Source: https://www.globallegalinsights.com/practice-areas/banking-and-finance-laws-and-regulations/china
Timestamp: 2019-04-20 13:12:49+00:00

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China’s banking system has been undertaking a fundamental change, in response to both the need to rein in the proliferating risks in the financial sector, and the pressures from economic slowdown and trade tensions with the US. One major step taken was the creation of the Financial Stability and Development Committee. Numerous actions were also taken with a view to, inter alia, clamping down on shadow banking, deleveraging measures toward the wholesale funding market and non-bank financial institutions, eliminating non-performing loans from the banking system, and the opening-up of China’s financial market to foreign direct investment.
China’s financial regulatory structure was historically called “one bank and three commissions”; comprising the People’s Bank of China (PBOC) acting as the central bank, and the China Banking Regulatory Commission (CBRC), the China Insurance Regulatory Commission (CIRC) and the China Securities Regulatory Commission (CSRC) playing the roles of regulators for banking, insurance and banking industries, respectively.
However, with the rise of the ‘shadow’ banking industry since 2008, which has produced firms and products that often blur the lines between banking, insurance, and securities, it became very difficult to effectively regulate these hybrid institutions, which often managed to fall between jurisdictions and industries. PBOC, in its capacity of central bank, does not have authority over the three commissions to coordinate regulatory efforts and handle a constantly changing, more complex financial sector. It was also difficult to take a systemic approach to regulation – which would usually require taking different areas of the financial system and their linkages into account.
In November 2017, the Financial Stability and Development Committee (FSDC) was established, a super financial regulator directly under the State Council and headed by a vice premier more highly ranked than the heads of the other regulatory commissions and the PBOC. The role of FSDC is to coordinate overall strategy for the financial sector and formulate policy at a high level, including supervising China’s monetary policy and financial regulation, formulating policies on systemic financial risk management and maintaining China’s financial security, and giving local governments guidelines on their financial development.
Another key move of the Chinese government was the merger of China’s banking and insurance regulators, CBRC and CIRC, into one regulator, the China Banking Insurance Regulatory Commission (CBIRC) in 2018. Insurance companies were allowed to invest in many new types of assets, and issue short-term insurance policies that, since 2002, had represented risky investments in China and created serious problems in the financial sector. Chinese banks sold wealth-management products with guaranteed yield to investors, and entrusted insurance companies to invest the proceeds from these products on their behalf. The insurance companies could then leverage and invest in riskier products. This sort of off-balance sheet activity had been expanding very quickly over the years, partly resulting from the difficulty of CBRC and CIRC to coordinate and launch an integrated crackdown on these activities. A consolidated banking and insurance regulator would adopt more effective and efficient approaches to bring such activities back under control.
The new CBIRC, however, had lost some of the responsibilities originally taken by CBRC and CIRC, namely their legislative and rulemaking functions, which were handed over to PBOC. Taking into account the fact that FSDC would have its head office sit within PBOC, the new financial regulatory framework had streamlined the policymaking and implementation functions within the regulators and been changed into a “one committee, one bank and one commission” structure, with FSDC being the “super regulator”, taking the leadership role in coordinating the financial regulators and making macroprudential policy, mostly through PBOC, PBOC being the central bank responsible for making and implementing monetary and exchange rate policy, issuing currency, regulating interbank lending and the interbank bond market, etc., and CBIRC acting as the conduct regulator and implementer of the policy formulated by FSDC and PBOC including monitoring compliance, with a particular view to deleveraging and mitigating systematic risks, which had been piling up in the Chinese financial market in the last decade.
The Law of the People’s Republic of China on the People’s Bank of China (1995, amended 2003).
The Law of the People’s Republic of China on Commercial Banks (1995, amended 2003 and 2015, hereinafter the “Commercial Banks Law”).
The Law of the People’s Republic of China on Regulation of and Supervision over the Banking Industry (2003, amended 2006).
These laws became pillars of China’s banking legislation and will be the main legal basis for the supervision and development of the Chinese banking industry for quite a long time into the future.
The second tier consists of administrative rules and regulations enacted by the State Council, the highest administrative authority of China. For example, the Regulations of the People’s Republic of China on Administration of Foreign-funded Banks (2006, amended 2014) were of great importance to foreign banks. They concerned foreign banks’ entry into the Chinese banking sector in the form of representative offices, branches, and local incorporation. They mandated that CBIRC has comprehensive power to license and regulate foreign banks that engage in banking business in China. CBIRC subsequently issued interpretive rules on specifics, and these have been implemented accordingly.
The third tier consists of PBOC’s and CBIRC’s guidelines, notices, and rules. Most of the PBOC and CBIRC regulatory initiatives fall into this category. As China finds specific measures more helpful than a principles-based approach, guidelines, notices, and rules are prescriptive in content and abundant in number. In general, the third tier of regulatory initiatives serves as a base for China’s banking regulations, and deals with contemporary regulatory issues. The main regulatory banking initiatives within this category are discussed in the following sections.
Guidelines for Procurement under IBRD Loan and IDA Credit.
The most substantial regulatory development in the past few years in China was the reform of the regulatory structure including the creation of FSDC, merger of CBRC and CIRC, and a reshuffle of powers among the main banking regulators, which we have discussed in detail above.
As one of its continuous efforts to address risks of shadow banking, CBRC has released a number of rules targeting peer-to-peer (P2P) lending since August 2016.
In recent years, online lending through P2P platforms has been increasing rapidly in China, which emerged as an alternative source of credit for individuals and firms that were otherwise not served by the commercial banks and provided higher rates of return to retail investors. Advances in the application of information technology had also fuelled the fast growth of the P2P lending businesses. This ballooning lending outside the banking system, however, had created substantial risks to the financial system, as many online P2P platforms had deviated from their initial function as information intermediaries and become credit intermediaries by providing guarantees and setting up pools of funds. Some other P2P platforms engaged in outright fraud by selling fraudulent investment products to a great number of individual investors.
CBRC, together with the Ministry of Industry and Information Technology, the Ministry of Public Security, and the State Internet Information Office jointly issued the Interim Rules for the Administration of the Business Activities of Internet-Based Lending Information Intermediary Institutions in August 2016 (“Interim Rules”), with the objective of reforming and standardising the industry to ensure healthy and sustainable development. The Interim Rules clarified that P2P lending platforms were information intermediaries, which were prohibited from, inter alia, absorbing deposits from the general public, gathering funds or setting up pools of funds, or providing guarantees in any form to lenders. P2P lenders were not allowed to sell wealth-management products, nor issue asset-backed securities, and should use third-party banks as custodians for investors’ funds.
The Interim Rules also required all P2P platforms to be record-filed with the local financial regulator. In August 2017, CBRC released the Guidelines on Information Disclosure for Internet-Based Lending Information Intermediary Institutions, pursuant to which P2P platforms must make timely disclosures of funding sources, the amount of outstanding loans, loans that are overdue for more than 90 days, and the repayment plans from guarantors. They must also disclose lending with connected parties such as the platform’s own personnel.
In order to tackle the risk of proliferating non-performing loans (NPL) in the banking system, the Chinese government had introduced a market-oriented debt-for-equity swap mechanism to the banking sector. In September 2016, the State Council issued the Guiding Opinions on Swapping Banks’ Debt into Equity in a Market-Oriented Manner, encouraging enterprises with good prospects but running into temporary difficulties to reduce their leverage ratio through market-driven approaches, including debt-for-equity swap.
strategic enterprises relating to national security.
In the meantime, certain enterprises such as “zombie enterprises” (i.e., enterprises without hope of ending losses and surviving), and enterprises that have deliberately evaded their financial indebtedness, were included in such debt-for-equity swap scheme.
Given that commercial banks in China are not allowed to invest in or hold stakes in non-banking entities, the banks had established financial assets investment companies which would purchase NPLs from the banks and swap such debts for the equity of the borrowers. In November 2018, a number of regulators including PBOC and CBIRC jointly issued a notice which invited market players such as insurance companies and private equity funds to engage in such debt-for-equity swap business, and encouraged resolution of NPLs by way of the issuance of asset-backed securities. This notice also mentioned support for foreign investment in the establishment of private equity funds to engage in market-oriented debt-for-equity swaps, and allowed foreign investors to purchase stakes in financial asset-investment companies and asset-management companies, and conduct market-oriented debt-for-equity swaps through these companies.
With the intention to promote competition and attract foreign capital in China’s financial services sector, China has since 2017 offered to further open up its financial sector by easing restrictions on foreign businesses. One of the major changes was that foreign firms can now own up to 51% of domestic securities, insurance and fund management firms, with such cap to be lifted in three years. The Chinese government has also promised to remove limits on foreign shareholdings in banks, which was previously 20% for an individual foreign investor and 25% for a group of investors, and to take similar steps in the insurance and securities sectors in the following few years. The objective was to phase in full-licence, full-ownership operation of overseas firms in China’s financial sector. Foreign invested banks (i.e., banks incorporated in China and wholly or partly owned by foreign investors) have also been allowed to engage in treasury bonds underwriting, custodial business, and financial advisory services since 2017 without the need to first obtain a licence from the regulator.
The above efforts were reinforced by proposed legislation for a foreign investment law. The full text of such new legislation had been released for public consultation on December 26, 2018. This new law, once enacted, was expected to, inter alia, set up and perfect a mechanism for facilitating foreign investment and significantly easing market access for foreign companies.
Board members of a commercial bank must meet certain qualification criteria.3 Generally speaking, a person shall have professional knowledge, work experience and capabilities which can satisfy the demands of the position to be held. For example, a director of a domestic commercial bank shall: (i) have no less than five years of work experience in law, economy, finance, accounting, or other fields which help to perform the director’s duties; and (ii) have the ability to understand the business management and risk situation of a financial institution by reviewing and analysing its financial statements and statistical reports. Each commercial bank must have independent directors who must be experts in such fields as law, economy, finance or accounting. A director of a foreign-funded bank must have a Bachelor’s degree or above, otherwise he/she must have at least six years of work experience in financing or eight years in economics (of which at least four years must be financial work experience).
Pursuant to Article 24 of the Commercial Banks Law (2015), CBRC has the responsibility for reviewing whether a nominee qualifies for a directorship of a particular bank. After being nominated and elected by shareholders, candidates for directors have to sit CBRC interviews and aptitude tests, and their appointment could be vetoed by CBRC. Thus, CBRC has in fact partially assumed responsibility for the operational soundness of individual banks.
The board of directors shall, according to the actual situation of a commercial bank, set up specialised committees, such as an audit committee, a risk management committee, a remuneration committee, and so on.4 Members of such specialised committees should be directors with expertise and work experience appropriate to their responsibilities. The specialised committees provide specialised advice to the board of directors, or make decisions on specific matters as authorised by the board of directors.
CBRC has issued guidance with a view to ensuring that the incentivising compensation policies adopted by a commercial bank do not encourage imprudent risk-taking. Incentive schemes must provide employees with incentives compatible with effective controls and risk-management, and should be supported by strong corporate governance, including active and effective board oversight.
In addition, the Guidelines for Supervision on Steady Remuneration of Commercial Banks (which was promulgated by CBRC on March 1, 2010) requires each commercial bank to develop a unified remuneration system, including basic remuneration, performance remuneration, medium- and long-term incentives and benefits packages. Commercial banks are generally required to cap their basic remuneration at 35% of their total remuneration, and performance remuneration at three times the basic remuneration. The medium- and long-term incentives and benefits packages shall be determined by commercial banks in accordance with the law.
Internal control of a commercial bank shall include effective risk-assessment and effective procedures to safeguard assets; generating timely and accurate financial, operational, and regulatory reports; and enabling the bank to comply with applicable law.
A commercial bank must have an independent and objective internal audit function to monitor its internal controls. The internal audit function must be staffed by qualified persons. It must test and review the banks’ information systems and verify management actions to address identified material weaknesses. The effectiveness of the internal audit function must be periodically reviewed by the bank’s audit committee.
CBIRC promulgated the Regulation Governing Capital of Commercial Banks (for Trial Implementation) (hereinafter the “Capital Regulation”) on June 7, 2012 with the intention to implement the Basel III capital standards, which marked a milestone for the regulation of the banking sector in China. The Capital Regulation put in place a capital regulatory framework with a four-tier structure, consisting of a minimum requirement (5% for CET1, 6% for T1 and 8% for total), a 2.5% capital conservation buffer and a counter-cyclical buffer between 0-2.5% as the second tier, the 1% SIFI surcharge as the third tier, and the Pillar II requirement as the last tier. The total capital requirements were 11.5% for systemically important financial institutions, and 10.5% for other banks.
In reaction to the rising uncertainty over the trade war with the US, China had decided in August 2018 to reduce the required capital buffers for certain banks by lowering their “structural parameter” in the Macro-Prudential Assessment of their balance sheets by around 0.5 points, which was previously 1.0 point. This ease of capital requirement was made to support local financial institutions in meeting credit demand and thereby boost the supply of new credit to the real economy.
CBIRC issued the Measures for the Management of Liquidity Risks of Commercial Banks with effect July 1, 2018 (hereinafter the “Measures”), which introduced three quantitative indicators: net stable funding ratio (NSFR); high-quality liquid asset adequacy ratio; and the liquidity matching ratio.
NSFR measures the long-term funding stability of a commercial bank and only applies to commercial banks with assets of RMB 200 billion or more. The high-quality liquid asset adequacy ratio measures whether banks possess sufficient high-quality liquid assets to cover short-term liquidity needs under stressful conditions and is applicable to commercial banks with asset values of less than RMB 200 billion. The liquid asset adequacy ratio is subject to phased compliance. For commercial banks, this ratio should reach 80% by the end of 2018, and 100% by the end of June 2019.
The liquidity matching ratio is intended to further improve the liquidity risk-monitoring system. It measures the maturity allocation structure of major assets and liabilities of banks and is applicable to all commercial banks. The liquidity matching ratio will be implemented starting from January 1, 2020 and will be temporarily monitored until 2020. Liquidity risk supervision indicators in China include liquidity coverage ratio, net stable funding ratio, liquidity ratio, liquidity matching ratio, and high liquidity asset adequacy ratio.
In China, only financial institutions licensed by PBOC can take deposits from the general public, although some other financial institutions (e.g., financial leasing companies, credit unions) may may take deposits from their shareholders or members.
At a time when the banking sector was rolling out the welcome mat for more private sector investment, the plan to launch a deposit insurance system had been announced by CBRC as one of the steps for further promoting the reform of the interest rate system.
In the absence of a formal deposit insurance scheme in China, the Chinese government plays the role of a lender of last resort in the event of a crisis. In the wake of the global financial crisis in 2007, the Chinese government provided an implicit guarantee for retail deposits to insure against the unravelling of the financial system and economy.
On February 17, 2015, the State Council promulgated the Deposit Insurance Regulations, in accordance with which each bank shall maintain insurance coverage for money deposited with it, and each depositor will be compensated for losses up to RMB 500,000 in case such bank becomes insolvent or goes bankrupt. The Deposit Insurance Regulations had come into force on May 1, 2015.
1. Art. 7, Guidelines on Corporate Governance of Commercial Banks.
3. Art. 20, The Law of the People’s Republic of China on Regulation of and Supervision over the Banking Industry.
4. Art. 22, Guidelines on Corporate Governance of Commercial Banks.
7. Art. 3 (4), Rules for Implementing the Regulations of the People’s Republic of China on Administration of Foreign-funded Banks (2015).
9. Art. 8, Guidelines for the Compliance Risk Management of Commercial Banks.
11. Art. 43, Commercial Banks Law.

References: Art. 7
 Art. 20
 Art. 22
 Art. 3
 Art. 8
 Art. 43