a market economy. some financial institutions, especially large ones, have not shed the bureaucracy - oriented mentality, a legacy of the centralized economy. in their business objectives, personal promotion is usually prioritized over profit indicators, which will definitely affect the transmission of price instruments of monetary policy. in order to enhance the micro foundation, china has been strengthening financial supervision over the years. it should be noted that the choice of regulatory intensity and indicators has direct impact on monetary policy effectiveness. for instance, with increasing concern on the rise of non - performing loans ( npl ), the regulatory authority required that npl ratio be reduced to a certain level. this regulatory indicator played its role to the extent that commercial banks did reduce npl ratios. however, in order to comply with the regulatory requirement of lower npl ratio, some financial institutions increased lending in an attempt to inflate the denominator and grow out of the npl problem. this exacerbated the excessive credit growth problem. at this point, some people started to realize that we should worry not only about the npl ratios, but also the quantity of npls. again, this was also an over - simplified perception. it was only after some time of market development, much experience and years of discussion, that consensus was finally reached in 2003 on the importance of capital adequacy. only when agencies at the micro level put in place risk control and capital constraint, could monetary policy transmission mechanism work. the chinese financial community has always watched the evolution of the basel accord closely. as early as in 1994, the pbc initiated the regulatory indicators on commercial bank ’ s capital in its circular 38 entitled “ notification on balance sheet management of commercial banks ”, and required that the ratio of monthly average capital of commercial banks to monthly average risk - weighted assets be no less than 8 percent, while the ratio of average core capital of commercial banks to monthly average risk - weighted assets be no less than 4 percent. the commercial banking act of 1995 also stipulated that capital adequacy ratio ( car ) of commercial banks be no less than 8 percent. however, for an extended period of time, no regulatory actions were ever taken against banks with inadequate capital. concession was even allowed in the calculation of car. compromise was made in the loan asset classification and bad debt provisioning rules in 1997. in the absence of realistic classification and sufficient risk provisioning, car can hardly indicate the risk of the bank. these problems made it impossible

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