debt (percent of GDP): - 2024: 63.3 - 2025: 71.0 - 2026: 76.3 - 2027: 79.9 - 2028: 83.6 - 2029: 86.9 - 2030: 90.2 - Gross official reserves (billions of U.S. dollars): - 2024: 3,749 - 2025: 4,075 - 2026: 4,216 - 2027: 4,403 - 2028: 4,604 - 2029: 4,801 - 2030: 5,012 - Nominal GDP (billions of RMB): - 2024: 129,584 - 2025: 134,907 - 2026: 142,687 - 2027: 151,041 - 2028: 159,641 - 2029: 168,416 - 2030: 177,481 - Augmented debt (percent of GDP): - 2024: 126.4 - 2025: 134.0 - 2026: 138.8 - 2027: 142.5 - 2028: 146.2 - 2029: 149.8 - 2030: 153.4 ### Authorities’ views and implementation status highlights - Authorities’ assessment: - Authorities view China’s financial sector as resilient and contest staff characterization that “financial stability risks are elevated and rising.” - They cite low NPL ratios, satisfactory capital, enhanced governance and risk management, and policy measures introduced in September 2024 as having contained risks. - DIF and LGFV measures reported by authorities (figures preserved): - DIF balance: US$8.8 billion as of end-2023 (down from US$17 billion at end-2019). - Authorities report outstanding LGFV operational debt "stood at about RMB 15 trillion, representing a 25 percent decline from the end of 2023" and that RMB 10 trillion implicit local government debt was addressed by a September 2024 RMB 10 trillion debt swap program. - Authorities report financial institutions supported extension/restructuring/swap of more than RMB 5.4 trillion of LGFV operational debt by end-2024 and claim average LGFV bond issuance interest rate in Q4 2024 was 2.67 percent. ### Implementation and data priorities for a lead coordinator - Recommendation 16 (priority and implementation): - Designate a lead authority to coordinate comprehensive risk assessments across the financial sector, aided by intensified market surveillance, while preserving sectoral agencies’ autonomy. Associated authorities: CFC, CSRC, NFRA, PBC. Priority: High; Timeframe: ST. - Implementation priorities and considerations: - Preserve sectoral responsibilities while providing centralized mandate for cross-cutting risk identification and market surveillance. - Prioritize closing data gaps: small banks, institution-level LGFV exposures, granular balance sheet items. - Coordinate with reforms in resolution frameworks, emergency liquidity assistance, collateral and reserve frameworks, AML/CFT, and BigTech prudential rules. *Source: IMF Financial System Assessment Program (FSAP) — People’s Republic of China (excerpts as provided).* ### EXECUTIVE SUMMARY ____________________________________________________________________________ 8 ### EXECUTIVE SUMMARY ### Macrofinancial context and recent developments - The financial system has grown faster than the economy to over 450 percent of GDP, with banks dominant. - Capital markets have grown deeper and more liquid since the 2017 Financial Sector Assessment Program (FSAP), and there is a sizeable asset management sector. - The system is largely government-controlled and highly interconnected; direct linkages to global financial markets remain limited. - Legal, regulatory, and supervisory reforms initiated since 2017 have progressed—including via the recent creation of the National Financial Regulatory Administration (NFRA) which has oversight responsibility for banks, insurers, and other financial institutions. ### Elevated and rising financial stability risks - Financial stability risks are elevated and rising, as compared to the 2017 FSAP. - Financial risks related to local government financing vehicles (LGFV) and the property sectors—flagged in the 2017 FSAP—are materializing, with a property downturn and widening strains on highly leveraged LGFV already having a negative impact on financial institutions. - Smaller banks with riskier business models have encountered difficulties, signaling a manifestation of risks. - The relatively larger capital and liquidity buffers of the largest banks and the availability of fiscal buffers for targeted interventions have thus far helped contain risks, but mounting risks call for a more comprehensive approach. ### Asset quality, loss recognition, and market price signals - More timely loss recognition and greater reliance on market price signals would improve risk pricing and reinforce confidence. - Nonperforming loan ratios have remained broadly stable, as banks remain focused on write-offs and less transparent asset disposals to asset management companies (AMCs). - Forbearance measures and continued reliance on implicit government support increases the proportion of legacy asset, risking mispricing and credit loss deferral. - Weak banks are often addressed via consolidations that may not address underlying fragilities. - Government-owned institutions and funds are used as ‘buyers of last resort’ and to intervene in financial markets to support asset prices. - Analysis based on publicly available data suggests that an LGFV restructuring strategy predicated on interest rate relief has serious implications for bank earnings and future lending capacity, while at the same time failing to restore LGFV repayment capacity. - Relying on temporary or partial solutions will exacerbate the misallocation of capital, mispricing of risk, and the gradual build-up of veiled losses with macroeconomic implications. ### Bank capital, liquidity, and stress testing - Bank capital and liquidity levels appear adequate in aggregate, but rising vulnerabilities warrant attention. - Slower economic growth compared with past decades will affect credit quality; accommodative monetary policy and directed lending are weakening banks’ organic profitability. - Smaller banks are more vulnerable than larger peers, given lower capital buffers, higher funding costs, declining net interest income, and increased concentration risks. - Stress testing of a sample of the 55 largest banks suggests that in aggregate, capital ratios remain above minimum hurdle rates even in a severe downside scenario, albeit with significant dispersion across the sample. - Some bank business models appear particularly vulnerable, with several banks breaching regulatory minima in the adverse scenario—even though shortfalls are manageable. - Risks from nonbanks have declined since 2017 due to regulatory reform, but non-bank financial intermediaries (NBFI) are highly interconnected with banks through ownership, common asset holdings, and substantial funding linkages; redemption shocks could cascade across sectors. - Data constraints—such as a lack of data on the distribution of exposures to LGFV risk across banks—limited analytical work; more granular, non-public data access would improve analysis. ### Regulation, supervision, and data gaps - Regulation and supervision warrant further strengthening, particularly given elevated risks. - Supervisors have limited autonomy with tension between stability and growth objectives calling for a sharpening of mandates and greater interagency coordination. - Notable weaknesses exist in headcount, skills, tools, methodologies, and an immediate need for additional capacity for risk analysis. - Further transition toward a more risk-based approach to supervision—including for NBFI—will promote supervisory effectiveness; strengthening conglomerate supervision can help mitigate cross-sectoral risks. - Bank capital requirements should be more tailored to individual bank risk profiles, including through active use of the Basel Pillar 2 framework. - Address deficiencies in asset classification; supervisory data collection, sharing among regulators, and analysis; and risk monitoring—along with critical disclosure gaps for financial institutions. - Regulatory forbearance and asset classification exceptions should be phased out. - Strengthen systemic risk monitoring and underpin supervisory, macroprudential, and financial stability policy actions with analysis. - Tighten regulation for payment services providers with greater differentiation of regulatory standards across risk profiles. - Ensure a proper balance between enabling price formation and managing market volatility; continue to reduce persistent perceptions of implicit guarantees. ### Financial safety net, resolution, and insolvency - Establishing a comprehensive bank resolution framework and buttressing the insolvency and debt resolution system remain priorities. - Progress since 2017 has been insufficient; the current financial safety net is fragmented, prone to inefficient decision-making, largely reliant on public funding, and not equipped to deal with systemic distress. - Recommended actions include strengthening the draft Financial Stability Law, designating an independent and properly resourced lead resolution authority, building greater crisis management capabilities, and introducing an effective emergency liquidity assistance framework. - The corporate restructuring and insolvency framework should be modernized and aligned with international standards to handle the overhang of distressed debt, including from the LGFV and property sectors. ### Financial inclusion and MSME finance - Financial inclusion is high and access to finance has increased, but financing gaps for micro, small and medium-sized enterprises (MSME) persist. - Account penetration, savings, and use of payment services is generally very high, but credit constraints for MSME appear to persist. - Efficiently leveraging targeted interventions, including partial credit guarantee schemes, can help support MSME lending while ensuring adequate risk pricing. ### Climate-related financial risks - China has been at the forefront of green finance and must increase focus on climate-related financial sector risks and enhance coordination, data, and capacity. - Risk analysis suggests that the impact of transitioning to a green economy would be limited for banks, but balance sheets are exposed to rising physical risks. - Regulators should bolster capacity for climate risk understanding and oversight and improve coordination to enhance efficiency and improve the climate information framework. ### Key recommendations (Table 1: China: FSAP Key Recommendations) - Cross-cutting - 1. Design and implement a medium-term comprehensive plan to address financial stability risks associated with LGFV debt overhang. — Multiple, High, I - 2. Take decisive steps to fully recognize expected losses on balance sheets of financial institutions and continue to move toward market-based pricing of financial assets. — Multiple, High, I - Systemic Risk Analysis - 3. Strengthen analytical and stress testing capacity, supported by more granular data and specialist staff, to comprehensively analyze bank specific and system-wide risks including those from concentrations of exposures including LGFV debt; ensure sufficient scrutiny of banks’ internal risk models. (¶22, 50, 52) — NFRA, PBC, High, ST - 4. Closely monitor the growth of exposures to non-viable entities in bank balance sheets; assess macrofinancial risks stemming from delayed loss recognition; and switch to a forward-looking approach in assessing systemic risks. (¶22, 49, 53) — NFRA, PBC, High, I - 5. Enhance analytical capacity for comprehensive and granular analysis of climate-related risks in the financial system, aided by improved data collection and strengthened collaboration with climate-relevant government and research agencies. (¶47) — NFRA, PBC, Medium, MT - Macroprudential Policy Framework - 6. Further strengthen systemic risk monitoring by creating a stress event dataset, back-testing indicator properties and deriving data-based thresholds for policy actions and enhance coordination by establishing a Macroprudential Policy Committee to include key agencies. (¶50) — PBC, Medium, MT - Financial Sector Oversight — Cross-cutting Issues - 7. Expand NFRA’s autonomy over resources and strengthen staffing, particularly at head office—informed by a bottom-up analysis—to meet new challenges, accommodate increased responsibilities, and strengthen supervisory intensity. (¶52) — NFRA, High, ST - 8. Clearly communicate and ensure the primacy of the NFRA’s safety and soundness objective, as compared to developmental objectives. (¶52) — CSRC, NFRA, High, ST - 9. Strengthen data validation and broaden the perimeter of horizontal risk analysis; continue developing technical skills to support supervisory risk assessments and centralize expertise through the establishment of dedicated risk teams. (¶52, 53) — NFRA, Medium, ST - Banking - 10. Enhance the effectiveness of the Supervisory Review Process to address institution-specific risks and risks not covered under Pillar 1; tailor bank capital requirements to individual risk profiles through more active use of Pillar 2. (¶51) — NFRA, Medium, ST - 11. Enhance transparency by making granular information on banks’ financial soundness—including prudential ratios, metrics on credit portfolio quality, profitability and liquidity metrics—publicly available. (¶54) — NFRA, PBC, High, MT - 12. Intensify oversight of smaller and high-risk banks (¶55, 22) — NFRA, High, ST - 13. Strengthen oversight of bank and banking group shareholders and reduce the limit on aggregate related-party exposures. (¶55) — NFRA, Medium, ST - Securities and Derivatives Market - 14. Ensure price-stabilization measures do not undermine the credibility of price formation including by closely monitoring use of market-wide circuit breakers and enhancing communication on the rationale for any intervention in the equity market. (¶58) — CSRC, Medium, ST - Insurance - 15. Continue addressing transitional issues (e.g., C-ROSS-II); refine supervisory assessment methods and skills regarding corporate governance; provide guidance on insurer stress tests. (¶59) — NFRA, High, ST (I = “Immediate” is within one year; ST = “short-term” is 1–3 years; MT = “medium-term” is 3–5 years.) *People’s Republic of China: Executive Summary, Financial Sector Assessment Program* ### 16. Designate a lead authority to coordinate comprehensive risk ### 16. Designate a lead authority to coordinate comprehensive risk assessments, aided by intensified market surveillance, while leaving the responsibilities and autonomy of the sectoral agencies intact. (¶61) ### Key recommendation and implementation priorities - Designate a lead authority to coordinate comprehensive risk assessments across the financial sector, with intensified market surveillance, while preserving the responsibilities and autonomy of sectoral agencies. - Associated authorities listed: CFC, CSRC, NFRA, PBC. - Priority: High; Timeframe: ST (short term). ### Related priority recommendations summarized (from Table 1) - Big Tech: Strengthen rules for systemically important PSPs, introduce tiered prudential requirements, and a consolidated monitoring framework for BigTech activities. (PBC; Medium; ST) (¶62, 63) - Systemic liquidity management: - Further optimize the reserve requirement framework by aligning its tenor with the OMOs and optimizing the penalty schedule for reserve shortfalls. (PBC; Medium; MT) (¶66) - Strengthen the collateral framework by revising eligibility criteria, introducing robust valuation methodologies, and applying conservative haircuts. (PBC; High; ST) (¶66) - AML/CFT: - Finalize and enact amendments to the Anti-Money Laundering Law. (PBC; Medium; ST) (¶68) - Strengthen beneficial ownership regime, fully operationalize the register and publication of information. (PBC; Medium; ST) (¶70) - Financial safety nets, crisis management, corporate insolvency (selection): - Refine and enact the draft Financial Stability Law to introduce an effective resolution regime aligned with international good practice. (CDIC, NFRA, PBC; High; I) (¶72) - Designate and operationalize a dedicated lead resolution authority and clarify the role of the Central Financial Committee (CFC) to centralize resolution functions. (CDIC, NFRA, PBC; High; ST) (¶73) - Extend LAC requirements to, at least, all D-SIBs and reconsider (or at least cap) reliance on DIF resources as a discount on TLAC requirements. (CDIC, NFRA, PBC; Medium; MT) (¶75) - Adopt regulations governing the FSGF, including funding target, governance, contributions, usage, and public backstops. (CDIC, MOF, NFRA, PBC; Medium; ST) (¶75) - Limit use of DIF resources to insured deposit payouts and contributions to transfer strategies on a ‘least cost’ basis; increase industry contributions to the DIF. (CDIC; High; I) (¶76) - Design and implement a dedicated framework for emergency liquidity assistance aligned with international best practices. (PBC; High; ST) (¶66) - Corporate insolvency: - Increase courts’ capacity and expertise and establish comprehensive regulation of insolvency administrators. (NPC, SPC; Medium; MT) (¶77) - Update the Enterprise Bankruptcy Law to regulate pre-reorganization procedures, amend reorganization provisions per international standards, and introduce provisions for group and cross-border insolvency. (NPC; High; ST) (¶79, 80) - Strengthen supervision, regulation, and transparency of AMCs; publicly disclose basic data such as sale prices and recovery rates. (NFRA; High; MT) (¶81) - Financial sector development: - Revise definition of “financial inclusion MSE” to objective criteria; phase out policies based on lending targets and reduced credit spreads for MSME loans. (MOF, NFRA, PBC; High; ST) (¶82) - Adhere to market-oriented and rule-based reforms to support long-term capital development objectives. (CSRC, exchanges, NFRA, PBC; High; ST) (¶82) - Enhance climate risk disclosure standards and guidance; further harmonize national taxonomies. (CSRC, MOF, MEE, NDRC, NFRA, PBC; High; MT) (¶82) ### Macrofinancial context and systemic findings relevant to the recommendation - Growth and inflation: - China’s growth is facing downward pressures; medium-term prospects expected to remain below pre-pandemic levels. (Annex 1, Figure 1, chart 1) - Inflation has trended down; monetary policy is accommodative amid continued economic slack, with risks of sustained disinflation. (Annex I, Figure 1, chart 2) - Property sector and LGFV vulnerabilities: - The property sector is experiencing the deepest correction in recent history, with profound macrofinancial implications; primary market sales plummeted in 2021 and sales remain sluggish. (Annex I, Figure 1, chart 3) - As of end-2023, outstanding LGFV debt was equivalent to 46 percent of GDP. (para 4) - Figure 2 reports: As of end-2023, LGFV debt amounted to 8 trillion USD (47 percent of GDP), 75 percent of which is held by banks. - Staff estimates suggest that 39-46 percent of LGFV debt needs restructuring to restore LGFV debt servicing capacity. - LGFV default wave is identified as a serious risk to financial stability given valuation uncertainty and potential insufficient provisions. - Credit and balance sheets: - Credit demand remained weak post-pandemic despite monetary easing and required reserve ratio cuts. (para 5) - Household debt to financial entities comprised around nine percent of total system assets; savings accounted for almost 32 percent of disposable income in 2023. (para 6) - Bank credit to nonfinancial corporates (including LGFV) amounted to 134 percent of GDP in 2023; corporate leverage around 38 percent. (para 6) - Bank lending to micro and small enterprises (SME) rose steeply to 12 percent of total bank loans in 2023. (para 6) - Financial system structure: - Banking sector remains dominant, bank-centric, largely government-controlled, and highly interconnected. (para 7) - Five state-owned G-SIBs and one other large bank together account for around 42 percent of total banking system assets. (para 7) - About 70 percent of debt securities held by banks are booked at amortized cost. (para 7) - Cross-border exposures are limited. (para 7) - Capital markets and institutions: - Bond and equity markets stand at 126 and 61 percent of GDP respectively. (para 8) - Key institutional investors are relatively small: pension funds 10 percent of GDP; insurance companies 24 percent of GDP. (para 8) - Insurance sector: total premium for 2023 was over US$730 billion; life insurance penetration 4.1 percent. (para 9) - Nonbank financial intermediaries: total assets under management estimated at 95 percent of GDP (down from 130 percent of GDP in 2017). (para 10) - Green finance and digital finance: - Green lending represents 12 percent of all bank loans; about US$270 billion in outstanding green bonds in the corporate market. (para 11) - Use of digital payments is almost universal, with 97 percent of account owners having made or received payments via digital channels (latest available data for 2021). (para 12) ### Analytical scope and data limitations relevant to coordinated risk assessments - FSAP resilience assessment used five core exercises: solvency and liquidity stress testing, climate risk analysis, interconnectedness (contagion) analysis, and targeted sector risk assessments (NBFI, LGFV, households, corporates). (para 13) - Data access limitations: - Authorities provided confidential supervisory data for 55 largest banks (assets > US$70 billion) for solvency stress tests and for 111 banks (assets > US$30 billion) for liquidity and interconnectedness analysis. - Systemic analysis of small banks was hampered by lack of supervisory data and limited public data; authorities did not share institution-specific exposures to LGFV and property developers. - To complement stress testing, FSAP conducted sensitivity analyses and used public data where possible. (para 14) ### Implications for policy design and coordination - Rationale for a lead authority: - Coordinating comprehensive risk assessments and intensified market surveillance would address cross-sectoral vulnerabilities (LGFV, property, NBFI, BigTech) and data fragmentation. - A central coordinator can facilitate information sharing across CFC, CSRC, NFRA, PBC, CDIC, MOF, NPC, SPC, MEE, NDRC, and other agencies referenced elsewhere in Table 1. - Implementation considerations: - Preserve sectoral agencies’ responsibilities and autonomy while providing a centralized mandate for cross-cutting risk identification, assessment, and market surveillance. - Prioritize closing data gaps (small banks, institution-level LGFV exposures, granular balance sheet items) to improve scope and depth of systemic risk assessment. - Coordinate with planned reforms in resolution frameworks, emergency liquidity assistance, collateral and reserve frameworks, AML/CFT, and BigTech prudential rules to ensure coherent macroprudential and crisis management frameworks. *Source: IMF Financial System Assessment Program (FSAP) — China (excerpts as provided).* ### 15. Analysis of the largest 55 banks—close to 80 percent of banking sector assets— ### 15. Analysis of the largest 55 banks—close to 80 percent of banking sector assets— ### Overview and key vulnerabilities - Sample: 55 banks (six state-owned banks—G02; 12 joint-stock banks—G03; 28 city-commercial banks—G04; eight rural commercial banks—G05; and one international bank allocated to G04). - Coverage: The sample represents close to 80 percent of banking sector assets. - General assessment: This segment is described as well-capitalized with ample liquidity buffers, though publicly available data and disclosure practices are opaque and may mask underlying vulnerabilities (Annex I, Figures 3 and 4). ### Asset quality and performance - NPL ratios: Have remained broadly stable and below 2 percent for several years (Table 3). - Opacity and forbearance: Balance sheets are opaque, with weak public disclosure on NPL inflows and loss-deferral practices including preemptive transactions, regulatory forbearance, and disposal of NPLs to AMCs at potentially inflated prices. - Profitability: Relative to international peers, capitalization is lagging, with low return on assets (ROA) and a high reliance on interest income. - Bond holdings: Smaller banks hold relatively large bond portfolios exposed to fair value changes; bonds classified as “amortized cost” can hide unrecognized losses that would crystalize on sale. - Investments: Joint-stock and city commercial banks hold more than 10 percent of their assets in “other investment,” which at least in part funds risky asset classes via non-bank financial intermediaries. - Liquidity funding mix: Joint-stock and city commercial banks rely more on wholesale and interbank funding and have a larger share of contingent liabilities (credit and liquidity lines to customers). - Profitability vulnerability: Joint-stock and city commercial banks show the lowest profitability despite relatively riskier business models; net interest income (NII) may be insufficient to absorb losses. - Smaller banks: A number of smaller banks in the group are fragile, with lower capital ratios, declining profitability, and elevated asset quality risks. ### Regulatory capital and RWA observations - Capital composition: About 70 percent of regulatory capital is comprised of Common Equity Tier 1 (CET1); Tier 2 capital comprises 20 percent of capital and is relatively high compared with other jurisdictions. - RWA density: Credit risk RWA represent over 90 percent of total RWA; market risk RWA are minimal. RWA density for credit risk appears rather low for the five largest banks that follow the IRB approach. ### Macrofinancial scenarios - Scenarios: A three-year baseline and adverse scenario underpin the systemic risk analysis (Annex I, Figure 5). The baseline aligns with the IMF’s April 2024 WEO. - Adverse scenario features: Abrupt economic slowdown, commodity price volatility, deepening property sector slowdown and balance sheet recession, and stagflationary risks from global oil market disruptions. - GDP impact: Under the adverse scenario, the two-year cumulative real GDP growth path for China deviates -8.2 percentage points from the baseline (2.5 times the standard deviation from the two-year historical mean). ### Solvency stress test results - Baseline projection: Aggregate CET1 capital ratio rises to 11.9 percent of total RWA by 2026 (up from 10.7 percent in 2023). All sample banks meet the minimum CET1 requirement of five percent, although three banks (two in G03 and one in G04) do not meet their Pillar 1 capital requirements. - Adverse scenario aggregate: CET1 falls by 3.7 percentage points relative to baseline and declines to 8.2 percent by end-2026. - Group outcomes: - G02 aggregate CET1 ratio: 9.7 percent by 2026; G02 banks remain profitable in final two years with capital depletion driven by a 22.8 percent increase in their IRB RWA due to sharp increase in projected PDs. - G04 banks: Aggregate CET1 drops to 5.4 percent. - G03, G04, G05: All incur losses throughout the adverse scenario, primarily driven by elevated credit impairments partially offset by more benign interest income paths. - Bank shortfalls: - Number failing minimum CET1 in adverse scenario: 12 of 55 banks (five in G03, six in G04, and one in G05). - Number failing full Pillar I capital requirements: 31 banks (four in G02, 11 in G03, 14 in G04, and two in G05). - Aggregate shortfall magnitudes by end-2026: - Total CET1 shortfall against minimum CET1 requirements: 0.5 percent of RWA (or 0.7 percent of China’s GDP). - Total CET1 shortfall against Pillar I requirements: 1.8 percent of RWA (or 2.5 percent of China’s GDP). - Cost to restore CET1 and total capital ratios of the banking sector to initial levels: about 3.9 percent of China’s GDP. - Group-level Pillar I shortfalls (as percent of each group’s combined RWA): - G02: 0 percent and 1 percent. - G03: 0.9 percent and 2.8 percent. - G04: 2.2 percent and 3.1 percent. - G05: 0.1 percent and 0.5 percent. - Distribution of credit impairments: Three-year cumulative credit impairments amount to 5.6 percent of starting RWA for the sample as a whole. - Net interest income behavior: - G02 NII: 7.4 percent in adverse scenario versus 7 percent in baseline. - Market risk contribution: Market risk contributes just 0.1 percent to solvency stress test results and losses are pronounced in first year then reverse. - Smaller banks extrapolation: Applying capital depletion rates from the sample to smaller banks suggests many more small banks would face capital shortfalls due to low starting capital, weaker asset quality, and subdued profitability, risking localized confidence shocks. ### Liquidity stress test results - Sample: 111 banks representing 87 percent of commercial bank assets; all subject to LCR and NSFR reporting. - LCR baseline: Under baseline all banks meet the LCR requirement, but some banks appear vulnerable to sudden deposit withdrawals. - LCR stress scenarios: Three scenarios—higher retail deposit withdrawals, higher wholesale deposit withdrawals, and combined—compared to baseline regulatory parameters. - Large state-owned and joint-stock banks tend to have lower LCRs as of end-2023. - In the retail scenario some city and rural commercial banks fall below the regulatory requirement. - Wholesale and combined scenarios erode liquidity buffers for some large banks because of reliance on deposits from corporate and financial entities reported as “unstable” or “non-operational.” - Deposits classification caveat: A sizeable portion of deposits labeled “unstable” may be deposits of large state-owned enterprises which are generally stable; term deposits reported as “non-stable” can be withdrawn with a small interest penalty but are in practice remarkably stable—this labeling may bias stress results upward. - Cash-flow analysis: A country-specific cash-flow analysis uses assumptions including: - Higher stability of term deposits; - Higher run-off rates for credit and liquidity lines to customers; - System-wide outflows anchored to approximately 20 percent of total liabilities over a one year period; - Inclusion of all unencumbered HQLA, not restricted by any cap. - Under the adverse scenario several joint-stock and city commercial banks experience small liquidity shortfalls beyond one month due to material contingent liabilities. - NSFR: Reported NSFRs show the 111 banks have sufficiently stable funding sources on average; all groups meet the regulatory 100 percent requirement but joint-stock banks have lower NSFRs due to reliance on short-term and less stable wholesale deposits. ### Contagion and interconnectedness - Interbank network analysis: Applied Espinosa-Sole framework to domestic bilateral exposures among 111 banks (interbank loans, deposits, repos, derivatives, certificates of deposit, bond holdings). - Contagion patterns: Large banks tend to be more contagious; hypothetical failure of a state-owned or joint-stock bank tends to have larger impact due to proportionally large exposures to counterparties. - Underestimation caveat: The 111-bank network is a fraction of China’s financial system (over 4,000 banks and hundreds of NBFIs). Interbank exposures captured represent less than 10 percent of the total inferred from banks’ balance-sheet information; contagion results should be viewed as a lower bound. - Cross-sectoral exercises: - Co-movement of PDs for 119 publicly listed banks, securities firms, and investment companies to build a network and quantify credit and contagion losses. - Econometric analyses identifying fiscal and financial factors influencing funding costs of LGFVs and regional banks across 31 provinces. - Parsimonious VAR model estimating macrofinancial feedback effects among three real estate sectors, five financial sectors, and three macro variables to measure impact over time of idiosyncratic shocks. ### Data limitations and implications - Key data gaps that limit precision: - Lack of granular, bank-specific data limits credit risk segmentation and provisioning analysis. - Absence of detailed IFRS 9 staging data and granular information on proportion of lending secured by real-estate collateral and loan-to-value distributions complicates modeling of credit risk parameter paths and loan transitions. - Absence of detailed interest rate data across asset and liability maturity ladders complicates net interest income modeling. - Resulting caution: Stress-test conclusions are subject to these limitations and improved data collection and data sharing would enhance the usefulness and precision of stress testing. ### Policy-relevant takeaways - Capital buffers: While aggregate resilience appears adequate, G03 and G04 banks are most vulnerable under adverse shocks, and restoring capital to initial levels would be costly (about 3.9 percent of China’s GDP). - Liquidity monitoring: Reliance on wholesale and interbank funding and large contingent liabilities for some banks necessitates close monitoring of funding stability and contingency planning. - Small-bank fragility: Fragility among smaller banks could generate localized confidence shocks with potential regional second-round effects—policy attention is warranted. - Data and disclosure: Enhanced public disclosure on NPL inflows, loss-deferral practices, transfer prices and secondary market sales by AMCs, IFRS 9 staging, collateral/LTV details, and detailed interest-rate maturity ladders is important to reduce uncertainty and improve stress-test accuracy. *Source: Chinese regulatory authorities and IMF staff calculations.* ### 31. Small financial intermediaries are highly connected with the wider financial system and ### 31. Small financial intermediaries are highly connected with the wider financial system and ### Interconnectedness and contagion - Small intermediaries (some joint-stock banks, smaller city commercial banks and securities firms) can cause material contagion loss because they "actively engage in financial market transactions with various market participants." - Hypothetical failure of big banks incurs heavy losses to their creditors due to the "sheer size of the liabilities." - Distress transmission channels: - Distress of privately-owned developers (measured by their PDs) is later experienced by state-owned developers and financial institutions due to recognition of losses on defaulted real estate exposures. - Distress in one group of financial institutions spills over to others and to developers, likely via funding shortfalls. - Declining property prices weaken developer profitability, dampen confidence, discourage real estate investment, and weaken macroeconomic prospects. ### Nexus between regional governments and financial institutions - The nexus varies in form and strength across provinces. - Empirical findings: - A stronger fiscal position of a provincial government (including via general budget and land sales) supports cheaper LGFV funding, possibly due to perceived implicit guarantees. - Some provinces are associated with higher risk premia, which may reflect LGFV debt servicing track records and governments’ ability and willingness to influence operations and market pricing. - Health of regional banks significantly affects LGFV financing costs, likely due to their dominant funding role or prevailing market perceptions. - LGFV soundness affects local banks’ financing burden. ### Local Government Financing Vehicles (LGFVs) — vulnerabilities and required relief - A sizeable portion of LGFVs is highly leveraged, exhibit structurally weak debt-servicing capacity, and/or face material liquidity risk. - Findings on LGFV debt holders: - Banks hold 75 percent of LGFV debt. - Asset management products hold another 16 percent of LGFV debt. - Illustrative debt relief exercise (based on a sample of about 3,700 bond-issuing LGFVs and about 400 banks covering about 95 percent of banking sector assets; bank sample based on WIND database): - LGFVs may require up to US$38 billion per year of interest reductions, or additional financial support (e.g., debt write-downs or debt swaps). - Support needed to restore debt-servicing capacity where debt is perpetually rolled over (but not reduced) could require debt relief up to US$1.24 trillion (or approximately 7 percent of GDP). - If debt service includes principal repayments, costs would be larger. - Repayment extensions can provide some relief but do not fundamentally address underlying problems. - Caveats: - The exercise is largely illustrative; rendering LGFV debt sustainable in the long term requires a comprehensive, multi-year solution because of variety in business models, governance arrangements, and complex macro-fiscal-financial interconnections. - Lack of data on holdings of LGFV debt by entity constrains the scope; quantitative impact assessment should be interpreted with caution. - The exercise assumes LGFVs whose earnings before interest and taxes during 2021–2023 are insufficient to cover interest expenses (based on current funding costs) would be subject to debt restructuring. ### Impact on banks and asset management products - Bank exposures and impacts: - FSAP assumed bank exposure to LGFV debt of US$6 trillion, mostly in the form of loans. - If banks bear the full burden of LGFV debt relief, losses could be considerable; in an extreme case with a full write-down of unsustainable debt and no interest rate relief, capital depletion for the sampled banks could reach around 2.9 percentage points. - Even interest reductions alone could substantially reduce bank profitability, especially for some local banks. - Overlay to banking solvency exercise (three principal repayment schedules: perpetual roll-over and over 10 and 20 years): - Additional impact on banks’ NII over year 2023 RWA from LGFV interest rate reduction would range from 25 to 31 basis points (subject to restructuring assumptions). - Respective impact on CET1 ranges from 11 to 27 basis points. - Results do not include impact of any debt write-downs that might be required to restore weaker LGFVs’ debt servicing capacity. - Sensitivity results should be taken as approximate because data on individual bank holders of LGFV debt was not available to the FSAP. - Asset management products: - Certain asset management products (plans managed by intermediaries, trust products and bank WMPs) have relatively large exposures to LGFV debt in comparison to their total assets under management. - LGFV debt restructuring could induce valuation losses, trigger large-scale redemptions on some asset management products, and disrupt corporate bond and repo markets. - LGFV restructuring could weaken market perception of future government support, triggering repricing of LGFV funding spreads and potential spillovers to banks, especially in provinces with weak fiscal positions. ### Corporate sector findings - Corporate debt and solvency: - Corporate debt in China was 134 percent of GDP in 2022 (even excluding LGFV debt the figure remains high at 82 percent of GDP). - Aggregate solvency indicators point to sound balance sheet fundamentals: relatively low aggregate long-term debt ratio (< 30 percent of corporate assets) and a relatively small increase in overall leverage levels. - Firm-level analysis: - Firm balance sheet data for 11,300 firms covering 2013–2023 were analyzed across eleven economic sectors. - Firm-level PDs and aggregate PD paths were estimated using a survival model. - SME lending sensitivity: - Increasing the share of SME lending materially affects bank credit risk under stress. - Cumulative total credit losses as a proportion of RWA are projected to rise by approximately 20 basis points for every 10 percent increase in SME lending under the baseline scenario; in the adverse scenario the rise would be one percentage point higher. - The corporate PD analysis splits PDs into large corporates (from survival model) and SMEs (conditional PD estimation using a Bayesian approach). - The FSAP could not convey numerical results for some analyses because authorities restricted extraction of confidential data. ### Households - Household debt and metrics: - Household debt reached 63.7 percent of GDP by end-2023. - Mortgage loans account for about half of all household debt. - Aggregate debt-to-assets for households is around 9.1 percent. - Average debt service-to-income ratio (DSR) is 18.4 percent. - Debt distribution is uneven: 20 percent of households hold 60 percent of the total debt. - Around 35 percent of total debt is held by households with a DSR over 40 percent. - 12.8 percent of total debt is held by those with a DSR over 60 percent. - Recent mortgage prepayments have further concentrated debt among the highly indebted households. - Aggregate loan-to-value ratios remain prudent, suggesting vulnerabilities to housing price shocks may not be large. - Data caveat: Figures derived from the 2019 PBC Survey on Urban Household Assets and Liabilities in China, which may not fully capture more recent developments. ### Climate-related financial risks - Exposure and risks: - China accounted for 30 percent of global CO2 emissions in 2021. - China is highly exposed to natural hazards (floods, typhoons, extreme temperatures) with probability and intensity expected to increase. - Transition risk analysis: - Adopted an integrated micro-macro approach with 26 economic sub-sectors. - Explored three climate policy scenarios via a global macro-econometric model: - "orderly" (reflecting China’s planned energy efficiency program), - "disorderly" (including accelerated decarbonization efforts in China), - "disorderly-global" (incorporating accelerated transition efforts at a global level). - Estimated impact on bank capital by 2040 relative to baseline: - Less than 1 percent of total RWA in the orderly scenario. - About 9 percent of total RWA in the disorderly-global scenario. - Banks have relatively modest exposures to sectors directly impacted by transition risk. - Physical risk analysis: - Assessed impact of floods and typhoons using historical and climate change scenarios across 31 provinces. - Climate risk can induce a significant increase in economic and financial tail risks relative to historical distributions. - Largest increases in probability of potential economic damages and associated credit and market risks are concentrated along eastern regions (which account for over 26 percent of GDP). - Caveats and needs: - Interpretation subject to caveats from data gaps, modeling complexities, and uncertainty in climate projections. - FSAP team did not have access to bank-specific data for physical risk analysis. - Calls for enhanced analytical capacity, more granular analysis, and improved data collection and collaboration. ### Financial sector oversight and macroprudential policy - Regulatory overhaul in 2023: - Overhaul created the NFRA, which took previous responsibilities of the China Banking and Insurance Regulatory Commission and financial holding company supervision and investor protection; staff were transferred from PBC regional offices. - The Central Financial Commission (CFC) is the Chinese Communist Party Central Committee's decision-making and coordinating body in the financial sector. - System-wide oversight and macroprudential policy: - Significant progress since 2017 in operationalizing the macroprudential framework. - The planned Macroprudential Policy Committee could improve policy formulation, but interagency cooperation (data-sharing and joint analysis) should be strengthened. - Recommendations to strengthen systemic risk monitoring: - Develop a more sophisticated stress testing framework incorporating advanced modeling techniques, diverse risk scenarios, and robust and granular data integration. - Build greater analytical capacity, notably within the PBC. - Improve analytical and empirical underpinnings of risk indicators and models. - Develop policy guides, conduct more frequent back-testing, and increase transparency to better inform market participants. - Consider introduction of a positive/positive-neutral countercyclical buffer (CCyB) and concentration limits for highly indebted companies. *Source: 1chnea2025001-print-pdf - chapter excerpt on financial interconnectedness, LGFVs, corporate and household vulnerabilities, climate-related financial risks, and regulatory structure.* ### 51. Notwithstanding important gains since the 2017 FSAP, banking regulation and ### Notwithstanding important gains since the 2017 FSAP, banking regulation and supervision warrants further strengthening, commensurate with the banking system’s scale and complexity. ### Banking regulation, Basel III, and Pillar 2 - Implementation of the Basel III framework, together with strengthened rules for asset classification, consolidated supervision, and related party transactions, has supported a significant shift towards more risk-based supervision. - To bolster bank resilience, capital requirements should be further tailored to institution-specific risk profiles, including through active use of the Pillar 2 framework. - Pillar 2 is needed to better capture risks not covered under Pillar 1 of the Basel framework (e.g., interest rate risk in banking book and concentration risk). - Conducting a round of thematic reviews on stress testing models of banks would contribute to a more proactive and effective Pillar 2 framework. - FHC rules should be further enhanced by developing rating methodologies and a more complete set of prudential requirements. ### NFRA independence, resourcing, and capacities - Greater independence of the NFRA and a clear prioritization of its safety and soundness mandate would enhance the agency’s credibility and effectiveness. - Lack of operational independence and the inability to prioritize stability over financial sector development were identified in 2017 as key issues for the NFRA’s predecessor and remain broadly applicable. - Resource and staffing needs: - NFRA should have more resources; a significant staffing increase seems necessary to strengthen oversight of regional offices, increase the depth of onsite inspections, allow more thorough horizontal data analysis and risk oversight, and meet additional demands arising from new responsibilities (FHC supervision, and investor protection). - Further efforts are needed to cultivate specialized skills in key risk areas and technical fields like stress testing and model validation. - A thorough review of staffing levels, competencies, and developmental plans will be pivotal to the long-term success of the new agency. ### Supervisory intensity, thematic reviews, and transparency - The NFRA utilizes a comprehensive set of supervisory tools, but there is room to increase supervisory intensity and horizontal analysis. - Following refinements of the internal supervisory rating system, supervision should be intensified for banks rated high or medium-high risk, with supervisory expectations communicated more effectively to foster a stronger risk culture. - Authorities should gather more detailed information on exposures to LGFV and property developers, conduct quantitative analyses (stress testing and sensitivity analysis), and ensure that residual forbearance measures are not further extended. - Greater use of thematic reviews can better identify systemwide risks and enable supervisors to benchmark institutions more comprehensively. - Enhancing transparency is imperative to underpin market confidence. - Greater transparency of banks’ financial conditions beyond the largest banks is needed. - Centralizing and making publicly available key information on banks’ financial statements and regulatory indicators would align China with international good practice. - Improving disclosure, accounting, and auditing requirements can help increase market discipline; progress since the 2017 FSAP has been slow. ### Supervision of smaller banks and consolidation - Supervisory focus on smaller banks is required because they have greater credit quality concerns, less diversified funding profiles and weaker profitability. - Enhanced risk analyses, aided by improved data quality, are key for strengthening oversight with particular attention to liquidity management and funding profiles. - Continued emphasis on banks’ risk cultures and governance practices—enhancing fit and proper assessments, reducing ownership opacity, and tightening limits for related-party exposures—is essential. - Weak institutions should be resolved rather than amalgamated into larger institutions; supervisors should assess merger proposals via forward-looking analysis, focusing on business model and financial soundness with emphasis on long-term viability. ### Securities and Derivatives Markets - Regulatory improvements: - The 2019 Securities Law and 2022 Futures and Derivatives Law provided greater legal certainty, improved disclosure standards and improved corporate governance requirements. - Primary markets moved to a registration-based regime; new mechanisms to support investor rights are starting to bear fruit. - Many G20 post-GFC over-the-counter derivatives reforms are in place. - Supervision and delineation: - Robust supervision of issuers, credit rating agencies, sponsor institutions, auditors, and law firms, combined with robust enforcement, remains critical. - The CSRC should more clearly delineate its role from that of China’s stock exchanges. - Market opening initiatives: - Connect programs for bonds, swaps, repos, and equities were launched and schemes enabling direct participation by qualified international investors in the Chinese mainland markets were introduced. - Authorities should carefully review new schemes prior to launch to ensure risks can be robustly managed and reliable legal remedies are available. - Market volatility measures: - Secondary trading systems have proven largely resilient; business continuity and operational resilience requirements are robust. - The market-wide price bands and stock-specific volatility halts that replaced market-wide circuit-breakers should be closely monitored to balance price formation and volatility management. - Interventions in equity markets should be clearly rationalized and limited to measures that do not unduly impede price formation. ### Insurance sector - Regulatory reforms have strengthened operational practices since the 2017 FSAP, with greater emphasis on capital, risk management and governance. - Continued transition to more risk-based supervision is needed, including further developing onsite supervision skills and corporate governance assessments. - Finalizing the transition to full observance of new prudential standards (C-ROSS-II) is important. - NFRA should ensure insurers link risk management more closely to business strategies, plans, and operational processes, including through stress testing. - As NFRA absorbs staff transferred from the PBC’s regional offices, strengthening data analytics and modelling capacity remains a priority. - Promoting insurance of mortgage collateral and other personal lending (e.g., vehicle loans) would add stability benefits. ### Nonbank Financial Intermediation (NBFI) - The 2018 asset management reform reduced linkages between NBFIs and the banking sector by aligning regulatory frameworks and addressing implicit guarantees, asset pooling, and opaque multi-layer investments. - Despite progress, episodes of heightened risk in trust companies, increased redemptions in mutual funds, and pressure on WMPs indicate the need for continued vigilance. - Oversight should be enhanced: - Regulation is currently compliance-based and fragmented across the PBC, NFRA, and CSRC. - Foster increased collaboration and greater use of risk-based approaches to supervision to enable a comprehensive system-wide approach and more timely responses to distress. - Pay particular attention to vulnerabilities from liquidity risk and increased redemptions in some NBFIs. ### BigTech - Regulation of BigTech financial activities is divided by function: payment services by the PBC; digital microfinance, digital banking, and digital insurance by the NFRA; investment activities by the CSRC; PBC coordinates overall approach. - Payment institutions under BigTechs are required to keep clients’ funds with the PBC and clear transactions through NetsUnion and China UnionPay. - Recommendations: - Differentiate between systemic BigTechs and non-systemic nonbank PSPs and adopt a framework to manage BigTech risks on an enterprise-wide basis, including tiered prudential requirements—this could be done through the existing FHC regime. - Consider standardized training for supervisors on digital technologies. - Designate a clear regulatory lead entity to monitor financial interconnections between BigTech and incumbent financial institutions, with coordination assigned to the agency overseeing the largest or most systemically important activities within each BigTech group. - Strengthened interagency coordination remains necessary despite transfer of FHC supervision to the NFRA. ### Financial Market Infrastructures (FMI) - PBC and CSRC have strengthened inspection models, disaster recovery, emergency response, and business continuity requirements, and implemented business continuity stress tests with non-bank payment institutions. - Priorities remain: - Develop recovery and resolution plans for critical FMI. - Enhance the risk management framework of the large-value payment system and the Shanghai Clearing House. ### Systemic Liquidity Management - Interbank money market: - Liquidity intermediation benefits from effective regulation and robust infrastructure; market driven by overnight general collateral pledged repo transactions with minimal unsecured lending and title-transfer special repo activity. - Central clearing enhances market liquidity and stability; NBFIs act as net borrowers constrained by regulatory limits and the absence of re-hypothecation. - PBC policy transition: - Systemic liquidity management is in a transitory phase as the PBC shifts from a quantity-based to a price-based framework. - The PBC should focus on providing an efficient backstop in times of liquidity stress rather than managing liquidity risk in normal times. - Flexibility in the reserve requirement framework should be pursued. - Replace the inefficient practice of easing reserve requirements upon request with a dedicated emergency liquidity assistance (ELA) framework. - Enhance risk mitigation measures for normal and emergency liquidity provisions, especially collateral valuation and haircuts in open market operations and re-lending facilities to safeguard the PBC's balance sheet. - Interbank bond market: - The interbank bond market operates effectively though trading is concentrated in a few liquid instruments. - Collaboration between the MOF and the PBC ensures liquidity for near-maturity off-the-run series, although in lesser amounts. - The PBC has started selling long-term government bonds while purchasing short-term securities to mitigate speculation at the long end of the curve. - Authorities should proactively design timely and targeted support programs to address potential stress from the NBFI sector, which plays a large role in the market but is not covered by the existing framework. ### Financial integrity (AML/CFT) - Legal and regulatory updates: - Authorities should reinforce AML/CFT efforts with enactment of amendments to the Anti-Money Laundering Law, which include increased penalties for violations and establishing the legal basis for the beneficial ownership regime. - Coverage of domestic PEP in the AML/CFT framework remains insufficient. - Supervisory improvements: - Quality of banks’ preventive measures has improved, but risk-based AML/CFT supervision should continue to be strengthened. - Broaden sanctioning options and deepen understanding of the nexus between financial integrity and financial stability. - Greater centralization through the AMLB Head Office would strengthen operational structure, sustain high-quality supervision, produce more consistent risk assessments, and facilitate inter-agency collaboration in connection with fit and proper tests. - Beneficial ownership: - A centralized registry system has been established, although it is not yet fully operational. - Consider benefits associated with public access to beneficial ownership information. ### Financial safety net, crisis management, and distressed assets - Progress since 2017: - Recovery and resolution planning (RRP) has been improved. - Total Loss-Absorbing Capacity (TLAC) requirements have been introduced for the G-SIBs. - A new Financial Stability Guarantee Fund (FSGF) has been established as a backstop for systemic risks. - Authorities have started using transfer strategies in recent episodes of failed entities, with some loss allocation to creditors when liquidating remaining assets. - Shortcomings and recommendations: - The crisis management framework is incomplete, relies on unpredictable and inefficient decision-making, and is de facto reliant on public funding. - Crisis-management powers are dispersed among central and local authorities with no designated lead resolution authority. - Weak institutions are often intervened before an official non-viability determination, interventions driven by social or developmental objectives, often involving government resources and lacking transparency. - The draft Financial Stability Law (FSL) should be strengthened to ensure full alignment with international standards. Critical components still missing include: - (i) unambiguous non-viability triggers; - (ii) strict conditions around the use of temporary public funding to facilitate resolution; - (iii) well-defined mandates and powers for central and local authorities; and - (iv) enhanced legal protection for officials or agents implementing crisis-related measures. - Adopting the FSL and introducing a comprehensive resolution regime would pave the way for further steps to strengthen financial sector resilience. - Institutional overhaul recommendations (paragraph 73): - First, designate/establish a lead resolution authority with operational autonomy and the necessary human and financial resources to design, trigger and implement resolution strategies; it could be standalone or an independent unit within an existing agency. - The authority should initially focus on banks whose (collective) failure could have systemic implications, including through confidence shocks, and in due course broaden mandate to encompass NBFI. - Second, clarify the role of the CFC in crisis management and strengthen inter-agency coordination through a dedicated operational committee. - Third, increase the number of staff dedicated to and specialized in crisis management to match the size and complexity of the sector. - Fourth, develop an interagency work plan for enhancing crisis preparedness. - RRP and resolution funding: - Implementation of an RRP framework is commendable but hindered by the lack of a resolution regime; during the transition, focus on extending RRP scope to all institutions and developing policy guidance and prioritizing banks’ preparatory work to implement resolution strategies. - Existing resolution funding mechanisms require adjustments to restrict the use of official support: - Extend loss absorption requirements to all domestic systemically important banks to enable more effective use of bail-in powers to allow greater burden-sharing with uninsured and unsecured creditors. - Reconsider (or at least cap) reliance on resources from the Deposit Insurance Fund (DIF) as a de facto discount on TLAC requirements. - The FSL should explicitly define public support as a last-resort source of funding. - The FSGF needs transparent governance rules, collection criteria, and usage triggers. *Source: 1chnea2025001-print-pdf - Notwithstanding important gains since the 2017 FSAP, banking regulation and supervision warrants further strengthening (extract).* ### 76. Extensive use of DIF resources has eroded available funding, which now must be ### 1chnea2025001-print-pdf - 76. Extensive use of DIF resources has eroded available funding, which now must be ### Deposit Insurance Fund (DIF): status and recommendations - Extensive use of DIF resources has eroded available funding and the DIF balance was US$8.8 billion as of end-2023 (down from US$17 billion at end-2019), well below its target level of around US$224 billion. - Recommended limits on DIF use: - Use of DIF resources should be strictly limited to insured deposit payouts and contributions to transfer strategies, subject to a least-cost test. - Annual contributions should be increased to allow the DIF to bridge the substantial gap to target level of 1.5 percent of covered deposits. - Backstop recommendation: - An explicit government backstop, in line with international good practices, would enhance resilience of the DIF. ### Corporate insolvency and distressed-asset resolution: findings and reforms - Use and institutional strengthening: - China’s restructuring and insolvency system is increasingly used to resolve distressed corporates, but its use is not yet significant compared to the size of the economy. - Insolvency cases have increased; institutional framework strengthened via increasing judicial specialization, strengthening the insolvency administrator profession, and leveraging technological tools. - Capacity and legal/regulatory gaps: - Areas for improvement include increasing the capacity of judges, introducing comprehensive regulation of insolvency administrators, and pursuing further integration between national and local IT platforms. - The ongoing reform of the Enterprise Bankruptcy Law (EBL) is an important opportunity to improve the insolvency regime and update related tax rules. - Collateral registration and enforcement: - Registries are digitalized, fast, and generally accessible to the public. - Enforcement of security rights in the Civil Procedure Law would be improved by an expedited channel for resolving objections. - The tax administration should register its claims to enjoy priority security over future security interests. - Restructuring practices: - The restructuring toolbox has been expanded and practices have deepened considerably. - Opportunities to converge further with international practices include introducing a standstill of creditor actions, addressing conflicts of interest, and providing priority for additional financing. - Committees would be more effective if they operated under strict time limits. - Pre-reorganization procedures that bridge informal restructuring and judicial reorganization should be explicitly recognized. - Liquidation and reorganization: - Liquidation is widely used and benefits from online auction platforms. - Lack of a temporary stay of enforcement actions impedes going-concern sales and should be addressed. - Improve reorganization by streamlining commencement standards, creating incentives for reorganization use, strengthening rules for contract treatment and post-commencement financing, and enforcing hierarchy of creditor and shareholder claims in plan approvals. - Asset management companies (AMCs) and distressed-loan market: - National and local AMCs are the only entities permitted to purchase NPLs from banks in the primary market. - Data on sale prices to AMCs and AMC recovery rates are not publicly available, complicating assessment of AMC effectiveness and price formation. - Recommendations: strengthen supervision and transparency of AMCs and open the primary market to purchasers beyond AMCs to enhance the market for distressed loans. ### Financial development: inclusion, viability, and climate information - Inclusion and financial gaps: - Account penetration, savings, and use of payment services is generally very high, though segments such as the elderly and new urban residents lag behind. - Estimates suggest up to 17 percent of all MSME continue to face a finance gap notwithstanding recent growth in lending. - Policy role and market development: - Authorities should focus on supporting commercial viability of financial products and additionality of policy interventions. - Consider transitioning from directly guiding financial service providers and advance a capital markets development strategy with: - A rigorous monitoring and evaluation framework. - Focus on improving data availability. - Commitment to enhance market transparency and price formation. - Removal of perceptions of guarantee and more frequent use of exit channels to reduce distortions. - Climate finance and disclosure: - Scope to improve the climate information framework to prevent “greenwashing,” including by enhancing disclosure standards, strengthening green finance taxonomies, and promoting emission data collection and dissemination. ### Authorities’ views (summary) - Authorities’ assessment: - The authorities appreciated the comprehensive and constructive nature of the FSAP and noted the Chinese financial sector has continued to perform well and remains resilient despite numerous global shocks. - They highlighted low levels of non-performing loans, satisfactory capital, enhanced corporate governance, and comprehensive risk management. - FSAP stress tests: even under an extreme shock, the capital shortfall in the banking sector would be modest and manageable. - On ongoing mitigation and data: - Authorities believe the FSAP underplays ongoing mitigation of financial stability risks and that these risks were largely contained by end-2024. - Measures include countercyclical fiscal and monetary support addressing the property sector and continued non-performing asset disposal. - Authorities contest FSAP assumptions on LGFV debt and interconnections, arguing staff analysis overstates risks and does not consider local government support and asset sales. - Authorities noted policy packages introduced in September 2024 helped further contain financial stability risks. - Regulatory progress and outlook: - Authorities welcomed assessments of regulatory and supervisory frameworks and noted steady progress since 2017 (regulatory ratings, on-site inspections, off-site reporting, governance standards, financial holding company regime, unified asset management regulation, insurance insolvency framework, macroprudential framework, Basel III, OTC derivatives reforms). - Emphasized the forthcoming Financial Stability Law will provide the framework for bank resolution and management of systemic crises. ### Key macroeconomic and fiscal projections and indicators (select figures preserved exactly) - Real GDP (base=2015) projections: - 2024: 4.8 - 2025: 4.6 - 2026: 4.5 - 2027: 4.2 - 2028: 3.8 - 2029: 3.5 - 2030: 3.4 - Consumer prices (average): - 2024: 0.3 - 2025: 0.8 - 2026: 1.3 - 2027: 1.7 - 2028: 1.8 - 2029: 1.9 - 2030: 2.0 - Total social financing (growth, percent): - 2024: 8.0 - 2025: 7.5 - 2026: 7.5 - 2027: 7.4 - 2028: 7.4 - 2029: 7.3 - 2030: 7.3 - Non-financial corporate domestic debt (percent of GDP): - 2024: 121.1 - 2025: 125.5 - 2026: 127.1 - 2027: 128.9 - 2028: 131.1 - 2029: 133.7 - 2030: 136.5 - Household debt (percent of GDP): - 2024: 64.5 - 2025: 63.8 - 2026: 63.5 - 2027: 63.2 - 2028: 63.0 - 2029: 62.9 - 2030: 62.9 - General budgetary government net lending/borrowing (percent of GDP): - 2024: -7.9 - 2025: -8.3 - 2026: -8.2 - 2027: -7.7 - 2028: -7.8 - 2029: -7.8 - 2030: -7.8 - Debt (percent of GDP) projections: - 2024: 63.3 - 2025: 71.0 - 2026: 76.3 - 2027: 79.9 - 2028: 83.6 - 2029: 86.9 - 2030: 90.2 - Current account balance (percent of GDP): - 2024: 2.1 - 2025: 2.0 - 2026: 1.9 - 2027: 1.8 - 2028: 1.7 - 2029: 1.5 - 2030: 1.5 - Gross official reserves (billions of U.S. dollars): - 2024: 3,749 - 2025: 4,075 - 2026: 4,216 - 2027: 4,403 - 2028: 4,604 - 2029: 4,801 - 2030: 5,012 - Nominal GDP (billions of RMB): - 2024: 129,584 - 2025: 134,907 - 2026: 142,687 - 2027: 151,041 - 2028: 159,641 - 2029: 168,416 - 2030: 177,481 - Augmented debt (percent of GDP): - 2024: 126.4 - 2025: 134.0 - 2026: 138.8 - 2027: 142.5 - 2028: 146.2 - 2029: 149.8 - 2030: 153.4 *Source: IMF staff analysis and projections contained in the cited chapter.* ### Annex I. Figure 10. Cash Flow Analysis Results ### Annex I. Figure 10. Cash Flow Analysis Results ### Liquidity under baseline and adverse scenarios - The system has sufficient liquidity buffer under the baseline scenario. - It also remains relatively liquidity under the adverse shocks. - While joint-stock banks fare well as a group, some individual banks experience liquidity shortfall in the adverse scenario. - However, several joint stock banks could experience liquidity shortfall due to their larger contingent liabilities and the associated higher run risk. ### NSFR (Net Stable Funding Ratio) findings (Figure 11) - All banks meet NSFR requirement, although joint-stock banks show relatively lower ratios. - NSFR by Bank Group: All banks require similar mix of funding for their credit extension and investment activities. - Required Stable Funding: All banks — longer term funding is mostly provided by the wholesale sector, while retail sector dominates in short term funding. - Available Stable Funding: All Banks — Joint-stock banks rely more heavily on short-term wholesale deposits. - Available Stable Funding: Joint-Stock Banks. ### Interconnectedness and contagion (Figure 12) - Exposures of state-owned and joint stock banks are proportionately larger to the smaller banks. - The interbank exposures captured in this analysis is limited compared to the bank balance sheet. - State-owned and joint stock banks tend to be more contagious due to the sheer size of exposures to the smaller banks based on the data available. - All bank groups appear similarly vulnerable, which could be influenced by the incomplete data coverage of the financial system. ### Too-Big-to-Fail vs Too-Interconnected-to-Fail (Figure 13) - Comparative conceptual mapping presented (sources: Credit Research Initiative, National University of Singapore). ### Fiscal and financial determinants of LGFV/bank financing cost (Figure 14) - Determinants and controls used in regressions: - Chart 1: Issuance = tenor and amount; Issuer = return on asset, interest coverage ratio, issuer’s credit rating, issuer fixed effects; Fiscal = fiscal surplus; Land sale = Land sale/GDP; Provincial premium = province fixed effects; Bank = non-performing loan ratio; Other = GDP growth, reverse repo rate among depository institutions. - Chart 2: Issuance = tenor, amount, bond type; Issuer = capital adequacy ratio, return on equity, issuer’s credit rating, bank type; Fiscal = fiscal surplus; Provincial premium = province fixed effects; LGFV = credit spread averaged across issuers; Other = GDP growth, reverse repo rate among depository institutions. ### Impulse responses to idiosyncratic shocks (Figure 15) - PDs of both public developers and financial institutions increase after shock hits private developers. - Stress of city commercial banks negatively affects other banking sectors and securities firms. - Rising property prices decrease stress of developers and banks; they also increase real estate investment, and to a lesser extent confidence. - Rising consumer confidence supports private developers and financial sector health. - Note: Macro variables include consumer confidence index, growth in real estate investment and property prices. The prescribed shock to them is defined as 1 percentage point and the impulse response is demonstrated in the same unit. By contrast, the unit of shock to and response of real estate and financial sectors is 1 basis point. ### LGFVs’ financial vulnerabilities (Figure 16) - LGFVs assessed on liquidity risk, viability, and indebtedness: - Liquidity risk: negative cash position accounting for short-term debt, net accounts payable, EBITDA, and net interest expense. - Non-viable: EBIT < net interest expense for three consecutive years. - Significantly indebted: net debt to EBITA exceeds 15 times. - Sources: S&P Capital IQ, WIND; and IMF staff estimates. ### Illustrative impact of LGFV debt restructuring (Figures 17–19) - Debt restructuring exercise considers three stylized options: interest reduction, additional financial support required to restore LGFVs’ debt-servicing capacity, and repayment extension. - Left-panel depiction: blue dots show required additional financial support (could come from local governments and/or creditors) for a given amount of interest reduction. - Additional scenarios: red/green dots consider principal repayment (annual amortization of 5 and 10 percent), accounting for larger interest income losses due to falling debt principal and larger additional financial support required to meet principal repayment up to three years. - Right-panel scenarios: yellow dots show alternative (higher) funding costs, assuming a minimum funding cost at 3 percent plus premiums for LGFVs in certain provinces. - Analysis is based on publicly available data covering a sample of about 3,700 bond-issuing LGFVs. - Impact of LGFV debt restructuring on banks: - Sample covers about 400 banks that account for about 95 percent of banking sector assets. - Scenarios illustrated include: - No principal repayment; interest reductions up to 0.5 percent, 1 percent, 1.5 percent, 2 percent, and interest rate reduction to fully restore LGFVs’ debt-servicing capacity (no principal repayment). - Repayment extension scenarios: principal repayment at 10 percent and 5 percent of outstanding debt with interest rate reductions up to 1 percent and up to 2 percent; scenarios also include no principal repayment. - Outcome metrics shown: - Reduced interest income (in percent of net income; for each year). - Required additional financial support (in percent of risk-weighted assets). - Required principal write-down (in percent of risk-weighted assets). - Potential losses reported for D-SIBs and other nationwide banks and local banks (by provinces). - Existing capital buffers and cumulative impact on capital (in percent of risk-weighted assets). - For charts in the middle and right panels, the exercise assumes that the required additional financial support totally takes the forms of principal write-downs. *Sources: Chinese regulatory authorities; IMF staff calculations; CEIC; S&P Capital IQ; WIND; Credit Research Initiative, National University of Singapore; IMF staff estimates.* ### Annex I. Figure 20. Corporate Debt and Performance Indicators ### Annex I. Figure 20. Corporate Debt and Performance Indicators ### Corporate debt levels and comparison - "Corporate debt in China is high relative to peers... even after excluding LGFV debt." - Sources: S&P Capital IQ; IMF’s Global Debt database, IMF’s World Economic Outlook database, and IMF staff calculations. - Note: "Figures in charts 2 through 4 are averages computed across a sample of 11,300 firms." ### Liquidity and leverage trends - "Liquidity has declined but remains broadly stable..." - "Corporate leverage has increased gradually but remains low on average, under 30 percent of firm assets." - "...with variation in debt...." ### Sectoral heterogeneity - "Corporate Debt Across Sectors" — variation in debt across industry sectors. - "Corporate Liquidity Across Sectors" — variation in liquidity across industry sectors. ### Corporate PD estimates and scenario sensitivity (Annex I. Figure 21) - Model regressions used "Firm-specific, sector-specific, and macro-financial variables." - "The model indicated a non-trivial increase in corporate risk, particularly in the initial three years after the shock occurs." - Corporate PD path observations: - "Corporate PD Paths: All Firms" - "Dropping financial firms did not change the PD path much." - "Corporate PD Paths: Nonfinancial Corporates" - "excluding LGFVs raised PD paths slightly in the adverse and baseline scenarios." - "Corporate PD Paths: Corporates Excluding LGFVs" - "Including only LGFV firms marginally lowered PD paths in the adverse and baseline..." - "Corporate PD Paths: LGFVs" - "excluding LGFVs and financial firms yielded results similar to the full sample results, with higher PD paths." - "Corporate PD Paths: Corporates Excluding LGFVs and Financial Corporates" - Source: "IMF staff calculations." ### Household sector (Annex I. Figure 22) - "After two decades of rapid growth, China’s household debt has surged to levels comparable to advanced economies, with mortgages making up half of total debt." - "Younger demographics are more likely to have debt, while high-income earners hold the majority." - "Recently, household debt growth slowed sharply, with mortgage loans declining." - "This coincides with a sharp adjustment in the real estate market." - Sources: "National Bureau of Statistics, CEIC, IMF staff calculations, China Household Finance Survey (CHFS, 2019)." ### Climate risk frameworks (Annex I. Figure 23) - "Overview Of Transition and Physical Risks and Climate Risk Analysis Framework" - Energy supply: "Coal and Oil & Gas dominate the energy supply ecosystem..." - Physical hazards: "...while floods and storms/cyclones occur more frequently." - Frameworks summarized: "Summary of Transition Risk Analysis Framework" and "Summary of Physical Risk Analysis Framework" - Sources: "IEA World Energy Balances, World Bank, Climate Change Knowledge Portal." ### Transition scenarios and sectoral default risks (Annex I. Figure 24) - "Transition Scenarios and Default Risks Across Selected Economic Sub-Sectors" - "Coal and Oil & Gas sectors see largest output decline by 2040..." - "some subsectors like electrical and transportation equipments see positive impact" - "Oil & Gas, air transportation, and fuel manufacturing see large increase in default risks under disorderly scenario.." - "the all other corporate portfolio sees non-trivial default risk due to indirect effects of transition" - Sources: "World Bank and IMF staff calculations." ### Banking-sector impacts under transition scenarios (Annex I. Figure 25) - "Impact On Banking Sector Under Different Transition Scenarios" - "Credit losses are notable in few sub-sectors..." - "also being relatively large in residual corporate segment and household portfolio due to indirect effects of transition" - "Market valuation losses are small across portfolios." - "total losses in banking sector is driven by credit losses and is non-trivial but managable." - Sources: "Chinese regulatory authorities and IMF staff calculations." ### Provincial severity and potential damages from climate change (Annex I. Figures 26–27) - "Severity Of Climate Change and Potential Damages Across Provinces of the Chinese Mainland" - "Severity of flood would rise significantly under climate change..." - "...so would wind intensity along the coastal provinces" - "Average damage from flood is heterogeneous across regions..." - "damages from wind is concentrated along coastal regions." - Provincial risk highlights: - "Jiangsu, Shanghai, Tianjin provinces face large increase in probability of default risks due to climate related damages..." - "...and consequently, higher probability of large credit losses." - "Probability of market losses are also pronounced across provinces." - "Probability of total impact on capital increases materially." - Source: "IMF staff calculations." ### Climate change impact distributions (Annex I. Figure 28) - "Climate Change Impact: Distributions Of Output, PDs, and Total Losses" - "Climate change can generate materially higher tail probability of economic losses and financial sector losses." - Source: "IMF staff calculations." ### Risk Assessment Matrix (Annex II) - Purpose: "The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path." - Relative likelihood guidance: "('low' ... below 10 percent, 'medium' ... between 10 and 30 percent, and 'high' ... between 30 and 50 percent)." - Global conjunctural risks: - Intensification of "regional conflict(s) and deepening geoeconomic fragmentation." — Overall Level of Concern: "High"; Relative Likelihood: "High". - Risks listed: "Rapid reconfiguration of trade and FDI, supply disruptions for key industrial and technology products, technological and payments systems fragmentation, a fracturing of international monetary and financial systems."; "Escalation of interventionist and protectionist policies..."; "Higher cost of import and barrier for export. Weaker confidence and investment. Financial inflows reverse. Drop in medium-term economic growth prospects." - "Abrupt global slowdown." — Overall Level of Concern: "Medium"; Relative Likelihood: "High". - Risks listed: "synchronized sharp growth downturn... adverse spillovers through trade and financial channels..."; "Persistent contraction in the property sector...disinflationary pressures and adverse macro-financial feedback loops."; "Sharp drop in external demand...Financial inflows reverse..."; "Employment and consumer spending weakens, credit and investment contracts and deflationary pressure strengthens." - "Commodity price volatility." — Overall Level of Concern: "High"; Relative Likelihood: "Medium". - Risks listed: "recurrent commodity price volatility."; "High inflation due to higher food and energy prices..."; "External and domestic demand slow down..." - "Systemic financial instability." — Overall Level of Concern: "Medium"; Relative Likelihood: "High". - Risks listed: "Risk-off sentiment surges... valuation losses and margin compression trigger bank insolvencies..."; "Funding withdraws from riskier and weaker banks and NBFIs..." - Global structural risk: - "Climate risk." — Overall Level of Concern: "Medium"; Relative Likelihood: "Medium". - Risks listed: "China is vulnerable to various physical climate risks particularly flooding and cyclones." "Economic damages/losses of physical assets, deterioration of corporates and households’ financial conditions, collateral devaluation, supply disruptions and productivity loss." "Disorderly shift to net-zero emissions and climate policy uncertainty cause supply disruptions, stranded assets, market volatility..." - Domestic risks to economic outlook: - "Deepening in the property sector slowdown." — Overall Level of Concern: "Medium"; Relative Likelihood: "High". - Risks listed: "A sharper and longer-than-expected slowdown in the property sector with financial repercussions and/or inadequate policy responses..." "Banks, NBFIs and private investors take sharp losses..." "Mortgage defaults increase." "Unexpected fiscal tightening due to local government financing stress." - "Protracted Deflation." — Overall Level of Concern: "Low"; Relative Likelihood: "High". - Risks listed: "Weak consumer and investor confidence could depress aggregate demand..." "Weak demand...delays the stabilization of the property market..." - "Balance Sheet Recession." — Overall Level of Concern: "Low"; Relative Likelihood: "High". - Risks listed: "Rising losses form real and financial asset price declines lead to materially impaired balance sheets..." "Broad based economic deleveraging...imposes further strains on medium term growth prospects." - "Unsuccessful debt restructuring of local government financing vehicles (LGFV)." — Overall Level of Concern: "Low"; Relative Likelihood: "Medium". - Risks listed: "Heavily indebted LGFVs default before restructuring arrangement is fully in place." "Asset quality of banks and NBFIs worsens. Weaker confidence dries up funding for the broader LGFV sector. Funding distress spills over to other segments of the capital market." *Source: IMF staff calculations and figures as presented in the Annex I and Annex II figures.* ### Annex III. Stress Testing Matrix ### Annex III. Stress Testing Matrix ### Banking Sector: Solvency Stress Test — Top-Down by FSAP Team - Institutional perimeter: - Agreed scope: 55 largest deposit takers. - Market share: 80 percent of the banking sector. - Scope of consolidation: solo basis. - Data and baseline date: - Data vintages: December 2023 (fiscal year end). - Accounting data: balance sheet, PnL, off-balance sheet and supervisory statistics. - Methodology and channels: - Market risk affects capital resources (via profit and loss or other comprehensive income—OCI) and capital requirements (market risk charges—RWA). Impacts arise from trading book positions and fair-valued banking book items; RWA impacts evolve with balance sheet assumptions. - Revaluation losses for securities portfolios (FVPL and FVOCI) are based on a duration approach. Losses on equities (long and short) are based on stock market price movements specified by the scenario. - Credit risk impacts capital resources (credit impairments) and capital requirements (credit risk charges—RWA). Projections include new flows of defaulted exposures, coverage ratio for defaulted loans, and risk weight downgrade for performing exposures. - Provisioning and impairments are modeled using an economic expected losses approach. - Net interest income (NII) projection: effective interest rates (lending, deposit, debt exposures, and debt issuance rates) are projected through an econometric satellite model with exogenous variables reflecting the interest rate environment. - Additional regulatory risk charges on RWA (operational risk charges—ORC and counterparty credit risk charges—CCRC) change according to overall balance-sheet growth assumptions. Balance sheet follows nominal GDP growth when positive, or remains stable when nominal GDP growth is negative. - Stress test horizon: - 2024: Q1–2026: Q4 (3 years) - Scenarios: - Two scenarios: - Baseline scenario based on the most recent to the April 2024 WEO macroeconomic projections. - Adverse scenario capturing key risks in the RAM, relying on GFM (structural macroeconomic model disaggregated into forty national economies); foreign-country scenarios for major exposures are extracted from GFM. - Tail shocks and risks covered: - Credit (banking book), market (trading book revaluation and P&L impact of net open positions, including foreign exchange), interest rate risk on interest-bearing assets and liabilities, and non-interest income projections. - Sensitivity analyses: - Deflationary path within original stress scenario. - Effects of higher SME lending proportion or different LGFV debt restructuring schemes on credit risk, NII, and capital adequacy. - Different deleveraging scenarios affecting NII via reduced lending volumes and cost of funding implications. - Behavioral assumptions and buffers: - Static balance sheet approach (balance-sheet growth not linked to nominal GDP due to technical challenges). - Interest income from non-performing loans is not accrued. - No new share issuance or repurchases by banks during the stress horizon. - Dividends paid at a fixed percent (recommended and agreed with Chinese authorities) on current period profit after taxes. - Dividends paid only by profitable banks meeting regulatory capital requirements. - Regulatory and market-based standards and hurdle rates: - Basel III regulatory minima on CET1: 5 percent (include any additional buffers). - Total capital adequacy ratio against the 8 percent level. - Tier 1 capital ratio against the 6 percent level. - Capital conservation buffer: 2.5 percent. - Chinese banks are not subject to a CCyB. - Banks below these hurdle rates are considered to have failed the test. - Output presentation: - Evolution of capital ratios at aggregate level and bank clusters. - Impact decomposition by result drivers (profit components, realization losses). - Projected credit impairments, market losses, net interest margins, and non-interest income at aggregate level and clusters. ### Banking Sector: Liquidity Stress Test — Top-Down by FSAP Team - Institutional perimeter: - 111 banks with total assets above CNY 200 billion: 6 state-owned, 12 joint-stock, 66 city commercial, 25 rural commercial, and 2 foreign banks. - Market share: 87 percent of commercial banking, and 77 percent of total banking system asset. - Data and reference date: - NFRA’s regulatory reports on LCR, NSFR, and maturity gap. - Data as of December 2023. - In total currency; financial reporting at solo basis. - Methodologies: - LCR: - Assesses whether high quality liquid assets (HQLA) cover net cash outflows over a 30-day horizon. - Ratio compared to regulatory requirement of 100 percent. - Four scenarios: baseline with regulatory parameters in China; retail (quick retail deposit withdrawal); wholesale (loss of funding by corporates and financial institutions); combined (retail and wholesale). - Haircuts on HQLA vary by scenario severity. - Microprudential analysis: individual-bank resilience; aggregate by bank group and compare across groups. - NSFR: - Assesses available stable funding versus required stable funding over one year. - Ratio greater than 100 percent meets regulatory requirement. - Regulatory parameters apply; microprudential analysis aggregated by bank group. - Cash Flow Analysis: - Assesses ability to cover net funding outflows with counterbalancing capacity. - Two scenarios: mild and severe funding run-off and investment roll-off over contractual maturities. - Asset haircuts reflect interest rate shocks and additional counterparty cost to accept collateral. - Counterbalancing capacity includes HQLA bonds, equity, cash, and release of required reserve once deposits are withdrawn. - Macroprudential emphasis: compare results across bank groups and aggregate to identify system-wide liquidity shortfall. - Horizon: five time buckets—overnight, 1 week, 1 month, 3 months, 1 year. ### Interconnectedness and Contagion Analysis - Institutional perimeter and coverage: - Four analyses: 1) banking network and contagion; 2) systemic importance of financial institutions; 3) regional fiscal-financial nexus between regional LGFVs and banks; 4) macrofinancial feedback among developers, financial institutions, and macro economy. - Exercise 1 uses a balance-sheet approach; others are market-based. - Data: - Banking network and contagion: 111 banks with total assets above CNY 200 billion (6 state-owned, 12 joint-stock, 66 city commercial, 25 rural commercial, 2 foreign). Supervisory reports on balance sheet, regulatory capital, RWA and bilateral large exposures (> 2.5 percent of Tier 1 capital) via six instruments: loans, deposits, bonds, repos, negotiable certificates of deposit, derivatives. - Systemic importance: publicly listed financial institutions including 6 state-owned, 10 joint-stock, 30 city commercial, 13 rural commercial banks, and 60 brokerage firms and asset management companies; uses probability of defaults (PD) for institutions. - Regional fiscal-financial nexus: 2,736 LGFVs and 241 regional banks in 31 provinces that have ever issued credit bonds. Data include bond yields, issuance and entity characteristics, and regional fiscal conditions. - Macrofinancial feedback: PDs of 5 financial sectors (state-owned, joint-stock, city commercial, rural commercial banks, brokerage and asset management companies), 3 property sectors (state-owned developers, privately owned developers, and real estate service companies), and 3 macro indices (consumer confidence, real estate investment, property price). Monthly data 2011–2023. - Methodologies: - Banking network and contagion: - Based on Espinosa-Vega and Sole (2010). - Uses bilateral exposures to build network among the six bank groups. - Contagion simulation: one institution fails at a time; credit channel (failure causes creditors’ losses) and funding channel (failed institution withdraws funding, forcing asset sales at haircut) propagate failures until no further defaults. - Vulnerability index: average loss borne by a bank as a share of its capital from others’ failures. - Contagion index: losses by all other institutions as a share of their capital if a bank fails. - Systemic importance of financial institutions: - Compares systemic importance of 119 banks and non-bank financial institutions to identify institutions that could cause wide system damage. - LASSO regressions identify co-movements of institutions’ PDs, underpinning a financial network for tracing default-risk spillovers; measures credit losses and collateral damage via direct exposure and contagion. - Fiscal-financial nexus between regional LGFVs and banks: - Regresses credit spreads of LGFV/bank bonds against issuer, issuance, macrofinancial, provincial factors and local banking/LGFV sector strength. - Regional focus: assesses provincial relationships and variation across provinces. - Macrofinancial feedback among developers, financial institutions, and real economy: - Reduced-form VAR with dimension reduction to identify spillovers among macro variables and financial health of 8 groups of banks and property developers. - Identifies Granger causality and contemporaneous correlation; impulse responses measure impacts of prescribed shocks. ### Banking Sector Climate Risk Analysis — Physical Risk (Top-Down, FSAP and Authorities) - Institutional perimeter and data: - Aggregate banking sector exposures by province for 31 provinces of Chinese mainland. - Geographical credit and market exposure breakdown based on publicly available provincial data. - Corporate data sample as in transition risk with geographical breakdown. - Corporate data as of end-2022; banking sector data as of end-2023 (cut-off). - Methodology and channels: - Climate scenario around tropical cyclones and floods under IPCC scenario SSP5-8,5 with comparison to historical conditions. - Stochastic modeling incorporates geospatial cross-correlation of economic activities across provinces and damage distribution. - Generates provincial-level impact on credit and market risk metrics (PDs, spreads) and corresponding impact on total loans and corporate bonds (including LGFVs). - Risk analysis horizon: 3 years. - Risks and buffers: - Focuses on credit risks; additional market and liquidity channels considered; all other channels assumed unaffected. - Projections of losses based on historical and climate conditions. - Sensitivity analysis: - Simplified liquidity risk analysis as added sensitivity to quantify short-term impact of climate shocks (largely illustrative). - Reporting format: - Measures of impact on economic activity by province, and credit and market risk impacts at regional and system-wide level. - Comparison with historical baseline conditions emphasized; results presented probabilistically (distributions). - Aggregate and provincial-level banking sector credit, market losses, and capital impact. ### Banking Sector Climate Risk Analysis — Transition Risk (Top-Down, FSAP and Authorities) - Institutional perimeter and data: - 20 D-SIBs with focus on sectoral impact. - Granular sectoral exposure breakdown (over 26 subsectors) from ad-hoc data collection by authorities from 20 D-SIBs, end-2023 (cut-off). - Firm-specific balance sheets, income statements, PDs for over 4,800 firms; historical data 2002–2022. - Aggregate sectoral macro-financial variables. - Methodology and channels: - Firm balance sheet stress approach with multi-year projection of balance sheet dynamics and vulnerability indicators under transition scenarios: - Step 1 (Bridge equation): relate firm-specific default rates to firm-level vulnerability indicators (cash ratio, current ratio, leverage ratio, equity volatility) via fixed effects panel regression on historical firm-level default rates (sample restricted to listed companies). - Step 2: Apply scenario-dependent sectoral GVA paths to firms’ balance sheets; perform micro-simulations for multi-year projections of balance sheets and profit components. - Step 3: Use elasticities from Step 1 to infer stressed default rates for firms. - Step 4: Produce weighted sectoral aggregate PDs by aggregating firm-level default rates using total outstanding debt as weights. - Step 5: Map bank-level sectoral corporate exposure breakdown to produce credit loss impacts using PDs from Step 4. - Step 6: Use stressed delta PDs to produce capital impact projections. - Impact on residual corporate and household portfolios anchored to overall economy impact to capture indirect general equilibrium effects. - Market risk anchored to corporate aggregate PD path implied credit spreads. - Projection horizon up to 2040 to capture medium-term transition effects. - Satellite models and scenarios: - Bridge equation linking default rates to vulnerability indicators via fixed effects panel regression. - Tail shocks scenario analysis based on transition scenarios across sectors via global macro-econometric model (E3ME). - Baseline: Hot house world/current policies. - Three climate policy (adverse) scenarios reflecting China’s climate goals and aligned to orderly/disorderly NGFS narratives. - Risks and buffers: - Credit and market channels considered; other channels assumed unaffected. - PDs, credit and market loss impacts reported relative to baseline; credit spreads anchored to aggregate corporate PDs. - Reporting format: - Measures of credit risk impact at granular and high-level sectoral levels; market risk impact at corporate securities portfolio level. - Impact on residual corporate credit portfolio, household portfolio, and system-wide impact. - Outcomes emphasized relative to baseline scenario; cumulative loss/impact relative to baseline by 2040. - Average aggregate capital impact over the next 5 years. ### Selected Policy Recommendation Snapshot (from Recommendations table) - Recommendation: De-emphasize high GDP growth projections in national plans that motivate setting high-growth targets at the local level. - Timeframe: Near term, high priority. - Status: Partly implemented, ongoing. - Implementation note: The Outline of the 14th Five-Year Plan and Long-Term Objectives for 2035 states GDP growth should be "kept within a reasonable range and proposed each year as appropriate.” - Recommendation: Create a new Financial Stability Sub-Committee (FSS-C) with the sole function of preserving financial stability. - Timeframe: Near term, high priority. - Status: Implemented. - Implementation note: In 2018 the Financial Stability and Development Committee (FSDC) was established; in March 2023 the Central Financial Committee (CFC) was established and responsibilities of the FSDC transferred to the Office of the CFC. - Recommendation: Establish robust mechanisms for cooperation, coordination, and exchange of information—including granular financial data—with domestic and foreign safety-net participants. - Timeframe: Near term, high priority. - Status: Implemented. - Implementation note: Coordination mechanisms established between November 2017 and March 2023 under the FSDC and since March 2023 under the CFC; examples include enhanced information-sharing between NFRA and PBC, NFRA sharing with relevant Ministries, National Bureau of Statistics and CSRC, and CSRC sharing balance sheet data of securities financial institutions with other domestic agencies. *Annex III. Stress Testing Matrix — source PDF: 1chnea2025001-print-pdf - Annex III. Stress Testing Matrix* ### Annex IV. ### Annex IV. Implementation of Recommendations from the 2017 FSAP ### Overview and status summary - Document records recommendations from the 2017 FSAP and the Chinese authorities’ summary of measures taken, with timeframes labeled as "Near term", "Medium term", "Medium term, high priority", "Medium priority", or similar. - Many recommendations are described as Implemented, Partly implemented, or Not implemented, often with ongoing work noted. - Authorities and agencies frequently cited: PBC, NFRA, CBIRC, CSRC, CSDC (China Securities Depository and Clearing Corp), SAFE, the State Council, and the CFC. ### Cross-cutting priorities: cooperation, autonomy, and data - Establish cooperation and information exchange mechanisms: - Near term, high priority: NFRA and CSRC promote cooperation with overseas regulatory agencies via regulatory cooperation agreements, supervisory colleges, periodic meetings, recurrent communication, and contributions to standard-setting bodies. - Amend primary laws to strengthen operational and budgetary autonomy and increase resources: - Medium term, high priority: Partly implemented, ongoing. - Regulator budgets have maintained positive growth; 2023 overhaul of regulatory structure updated budget calculations and provided additional fiscal resources; NFRA and CSRC increased staffing and training. - Authorities note further resource increases remain warranted. - Address data gaps impeding systemic risk monitoring: - Medium term, high priority: Partly implemented, ongoing. - March 2018 "Opinions on Comprehensively Promoting Comprehensive Statistics of the Financial Industry". - 2020 National Financial Basic Database put into operation as core data hub. - NFRA refined off-site reports; CSRC accelerating construction of regulatory big data warehouse. ### Macroprudential framework and CCyB - Trigger the countercyclical capital buffer (CCyB): - Near term, high priority: Not implemented. - September 2020: "Notice on Establishing a Countercyclical Capital Buffer (CCyB) Mechanism" set initial CCyB requirement to zero. - PBC and NFRA are considering macroeconomic and financial factors to evaluate and adjust CCyB as needed. ### Regulation and supervision: banks - Enhance group risk supervision and identify ultimate beneficial owners: - Medium term, high priority: Partly implemented, ongoing. - Strengthened qualification requirements for controlling shareholders; multiple FHC-related measures issued (November 2020; December 2021; February 2023). - Ongoing enhancements after regulatory responsibilities moved from the PBC to the NFRA in March 2023. - Eliminate use of collateral in loan classifications and classify loans overdue by more than 90 days as non-performing: - Medium term, high priority: Implemented. - February 2023: "Measures for the Risk Classification of Financial Assets of Commercial Banks" emphasize debtor-centered risk classification; loans overdue more than 90 days included in non-performing category; restructured assets definitions refined with at least one-year observation. - Strengthen enforcement of “look-through” principles: - Medium priority: Implemented. - Multiple policy documents since April 2018 strengthen supervision of asset management, wealth management, insurance asset management, related-party transactions; "look-through" included in on-site inspections. - Increase LCR requirements for interbank and off-balance-sheet WMPs: - Medium priority: Implemented. - May 2023 "Commercial Bank Liquidity Risk Management Measures" include interbank products in LCR consistent with Basel standards; introduced liquidity matching rate and stricter discount rate requirements for interbank wholesale financing. - Enhance regulatory reporting and granular supervisory data on banks’ investment holdings and provisioning: - Medium priority: Implemented. - Introduction of off-site reporting system, big data platform, corporate governance supervision system, regular credit risk reporting, supplementary tables for city and rural banks, national banking wealth management information registration system. - CBIRC established monthly and quarterly risk monitoring for insurance asset management products in early 2023. ### Forward-looking supervision and stress testing - Enhance forward-looking integrated risk analysis and stress-testing capacity: - Medium priority: Implemented (for forward-looking supervision); stress testing: Partly implemented, ongoing. - NFRA improved forward-looking supervision using "Commercial Bank Supervision Rating Method"; banks encouraged to conduct regular stress tests covering main risks and economic cycle impacts. - PBC conducts annual banking stress tests; stress tests use internal and regulatory data with gradual improvements in granularity (e.g., trend information for non-performing assets, classification of interest-bearing assets/liabilities, bond investment categories). - NFRA uses detailed underlying asset data in stress testing; CSRC uses detailed business data for securities, funds, and futures institutions. - Authorities advised to continue strengthening stress-testing frameworks and capabilities. - Expand coverage of non-banks and integrate stress testing of collective investment schemes (CIS): - Medium priority: Implemented. - PBC uses network analysis models; stress tests consider non-standardized debt, off-balance-sheet business, bonds at amortized cost, wealth management product redemptions. - NFRA and CSRC improved scenario design, parameter indicators, contagion analysis, and guidance to industry associations. - Enhance inter-agency coordination and analytical capacity of stress testing teams: - Medium priority: Partly implemented, ongoing. - Under CFC leadership, information sharing mechanisms exist (social financing, monetary credit, banking operations, securities/futures statistics). - PBC stress test teams include PBC head office, branches, and commercial banks; participation in IMF training noted. - NFRA sent personnel to Basel Committee stress testing working group; CSRC establishing financial policy coordination mechanism. ### Shadow banking and implicit guarantees - Ensure bankruptcy remoteness of CIS and WMPs in manager/custodian insolvency: - Medium term, high priority: Implemented. - Joint "Guiding Opinions on Regulating the Asset Management Business of Financial Institutions" confirm asset management is off-balance-sheet and introduce custody and fair valuation provisions. - Regulations state WMP property is independent from managers’ and custodians’ assets; January 2023 revisions further clarified trust property attributes. - Move towards eliminating sector-specific lending limits, conditional on eliminating implicit guarantees: - Medium priority: Partly implemented, ongoing. - PBC guides institutions to improve credit quality and efficiency without direct micro-level credit restrictions; NFRA requires banks to adhere to market-oriented, rule-of-law principles. - Limit interventions in asset markets to systemic episodes: - Medium priority: Not implemented. - NFRA emphasizes prevention and control of real estate-related risks through monitoring, inspections, early warning; CSRC does not interfere under normal circumstances but may act decisively when markets are seriously detached from fundamentals. ### Regulation and supervision of securities markets - Improve disclosure of CIS; prohibit specifying expected returns in WMP prospectuses: - Near term, high priority: Implemented. - CSRC measures (August 2020) and administrative measures prohibit expected return listings; private asset management rules prohibit promising expected returns. - Introduce functional overlay to ensure similar products across firms are supervised similarly: - Medium term, high priority: Implemented. - PBC, NFRA, CSRC promoted industry rules to ensure equal access and unified regulation for asset management businesses; CBIRC and CSRC issued multiple implementing regulations (April 2018; Sept 2018; March 2020; Aug/Sept 2020). - Tighten eligibility and enhance haircut methodology for repo collateral: - Medium priority: Implemented. - October 2018: launch of inter-bank tri-party repo; April 2024: guided launch of general repo in inter-bank bond market and improvement of collateral management and discount-rate calculations. - Strengthen systemic risk monitoring of securities markets and interconnectedness: - Medium priority: Implemented. - PBC established bond default early warning mechanism and consults on bond market risk; CSRC expanding functions of stock market risk monitoring and response leadership group, improving systemic risk monitoring and information-sharing. ### Regulation and supervision of insurance - Develop risk-based supervision plans including market conduct: - Medium priority: Partly implemented, ongoing. - Revised "Insurance Group Supervision and Administration Measures" (November 2021) and "Insurance Company Solvency Supervision Rules (II)" (December 2021) issued; NFRA transitioning from rules-based to risk-based supervision. - Move valuation to more market-consistent basis: - Medium priority: Implemented. - March and September 2020 measures require fair net value measurement of insurance asset management products; net value management operations achieved for existing products. - 2020 "Guidelines for Valuation of Insurance Asset Management Products (Trial)"; China Insurance Registration and Trading System and China Bond Valuation Center developed valuation models and regularly publish valuation results. ### Financial market infrastructures (FMI) - Adopt full delivery-versus-payment (DVP) in CSDC: - Near term, high priority: Implemented. - December 2022: DVP fully implemented in China's securities market. - October 2023: CSRC instructed CSDC to reduce minimum settlement reserve ratio for stock business from 16 percent to an average of nearly 13 percent, releasing nearly RMB 40 billion in funds. - Strengthen FMI resilience and legal framework; full implementation of CPSS-IOSCO principles: - Medium term, high priority: Implemented. - PBC “Work Plan for Coordinated Supervision of Financial Infrastructure” (February 2020) and draft "Measures for the Supervision and Administration of Financial Infrastructure" and draft "Decision of the State Council on the Implementation of Access Management for Financial Infrastructure". - December 2023 “Guiding Opinions on Strengthening the Supervision of Payment and Clearing Business of Clearing Institutions.” - Expand central bank services to systemically important CCPs: - Medium priority: Implemented. - July 2023 "Central Bank Deposit Account Management Measures" allow systemically important CCPs to apply for central bank deposit accounts; PBC provides settlement services to China Central Depository and Clearing Co., Ltd. and Shanghai Clearing House. ### Anti-money laundering and combating financing of terrorism (AML/CFT) - Mandate enhanced customer due diligence (CDD) for domestic PEPs on a risk-sensitive basis: - Medium priority: Partly implemented, ongoing. - Revision of Anti-Money Laundering Law and regulations progressing; Revised Draft discussed and approved at the State Council Executive Meeting in January 2024; Standing Committee of the National People's Congress conducted initial review and solicited public opinions in April 2024. - China adopts risk-based CDD for domestic politically exposed persons. - Ensure self-laundering is effectively prosecuted as stand-alone offense: - Medium priority: Implemented. - Criminal Law Amendment (XI) passed in 2020 criminalizes self-laundering as an independent crime; independent investigation, prosecution and sentencing are common judicial practice. ### Crisis management and resolution frameworks - Clarify triggers for government-led crisis response, limited to systemic cases: - Near term, high priority: Partly implemented, ongoing. - Since March 2021, PBC and departments promoting financial stability legislation. Draft Financial Stability Law (FSL) under review: Article 26 stipulates PBC leads in dealing with systemic financial risks and acts as lender of last resort; State Council financial department participates accordingly. - Draft FSL provides institutional arrangements and allows use of the Financial Stability Guarantee Fund (FSGF) and PBC liquidity support for the Fund. - Identification standards for major risk assessment are not static; competent authorities to make professional identification. - Develop special resolution regime for banks and systemically important insurers: - Medium term, high priority: Partly implemented, ongoing. - Draft FSL identifies competent authorities and incorporates key elements of international resolution standards (bridge bank, bail-in, “no-creditor-worse-off”, express override of shareholder/creditor rights, reference to funding sources including FSGF and creditor hierarchy). - No provisions establishing adequate safeguards for government support noted. - TLAC applied to Chinese G-SIBs: Industrial and Commercial Bank of China and Bank of China issued TLAC bonds of RMB 40 billion. - June 2021 "Interim Measures for the Implementation of Recovery and Disposal Plans for Banking and Insurance Institutions" require recovery/disposal plans for deposit-taking institutions with leverage ratio denominator > RMB 300 billion and insurance companies with on-balance sheet total assets > RMB 200 billion. - Develop formal ELA framework by PBC: - Medium term, high priority: Not implemented. - Authorities have not introduced an operational framework for emergency liquidity assistance (ELA). - Enhance protection fund design to limit moral hazard: - Medium priority: Partly implemented, ongoing. - FSGF positioned as central-government controlled fund to deal with major risks; funds from market entities and operates in a two-tier manner with deposit insurance and industry guarantee funds. - Basic framework of FSGF initially established; initial industry contributions accumulated; no recent reforms of deposit insurance fund. ### Financial inclusion and fintech - Upgrade legal, regulatory, and supervision framework for fintech: - Medium priority: Implemented. - PBC issued "Financial Technology (Fintech) Development Plan (2019-2021)" and "Financial Technology Development Plan (2022-2025)". - NFRA issued "Guiding Opinions on the Digital Transformation of the Banking and Insurance Industries"; unified supervisory standards for technology outsourcing in banking and insurance. - CSRC improved regulatory framework for fintech in securities and futures; studied measures for IT service institutions, promoted fintech innovation pilots, issued security management notice for mobile applications, and in 2021 issued “14th Five Year Plan for the Development of Science and Technology in the Securities and Futures Industry.” ### Key statistics and indicators cited by the authorities (exact values preserved) - As at end-December 2024: - capital adequacy ratio of commercial banks: 15.74 percent - non-performing loan (NPL) ratio of commercial banks: 1.50 percent - provision coverage ratio of commercial banks: 211 percent - Central bank rating results at end-June 2024: - assets of high-risk banks in the “red zone”: 1.85 percent of all participating banks - Stress tests referenced: - solvency stress test covered 55 banks, covering nearly 80 percent of China’s banking sector assets (para 17) - liquidity stress tests covered 111 banks, covering 87 percent of the total assets of commercial banks (paras 25 and 27) - Financial aggregates in 2024: - Aggregate Financing to the Real Economy (AFRE) growth: 8 percent - loans growth: 7.6 percent - M2 growth: 7.3 percent - nominal GDP growth rate for same period: (stated as lower than the above aggregates) - GDP growth: - Q4 2024 year-on-year growth: 5.4 percent - 2024 full-year growth: 5 percent - Loan growth for targeted segments in 2024: - loans to SRDI enterprises increased by 13 percent year-on-year - inclusive loans to micro- and small- businesses (MSBs) increased by 14.75 percent year-on-year - Market and policy measures since September 2024: - RMB 10 trillion program to swap implicit local government debt - unified minimum mortgage down payment ratios to 15 percent - estimated annual household mortgage interest savings from interest rate reductions: about RMB 150 billion - Equity market performance (September 24, 2024 to March 18, 2025): - Shanghai Composite Index increase: 24.77 percent - Shenzhen Composite Index increase: 41.81 percent - CSI 300 Index increase: 24.74 percent - ChiNext Index increase: 45.61 percent - Hang Seng Index increase: 35.59 percent - Hang Seng Tech Index increase: 64.09 percent - NASDAQ Golden Dragon China Index increase: 41.81 percent - FMI measures: - October 2023 CSRC instruction to reduce minimum settlement reserve ratio for stock business from 16 percent to an average of nearly 13 percent, releasing nearly RMB 40 billion in funds - TLAC issuance: - Industrial and Commercial Bank of China and the Bank of China each issued TLAC bonds of RMB 40 billion - Recovery and resolution thresholds: - deposit-taking financial institutions required to formulate recovery/disposal plans if leverage ratio denominator > RMB 300 billion - insurance companies required to formulate recovery/disposal plans if on-balance sheet total assets > RMB 200 billion ### Statement by Executive Director (summary points preserved verbatim where numeric) - Statement by Mr. Zhang, Executive Director for People's Republic of China, dated April 4, 2025. - China appreciates FSAP team engagement: team visited China four times and had almost 500 meetings with Chinese authorities. - Authorities view China’s financial system as resilient and risks manageable; disagree with staff characterization that “financial stability risks are elevated and rising.” - Recent policy package and measures (noted as September 2024 package and subsequent actions) cited as having substantially mitigated LGFV and real estate risks and improved market confidence and macro indicators. - Specific figures cited in the statement are preserved in the Key statistics section above. - The statement notes staff assessment is based on data as of September 2024 and that authorities regard the package of macro policies introduced in September 2024 as timely and appropriate. *Annex IV. Implementation of Recommendations from the 2017 FSAP* ### 1.71 trillion, more than double the amount prior to the introduction of the package of ### 1chnea2025001-print-pdf - 1.71 trillion, more than double the amount prior to the introduction of the package of ### Funding uplift and policy impact - Reported figure: 1.71 trillion - Characterization: "more than double the amount prior to the introduction of the package of incremental policies" ### Market liquidity indicator - Observation: "the average daily turnover of the Hong Kong stock market is around HKD" *Source: 1chnea2025001-print-pdf - 1.71 trillion, more than double the amount prior to the introduction of the package of* ### 165.2 billion, also more than double the amount before the policy introduction. We believe ### 1chnea2025001-print-pdf - 165.2 billion, also more than double the amount before the policy introduction. We believe ### Financial system outlook and overall assessment - "We believe that the financial system is a good reflection of the real economy." - "With a steady economic growth and continuous policy support, China’s financial system will continue to remain sound." - China has "one of the largest climate finance markets in the world in US dollar terms (para 11)." - "Digital finance is well-advanced with larger technology companies playing a central role (para 12)." ### Progress in financial regulatory reforms (findings) - "Significant progress has been made in operationalizing the macroprudential framework since 2017 (para 49)." - "Implementation of the Basel III framework, together with strengthened rules for asset classification, consolidated supervision, and related party transactions have helped underpin a significant shift towards more risk-based supervision (para 51)." - "The regulatory framework for securities and derivatives markets has been materially enhanced in recent years (para 56)." - "Since the 2017 FSAP, regulation and supervision on the insurance sector have been enhanced, with greater emphasis on capital, risk management, and governance (para 59)." - "Risks arising from the significant growth in the nonbank financial intermediary (NBFI) sector observed in the 2017 FSAP have been reined in, thanks to proactive measures taken by the authorities (para 60)." - "Various market-opening initiatives have been put in place or expanded since the 2017 FSAP (para 57)." ### Local Government Financing Vehicle (LGFV) debt risks — summary of authorities' view - A regular monitoring system for LGFV debt was established led by the PBC; "as of end 2023, the outstanding LGFV debt nationwide was around RMB 44 trillion (about USD 6 trillion), comprising of about RMB 10 trillion of implicit local government debt, about RMB 14 trillion of non-interest-bearing debts unrelated to the financial system (such as accounts payable), and about RMB 20 trillion (about USD 3 trillion) of operational debt of LGFVs." - Authorities consider the "RMB 20 trillion (about USD 3 trillion) of operational debt" as "the real risk exposure of the financial system to LGFVs" and state it is "much lower than the RMB 58 trillion (about USD 8 trillion) as estimated by staff." - September 2024 RMB 10 trillion debt swap program: - Converts implicit LGFV debt into local government bonds. - Raises local government debt limit by RMB 6 trillion over three years (RMB 2 trillion per year from 2024 to 2026). - Allocates RMB 800 billion each year of new local government special bonds issued from 2024 to 2028 for debt resolution. - "After the introduction of the debt swap program, the implicit local government debt of RMB 10 trillion has been properly resolved." - Clarified principle: "provincial governments should bear the overall responsibility" for resolving LGFV operational debts; measures include mobilizing funding, cutting public spending, selling assets, separating financing role from LGFVs, transforming LGFVs into market-oriented enterprises through "asset injection, mergers and acquisitions, and restructuring." - Financial institutions' support: "By the end of 2024, financial institutions have supported the extension, restructuring, and swap of more than RMB 5.4 trillion of LGFV’s operational debt." - Resulted in lowering the average interest rate of LGFV financial debt by "0.76 percentage point," reducing interest expense by "about RMB 200 billion each year." - Outcomes reported by authorities as of end-2024: - Outstanding LGFV operational debt "stood at about RMB 15 trillion, representing a 25 percent decline from the end of 2023." - In Q4 2024, average interest rate of newly issued LGFV bonds fell to "2.67 percent," a decline of "more than 200 basis points" from Q1 2023. - By end-2024, "40 percent of LGFVs have either transformed into market-oriented enterprises or were completely wound down." - Impact on financial institutions claimed minimal: - Interest rate of LGFV financial debt at end-2024 was "4.14 percent," down "0.76 percentage point" from end-March 2023. - Over same period, "1-year LPR fell from 3.65 percent to 3.1 percent," and "5-year LPR declined from 4.3 percent to 3.6 percent." - NPL ratios at end-2024: "NPL ratio of LGFV loans held by national banks was 0.21 percent," local banks "0.10 percent." - As of end-2024, LGFV operational loans held by 21 national banks accounted for "74 percent of all LGFV operational loans" and represented "3 percent of the total loans of these banks." - For small-and medium-sized banks: new LGFV loans subject to higher-level approval; "small and medium-sized banks in rural areas should be strictly prohibited from providing new financing to LGFVs." ### Authorities' critique of staff analysis on LGFV debt - Alleged data and methodological issues in staff estimates: - Double counting: among ~3700 bond-issuing LGFVs in WIND database, "1016 of them present their financial statement on a consolidated basis"; staff "only took out the debt of the subsidiaries of 205 LGFVs" but not for remaining "811 LGFVs." - Corrected size claim: "The correctly adjusted size of LGFVs’ interest-bearing debt should be no more than RMB 51 trillion (USD 7 trillion) instead of RMB 58 trillion (USD 8 trillion)." - Staff did not exclude implicit debt to be repaid by local governments; note that central government announced RMB 10 trillion local government special bond swap program last November. - Staff underestimated solvency by not fully considering asset liquidation: FSAP cited total assets of LGFVs at "118 percent of GDP in 2023"; authorities note inclusion of land and government receivables, and claim "debt-to-asset ratio of LGFVs is not high." - Staff "did not consider the support from the local governments." - Regional distribution point: eastern and central regions account for "three quarters of the total" LGFV operational debt while contributing "about 80 percent of China’s total GDP"; provinces with large debt burdens "have strong fiscal space and are fully capable of resolving these obligations independently." ### Real estate sector risks — measures and assessment - Government actions described as market-oriented and law-based; measures from demand and supply sides include: - Removal of policy differentiation for ordinary and non-ordinary houses; reduction in deed tax on first and second home purchases. - Abolished nationwide policy floor of mortgage rates for new loans; reduced minimum down payment ratios and interest rates of provident fund loans; improved pricing mechanism of commercial residential mortgage rates. - PBC launched "a RMB 300 billion central bank lending facility for affordable housing." - Banks can borrow back-to-back from the central bank for "100 percent of the real estate acquisition loans" instead of previous "60 percent." - More than 30 cities implemented acquisition projects; banks have issued loans of "more than RMB 40 billion" under the affordable housing facility. - Local government special bonds allowed for "idle existing land buyback, new land acquisition and reserve, and residential housing purchasing." - "More than RMB 6 trillion of loans have already been approved under the 'whitelist' policy" to ensure timely delivery of projects. - Two phase-specific policy measures extended to end-2026: rollover of existing financing under "Sixteen Financial Policy Measures to Support the Real Estate Sector" (2022) and policy regarding commercial property loans. - Reported financing and market indicators: - "Real estate development loans have increased cumulatively by more than RMB 400 billion in 2024," which is "200 billion more than the total increase in 2023." - Market activity (authorities' view): Q4 2024 sales area of residential housing in 30 large and medium-sized cities increased month-on-month for three consecutive months and year-on-year for two consecutive months. - Q4 2024 sales area of commercial housing in first-tier cities increased "by 57 percent quarter-on-quarter and 40 percent year-on-year." - January 2025: month-on-month decline in new home prices in 70 large and medium-sized cities narrowed for five consecutive months; prices in first-tier cities "rose month-on-month for three consecutive months." - Exposure and resilience points: - "Real estate-related loans account for 20 percent of the outstanding bank loans, and about 80 percent of all real estate-related loans are mortgage loans." - Authorities cite an average effective down payment ratio of mortgage loans of "about 35 percent." - NPL ratio "has remained at a low level below one percent for a long time." - Real estate development loans "are secured by land and projects under construction" with strict risk management. - Outlook: "China’s real estate market is set to bottom out and stabilize over time." Factors supporting stabilization include "construction of affordable housing, the redevelopment of urban villages, and the on-going urban renewal," and continued urbanization. ### Mandate of authorities and regulatory issues - Authorities assert prevention and resolution of financial risks and safeguarding financial stability are "their primary responsibility" while balancing development and stability. - Decision-making independence and powers to act "in accordance with the law" are emphasized; agreement that "it would be beneficial to further improve the coordination among regulators." - Regulatory strengthening actions taken: - Revised prudential regulatory rules related to "financial holding companies, capital management, asset classification, corporate governance, insurance solvency, recovery, and resolution, etc." - Optimized regulatory processes including "on-site inspections, off-site supervision, regulatory ratings, and stress testing." - Built "smart regulatory platforms, integrated regulatory data, and established standardized and online procedures." - Promoted risk resolution and reform/restructuring of small and medium-sized banks; mitigated shadow banking and large corporate debt risks; punished covering up of non-performing assets. - Draft Financial Stability Law "has undergone the second reading" clarifying "debt write-down and the strict use of public funds during debt resolution." - On regulatory forbearance: - Authorities disagree that stable NPL ratios are due to forbearance; attribute stability to proactive resolution where "the amount disposed being roughly equal to the new NPL loans in the same period." - Claim "about RMB 3 trillion of non-performing assets are resolved every year, which is roughly equivalent to the scale of newly formed non-performing assets." - State banks resolve NPLs through "market-oriented and law-based methods such as writing off NPLs at their own discretion and selling them in the market" with "open and transparent channels" and "fair and full bidding process." ### Market-oriented pricing reform (findings) - Authorities assert progress in market-based pricing since 2017 and dispute view that transition "has stalled." - Note full implementation of "the reform of the registration-based stock issuance system in 2023" making the system "substantially more market-oriented." - On asset disposals: authorities state disposals "have followed the market-oriented and law-based principles" with creditor recovery rates "generally been low"; occasional sales at modest discounts described as ad hoc measures consistent with international practices when considering "financial and social stability." ### Data gaps and stress testing (findings and authorities' position) - Authorities "agree with staff’s recommendations on improving data collection and quality." - Improvements claimed: substantial enhancements in "breadth, depth, and granularity of regulatory data" and data management capability. - Stress testing developments: - PBC and NFRA "have established their regular stress testing mechanisms for the banking sector." - The authorities "carry out thematic stress tests" including for "the real estate sector and to the interest rate risk of fixed income investments" and "are also exploring stress testing in emerging areas such as climate risk." - Data provided to staff for FSAP stress tests: - Solvency: data on "55 commercial banks with assets of more than RMB 500 billion," aggregate asset size "accounts for more than 80 percent for all commercial banks." - Liquidity and contagion: data on "111 commercial banks with assets of more than RMB 200 billion," aggregate asset size "exceeds 85 percent of the total assets of commercial banks." - Authorities assert the scope, type, granularity, and time series of the data "can meet the needs of systemic risk analysis and stress testing." - Authorities disagree with staff assessment that "the data gap has limited the depth and breadth of our systemic risk analysis." *Source: Excerpts from the provided IMF chapter/section content.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2025/english/1chnea2025001-print-pdf.pdf_