The Chinese banking sector may have emerged relatively unscathed from the financial crisis, but regulatory reform is still high on its agenda, meaning that the China Banking Regulatory Commission has been keen to stay one step ahead of the game by introducing a new set of regulatory standards in the first half of 2011, which placed a strict emphasis on liquidity.
The financial turmoil that erupted in 2008 has led to significant changes in the global economic and financial system, but the future landscape still remains uncertain. After more than a decade of financial deregulation, the international regulatory grip is being tightened up once again, yet the ongoing global financial reform is a painful and protracted process.
Since its inception eight years ago, the China Banking Regulatory Commission (CBRC) has been committed to building a safe banking sector and ensuring that banking services support the real economy. During the darkest days of the global financial crisis, the Chinese banking sector has stood largely unaffected. By the end of June 2011, the total assets of China’s banking institutions had reached Rmb104,000bn ($25,000bn), almost four times the 2003 figure.
In the first half of 2011, China’s banking industry reported an after-tax profit of Rmb644bn, representing a year-on-year increase of 39%. The non-performing loan ratio of major commercial banks declined to 1.01%, while the average return on assets and return on equity rose to 1.37% and 22.55%, respectively. Additionally, the provisioning coverage ratio of major commercial banks reached 254.29% by the end of June 2011.
Despite these encouraging figures, the Chinese banking regulators have remained cool-headed about future challenges and have tried to stay ahead of the curve. The Chinese banking sector still operates with low efficiency and heavy capital consumption, and the prudential risk management culture is yet to take hold in many banks’ day-to-day operations.
Laying out the law
Economic and industrial restructuring presents new challenges to banks’ sustainable operation. These daunting challenges call for adaptable and proactive banking supervision. Regulators need to improve the effectiveness of their supervision by dynamically identifying and measuring the risks in key areas, flexibly using supervisory approaches and tools, and daring to say no as necessary. Also, they need to place more emphasis on the build-up of a well-functioning comprehensive risk management mechanism within banks as automatic stabilisers.
The CBRC has also been engaged in the formation of international supervisory standards since 2008, sharing Chinese philosophies and practices with its counterparts across the world. In April 2011, the CBRC promulgated its 'Guidelines on Implementing New Regulatory Standards in the Chinese Banking Industry', making it one of the first major economies to localise as well as legalise financial regulatory reform.
The guidelines introduce new regulatory standards, recalibrate a series of supervisory tools including capital adequacy ratios, dynamic provisioning, leverage ratios and liquidity ratios. In line with Chinese principles, the standards are stricter and adhere to a tighter timetable than advised. Under the new rules, systemically important financial institutions (SIFIs) are required to meet the new standards by the end of 2013 and non-SIFIs by the end of 2016, while a few will be granted an additional grace period.
Number crunching
The CBRC has set three minimum capital requirements, namely 5% core Tier 1 capital, 6% Tier 1 capital and 8% total capital. Moreover, the capital conservation buffer is set at 2.5%, and SIFIs are subject to 1% additional capital surcharge. Under the new rules, the capital adequacy ratios of SIFIs and non-SIFIs should be no lower than 11.5% and 10.5%, respectively. In case of rapid credit expansion, there would be a counter-cyclical capital buffer built up to absorb losses.
To underpin a quality capital base, the CBRC requires that core Tier 1 capital should be no less than 75% of banks’ total capital, and requires the subordinated debts cross-held by banks be deducted from the issuer’s Tier 2 capital. In addition, the CBRC requires banks to set up a sound capital replenishment mechanism, which prioritises the replenishment of core capital, encourages capital injection from shareholders and enhances the capacity for retaining profits.
The CBRC has set the leverage requirement at 4%, a prudent level that gives us a freer hand to control banks’ leverage build-up and maintain the stable and sound performance of the Chinese banking sector. This exemplifies the will and determination of Chinese regulators to strengthen regulation and supervision.
Given the rapid credit growth in recent years, the CBRC has raised the provisioning coverage ratio from 100% to 150%, and required that the provisioning ratio (total provisions/total loans) be no lower than 2.5%. Meanwhile, the CBRC has embarked on the study of policies and procedures for dynamically adjusting the provisioning requirements.
In addition to traditional liquidity requirements, the CBRC has introduced the new liquidity standards, such as liquidity coverage ratio and net stable funding ratio. Meanwhile, individual banks are urged to place the improvement of liquidity risk management capacity high on their agenda, and strengthen their overall resilience in the face of liquidity stress.
Since its inception, the CBRC required that a bank’s total lending to a single borrower should not exceed 10% of the bank’s net capital, while its total credit exposure to a group borrower should be limited within 15% of its net capital. This is a fairly stringent requirement, even by global standards.
Effective measures
To mitigate current risks facing the Chinese banking sector, the CBRC has adopted a series of measures to ensure its supervision is effective. We have strengthened the supervision of banks’ exposures to local government funding platforms (LGFPs) by requiring banks to sort their LGFP loans through stringent classification of loans, clarification of debt repayment parties, enhanced cushion, sufficient provisioning and prompt write-offs.
To curb the housing bubbles, the CBRC has tightened supervision of mortgage loans and off-balance-sheet financing of property developers through dynamically adjusting ratios such as loan to value and debt to income.
The 12th 'five-year plan' has been introduced in 2011, to outline the roadmap for China’s rising trajectory in the next five years. Looking forward, the transformation of economic growth patterns and industrial restructuring will bring about unprecedented challenges and opportunities, and many economic and financial reforms that are on the agenda will inevitably have significant bearings on the banking sector.
The CBRC will continue to make every effort to build a prudential supervisory framework, improving supervisory tools and approaches, and thereby making the Chinese banking system healthier, more robust and resilient in years to come.
Liu Mingkang recently retired as the chairman of China Banking Regulatory Commission
