2  BIS central bankers’ speeches  However, this requires that enterprises that are no longer viable are unwound in an orderly manner. •  Earlier this year, Chinese authorities announced plans to reduce excess capacity in the steel and coal sectors. •  The government has also issued directives to banks to stop extending loans to firms that are persistently loss-making, while providing credit to competitive companies which are experiencing temporary difficulties. The road to addressing China’s debt vulnerabilities is long and fraught with risks along the way. But if recent efforts are sustained and economic growth does not tank, the prospects are good for an orderly and gradual deleveraging. Structural reforms More than the moderation in economic growth or even the vulnerabilities in the financial system, it is the outcome of the structural reform effort that will be decisive for the long-term prospects for the Chinese economy. The Third Plenum reform blueprint of 2013 provides a comprehensive roadmap for China’s full transition to a market economy. It is a thoughtful, coherent, and well-conceived plan. While implementation has been slower than expected in some areas, China has probably made more progress in structural reforms than any major economy during the last few years. But much work still lies ahead. Take for instance fiscal reform. China has taken several steps to improve the sustainability and transparency of its public finances, especially at the local government level. •  Changes to China’s budget law last year have helped to bring more government spending on-budget.

In the wake of the sub-prime mortgage crisis in the United States, several aspects of Basel II have attracted attention. Among them has been the use of ratings in the regulatory framework and whether this has unintentionally discouraged investors from performing their own due diligence. The underestimation of risk for structured credit securitisations has now come under greater scrutiny. There has also been increased debate over the cyclicality impact of Basel II. The effectiveness of the supervisory review process in ensuring that additional capital buffers are provided by banks for risks not fully captured under Pillar 1 of the framework has also been the subject of this review by authorities. The relative importance of these issues will be different for different countries, depending on the stage of development of the financial markets and the banking system, as well as the supervisory structure that is in place. Among Asia Pacific countries, experiences with the implementation of Basel II have been varied. For emerging economies, Basel II has arguably a more far reaching impact. This is on account of several factors. Firstly, many emerging economies continue to depend heavily on the banking system to finance economic activity. With a few exceptions, commercial banks are the main providers of credit in most emerging economies, accounting for an average of 90% of total credit. This produces a higher correlation to the economic sectors where the implications on the banking system could result in significant disruptions to credit supply which could in turn affect economic activity.