IMF published its staff report in context of the 2019 Article IV consultation with the People’s Republic of China. The IMF Directors stressed the importance of staying the course on deleveraging and reducing financial risks. They concurred that continuing financial regulatory reforms while strengthening bank capital, developing a clear resolution regime for banks, and containing vulnerabilities from rising household debt would help deliver a more sustainable growth path. To improve credit allocation, most Directors agreed that a plan to reduce implicit guarantees for state-owned enterprises would be important.
The staff report highlighted that the build-up of risks in the financial sector has been contained, but vulnerabilities remain elevated and credit growth is picking up. Financial deleveraging and reduced interconnectedness between banks and non-banks, along with somewhat improved risk-differentiation, have resulted from regulatory and supervisory reforms. Credit growth slowed through 2018 but has begun to pick up in 2019. The government in May took over Baoshang, a medium-sized “zombie” bank with solvency and liquidity problems; this was the first public takeover in 20 years. The announcement that negotiated haircuts would be applied to large creditors’ claims raised concerns about counterparty risks and highlighted balance sheet weaknesses facing many small and medium-size banks, including more than a dozen banks that have yet to release the 2018 financial statements. The authorities viewed Baoshang Bank as an isolated case and considered the risk of contagion to be low and manageable, as the PBC is ready to provide sufficient liquidity to mitigate funding problems that could affect other banks.
The authorities also agreed with the need to establish a well-functioning resolution regime. The authorities are pressing ahead with financial regulatory reform, despite heightened external risks. To strengthen the solvency of small banks, the authorities are encouraging profit retention and capital raising from outside sources. If these options fail to strengthen the weakest banks in the system, consolidation through acquisitions is being viewed as another option to boost systemic resilience.
Efforts to strengthen financial regulation, reduce regulatory arbitrage, and improve the institutional framework for financial supervision led to a contraction of shadow banking and financial interconnectedness. However, business models and profitability of many banks have come under pressure and system-wide capital remains comparatively low, particularly in small and medium-size banks. Additionally, household debt rose rapidly and credit allocation worsened, as private firms’ access to credit was curtailed. The priority should be to avoid regulatory backtracking and continue with structural regulatory reforms to reduce the still-elevated vulnerabilities, while boosting bank capital. The heightened risk aversion and funding pressures on small banks following the first public bank takeover in 20 years underscore the need to move promptly on needed reforms, including those recommended by the FSAP. The key FSAP recommendations include the following:
- Implement announced regulatory reforms. The asset management sector, which continues to see significant maturity and liquidity mismatches, should be uniformly regulated and supervised and reforms for the sector, which were introduced from late 2017, should be fully implemented without delays.
- Strengthen bank capital to facilitate the continued downsizing of shadow banking and encourage migration of these assets onto bank balance sheets. Finalize the framework for D-SIBs and SIFIs, including additional capital surcharges.
- Enhance the financial framework by developing a resolution regime for consistent application across banks (following up on FSAP recommendations). Also, strengthen the deposit insurance system to help facilitate the exit of weak institutions.
- Contain vulnerabilities from rising household debt by strengthening macro-prudential tools and developing a personal bankruptcy regime. The authorities plan to enhance the role of debt-service-to-income (DSTI) limits as a macro-prudential tool going forward but emphasized the need to improve the information of all household debt obligations. The authorities agreed on the need to promote the establishment of a personal bankruptcy regime, to improve the existing enterprise bankruptcy law, and to strengthen institutional arrangements.
- Focus on fintech regulation and comprehensive fintech supervisory oversight. Current initiatives that strengthen data gathering and enhance “know your customer” requirements are welcome. The authorities recognized that the dominance of a few market leaders could amplify risks to the financial system. Accordingly, the authorities are formulating rules for fintech regulation, which will establish basic principles for innovative fintech products and create rules for new financial services channels, including administrative and safety rules for banks’ application programming interfaces, data protection, and regulation of key technologies such as cloud computing. A comprehensive oversight plan of fintech firms is expected to be rolled out.
Related Link: Staff Report
Keywords: Asia Pacific, China, Banking, Insurance, Securities, Resolution Regime, FSAP, Article IV, Fintech, Baoshang Bank, Shadow Banking, Regulatory Arbitrage, Systemic Risk, Macro-Prudential Policy, PBC, IMF
Sam leads the quantitative research team within the CreditEdge™ research group. In this role, he develops novel risk and forecasting solutions for financial institutions while providing thought leadership on related trends in global financial markets.
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