Progress and Impact of the Global Regulatory Reform in China LIAO Min Director-General CBRC Shanghai Office 1
Annual International Conference on Policy Challenges for the Financial Sector The themes of the Annual International Conference: 2009 Emerging from the Crisis: Building a Stronger International Financial System 2010 Towards a Brave New World: Reshaping Financial Regulation 2011 Seeing Both the Forest and the Trees: Supervising Systemic Risk 2012 Raising the Bar: Implementing Higher Standards for the Financial Sector 2013 Systemically Important Financial Institutions: Priorities and Policies in a Volatile World (missing) 2014 Global Financial Sector Reform: Five Years on Are we treating ti the symptoms or curing the disease? 2
Progress and Impact of the Global Regulatory Reform in China Global regulatory reforms and their implementation ti in China Unintended consequences need to be considered in regulatory reforms Some key risks in China s financial sector Simplicity VS. Complexity Unintended consequences and implication in Asian countries and EMDEs 3
Four Elements of Global Financial Reforms 1 Building resilience of financial i institutions 2 Ending too-big-to-fail t il 3 Transforming shadow banking 4 Structural reform and organic changes 4
Building resilience of financial institutions Capital Basel III Regulatory Standard in China Core Tier 1 Capital Tier 1 Capital Tier 2+Tier 1 Capital Core Tier 1 Capital Tier 1 Capital Tier 2+Tier 1 Capital Minimum Requirement (1) 4.5% 6% 8% 5% 6% 8% Conservation Buffer (2) 2.5% 2.5% (1)+(2) 7% 8.5% 10.5% 7.5% 8.5% 10.5% Countercyclical Buffer 0-2.5% 0-2.5% SIB Surcharge Not yet settled 1% (Tentative) ti Transition Period until the end of 2018 until the end of 2016 5
Building resilience of financial institutions Liquidity LCR NSFR Basel III Regulatory Standard in China 100% 100% effective in 2015 effective in 2013 Commercial banks with assets MORE THAN 200 billion Yuan are subject to LCR minimum standards Phase-in period consistent with Basel III 100% 100% effective in 2018 effective in 2016 LTV 75% Liquidity ratio 25% 6
Building resilience of financial institutions Leverage Ratio Provision Ratio Basel III 3% Final adjustments 2017 Regulatory Standard in China 4% SIBs: until the end of 2013 Non-SIBs: the end of 2016 Provision to-loan Ratio > 2.5% Provision-to-NPL Coverage Ratio > 150% (Stick to the stricter one) SIBs: until the end of 2013 Non-SIBs: the end of 2016 or 2018 7
Ending too-big-to-fail FSB Strengthened national resolution regimes; Resolvability assessments and improved recovery and resolution plans; Cross-border cooperation arrangements; More intensive and effective supervision China In addition to FSB s standards, China has some special measures: Continuously improve governance structure Bolster capital Surcharge(1% ) Strengthen the quality, integrity of database and IT system Strengthen intrusive and forward-looking supervision 8
Transforming shadow banking FSB, BCBS and IOSCO China Reduce risks and increase transparency in repo and securities lending markets. Address the risks from banks' interactions with shadow banks. Agreed reforms to money market funds and the alignment of incentives in securitization. 9 Substance over form: Banks are required to book their business precisely, which means some channel business risk weight will be enhanced from 20% or 25% to 100%. Ring-fence: The accounting and risk taking of inter-financial institution businesses such as lending, repo and CD should be centralized in specialized units in institutions. Firewall: Micro-credit company can get funding from no more than 2 commercial banks, within the limit of 50% of the company s own capital. Fill the gap: New regulation on booming internet financing activities.
Structural reform and organic change 10 Others Organic Change US:FSOC, CFPB UK: FPC, PRA, FCA EU:ESRB, ESRB EBA Structure Reform Volcker Rule Vickers Report Liikanen Report China State council vice-premier s meeting Inter-ministerial joint meeting, chaired by PBOC governor to coordinate financial regulation PBOC, CBRC, CSRC and CIRC have established Consumer Protection Bureau Deposit insurance system is on its way Adopt ring-fence approach to separate high-risk businesses, e.g. inter-fi, WMP (implementation may need more time than prudential requirement)
Global Regulatory Reforms and Their Implementation in China Conclusion: In spite of some minor differences in detail, China fully supports all these global regulatory reform initiatives. Since joined BCBS and FSB in 2009, China continues to accelerate the implementation of international regulatory rules and change our regulatory frameworks. In the process of implementation, we are more capable of forward- looking risk evaluation and locating risks at their early stages. In spite of being at different stages of development, the general principles for risk management are the same. By steepening our learning curves, we are able toupgrade people, process and data to better address issues such as systemic risk and shadow banking activities. 11
Unintended Consequences Need to Be Considered in Regulatory Reforms (2) Shadow Banking CN: Quasi-Loans Capital Requirements Reserve Requirements Loan to Deposit Ratio Loan Size Limit Unintended Consequences Quasi-Loans (Channel Business): Trust, Entrusted Loan, Off-Balance Wealth Management Products 12
Shadow banking 35 The estimated scale of China s shadow banking (in Trillion RMB) 30 27 30 25 20 21 24 15 13 10 5 0 FSB(by the end of 2012) IMF(by the end of 2012) CITIC Securities (by the end of 2012) CASS(by the end of 2013) S&P(by the end of 2013)
Composition of Aggregate Financing To The Real Economy 100% Others 80% 60% 40% 20% 91.9 81.1 79.2 78.5 73.8 60.9 70.3 69.0 Equity Financin Net Financing of Corporate Bonds Undiscounted Bankers' acceptances Trust Loans 56.7 58.2 52.0 51.4 Entrusted Loans 0% -20% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Foreign Currency Loans RMB Loans 14
Unintended Consequences Need to Be Considered in Regulatory Reforms (3) Unintended Consequences in other areas Capital Requirements: Actually lower the capital quality in China (e.g. other Tier 1 capital instruments) New Liquidity Ratios: Banks may have incentives to chase after certain types of deposit and loans, resulting in market distortion. ti Given the current balance sheet of Chinese banks, only adopting LCR and NSFR actually lower the liquidity standard. 15
Unintended Consequences Need to Be Considered in Regulatory Reforms 16 The root cause of unintended consequences: Institutions care the P&L, but not the systemic impact of the individual activities. Institutions don t realize that we move into a brave new paradigm, in which we need to prevent systemic risk, not to prevent innovation and functioning of financial market. Examples For one individual bank, 60% concentrate in real estate loans can be acceptable if the bank has the robust manage skills. But if most banks have 60% concentrate in real estate loans 30% down payment for first house,70% down payment for second house. But if material collapse of property market occurs
Unintended Consequences Need to Be Considered in Regulatory Reforms Solutions: 1. Enhance comprehensive dialogues and reach consensus between regulators and financial institutions. 2. Through dialogues, consider the effective supervisory policy transmission mechanism in advance. 3. Through h dialogues, the concern and intention ti of regulators to prevent systemic risk can be passed to and internalized in financial institutions, which can really help to reach regulatory objectives. 17
Some Key Risks in China s Financial Sector Shadow banking: The estimated size ranges from USD 300bn to 5tn. Only 3% of the world, but increased by 42%. (FSB, 2013) Too-big-to-fail: In 2012, TOP 5 Banks / Financial Holding Companies Assets to GDP: 121% (China) VS. 55% (US). Real estate loans: Real estate related loans accounts for 40% of the total of loans in Shanghai by the end of Q1 2014. And the nation-wide percentage is 38% by the end of 2013. 18 Liquidity risk: O/N SHIBOR hit 13.44% on June 20 2013; banks are much more relied on whole-sale funding, the percentage of inter-bank liability to the total liability almost doubled d in the past 7 years(13.26% of Q1 2014 VS. 7.35% of Q1 2007).
Some Key Risks in China s Financial Sector Conclusions: The balance sheet of financial institutions is a mirror of potential risks within growth model. Problems are there, it is the regulator who is the first one to identify, measure and address them. The overall risk is controllable and no crisis yet, however, more bold actions and reforms have been taken to minimize the impact, including BASEL III s implementation, structural regulatory policy, deposit insurance regime, interest liberalization Structural and holistic change is badly needed, joint efforts from relevant government departments and all kinds of market participants are crucial. 19
Simplicity VS. Complexity The financial system has become increasingly complex over recent years. In order to address this complexity, more sophisticated and complicated modeling and risk management strategies are introduced d by global l regulatory reforms. But whether complexity outperforms simplicity? Simple approaches can usefully complement more complex ones. And in certain circumstances, less can be more. 20
Simplicity VS. Complexity Example A real story in Shanghai, a a large exposure e from banks to steel traders (use steel as collateral to borrow money from banks), the business model is a complicated picture, e.g. loan, bank notes, L/Cs. We use 3 simple indicators (price, turnover ratio, trade volume) to analyze potential risks. The estimated financing demand is 150 billion RMB, but the outstanding balance is 300 billion RMB indeed. 21 So we immediately send a signal to the banks to control ol the risk, 2 years earlier than the rest of the nation.
Simplicity VS. Complexity In China context, the financial system will become more complex in the future. The e history tells us simple approaches rather than complex ones help us escaped from the global financial crisis. In the future, whether simplicity can help us again is still unknown. 22
Unintended consequences in Asian countries 23 (1) The Implementation of Basel III in Asian Countries Asian banks are well capitalized and many Asian jurisdictions have moved beyond Basel III. Nearly half of all jurisdictions currently implementing Basel III are Asian. But, the more stringent Basel III requirements for liquid assets may trigger unintended consequences in terms of reallocation of funds at the sectoral level that penalize bank lending for trade finance, small and medium sized enterprises (SMEs) and infrastructure projects all critical to Asia s future growth.
Unintended consequences in Asian countries Trade Finance: The new leverage ratio treatment (still under discussion) may lead to a significant increase in capital requirements, thus driving up the costs of conducting trade finance business. SME: The requirement on a higher level and quality of equity capital will squeeze banks capacity to lend to SMEs. Infrastructure Projects: Banks may be disincentivized to hold long-term assets under Basel III, given the higher capital and Net Stable Funding Ratio (NSFR) requirements. 24
Global Regulatory Reforms and Their Implementation in emerging economy Global Standards VS Local Constraints in EMDEs Capital requirement Financial infrastructure inefficiency, e.g. capital market bond market. Financial inclusions tops the agenda, e.g. government injects the capital. Liquidity requirement Leverage ratio Corporate Governance Limited qualified liquid assets. Corporate less self-disciplined and get financed outside banking sector. Difficult to find qualified board directors. Structural measures Cross-Border Resolution Regimes Risky activities may be driven to unregulated areas. Lack of communications between home and host regulators. High global cost Growing Fragmentation Regulatory differences create incentives for arbitrage Source: The Global Financial System: Fixing many old problems, Creating some China Banking new ones. Regulatory World Commission Economic Forum Global Agenda Council on the Global Financial System, Dec 2013. 25
Global Regulatory Reforms and Their Implementation in emerging economies 26 Conclusion: For all EMDEs, we should embrace these reforms, especially the philosophy and rationale behind them. Having a common language with the global community is the right path. We do not have a once-size-fits-all solution for 200+ economies. It is objective to exercise judicious national discretion in tailoring Basel III implementation that is risk-appropriate for individual economies. The aim is not to dilute prudential regulations, but to ensure that the complex Basel III regulations are fit for purpose, and commensurate with the different stages of development and risks in different countries. During the process of establishing global regulatory rules, we should also listen to EMDEs' voices and views; pay more attention to the effects of new rules and standards to EMDEs; and if possible, leave some flexibility and grace-period, especially for a large number of small and medium banks.
Diversity and difference can be turned into energy and driving i force to the safety and soundness of global financial system.
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