IMF published its staff report under the 2018 Article IV consultation with China. The report outlines recent and ongoing improvements in regulatory framework, among other issues. The guidelines to regulate the asset management businesses of financial institutions and the rules on liquidity risk management of commercial banks had been announced; phase-in periods are already locked-in and financial institutions are granted the necessary time to adapt their business models to the new rules. In particular, banks would need to increase capital and change their funding modalities as they brought nonstandard credit assets previously channeled through asset management products back into their own balance sheets.
The IMF staff sees tensions in the authorities’ strategy between, on the one hand, the stated goals of stabilizing leverage, allowing market forces a decisive role, and greater innovation and opening-up, and, on the other, still-unsustainable debt growth, the pervasive role of the state in the economy, and the relatively restrictive trade and investment regime in some areas. To achieve the desired higher-quality development will require addressing these policy tensions by building on the existing reform agenda and taking advantage of the current growth momentum to “fix the roof while the sun is shining.” Key elements to be worked on are continuing to rein in credit growth, accelerating rebalancing efforts, increasing the role of market forces, fostering openness, and modernizing policy frameworks. The authorities recently announced important guidelines for the large (120% of GDP) asset management business. The rapid expansion of the asset management sector reflects regulatory gaps that encouraged rampant arbitrage. The new guidelines aim to harmonize regulations on all asset management products, irrespective of who issues them, by setting basic principles on product classification, investor suitability, conduct of business rules by managers/distributors, risk management, disclosure, valuation and reporting.
The report reveals that, in line with the recommendations of the 2017 Financial Sector Assessment Program (FSAP), regulators adopted a wide range of decisive measures to tackle the excessive expansion of the riskier parts of the financial system, such as interbank borrowing, wealth management products (WMPs) and off-balance sheet activities of banks. Key measures included setting limits on the growth of WMPs and banks’ reliance on negotiable certificate of deposits (NCDs, a type of wholesale funding), more strict enforcement of the “look-through” principle (whereby the quality of the underlying assets is considered), and adjustments to loan provisioning requirements to encourage NPL recognition and disposal. These measures have reduced not only the size of the shadow banking sector but also the interconnections between banks and nonbanks. Additionally, PBC maintained sufficient liquidity in the wholesale market to prevent any systemic liquidity risks. Furthermore, to maximize the long-run benefit of digitalization, the government will need to strike a balance between allowing innovation to develop and flourish and playing an active role in addressing emerging risks such as privacy infringement and cyber-crimes, promoting competition (including with foreign firms), and strengthening protection of intellectual property rights and anti-money laundering.
In the fintech arena, the authorities have taken a range of actions to establish a comprehensive regulatory framework, including setting up a fintech committee to coordinate among regulators and industry, adopting a “substance over form” approach to close regulatory gaps, a centralized clearing house for third-party payments, and banning initial coin offerings. Given the transformative nature of fintech, regulators will need to stay nimble to head off emerging risks, for example, by strengthening data gathering/analysis and “know-your-customer” requirements for third-party payments. The authorities had embarked on a set of regulatory initiatives to streamline data collection and strengthen regulatory oversight. The regulatory framework was guided by the need for a level playing field for all payment service providers, the recognition of substance over form to ensure financial service provision fell under regulatory purview, and the desire that these services supported financial inclusion and did not jeopardize financial stability. Also, large fintech companies that posed systemic risks (for example, to the payments system) would be treated as systemically important financial institutions.
Related Link: Staff Report
Keywords: Asia Pacific, China, Banking, Securities, Article IV, FSAP, Regtech, IMF