Progress and Impact of the Global Regulatory Reform …siteresources.worldbank.org/FINANCIALSECTOR/Resources/Liao.M...2014 Global Financial Sector Reform: Five Years on ... and Impact

Progress and Impact of the Global Progress and Impact of the Global Regulatory Reform in China

LIAO MinDirector-General

CBRC Shanghai Office

中国银行业监督管理委员会China Banking Regulatory Commission中国银行业监督管理委员会China Banking Regulatory Commission

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Annual International Conference on Policy Challenges for the Financial Sector

The themes of the Annual International Conference:

2009 Emerging from the Crisis: Building a Stronger International 2009 Emerging from the Crisis: Building a Stronger International Financial System 2010 Towards a Brave New World: Reshaping Financial R l tiRegulation 2011 Seeing Both the Forest and the Trees: Supervising Systemic Risk 2012 Raising the Bar: Implementing Higher Standards for the Financial Sector 2013 Systemically Important Financial Institutions: Priorities and 2013 Systemically Important Financial Institutions: Priorities and Policies in a Volatile World （missing） 2014 Global Financial Sector Reform: Five Years on – Are we t ti th t i th di ?

中国银行业监督管理委员会China Banking Regulatory Commission

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treating the symptoms or curing the disease?

Progress and Impact of the Global Regulatory Reform in China

Global regulatory reforms and their i l t ti i Chiimplementation in China

Unintended consequences need to be qconsidered in regulatory reforms

Some key risks in China’s financial sector Some key risks in China s financial sector

Simplicity VS. Complexity

Unintended consequences and implication in Asian countries and EMDEs


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p

Four Elements of Global Financial Reforms

B ildi ili f fi i l i tit ti1 Building resilience of financial institutions1

E di t bi t f il2 Ending too-big-to-fail2

Transforming shadow banking 3

Structural reform and organic changes4


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Building resilience of financial institutions

Capital Basel III Regulatory Standard in ChinaCapital Basel III Regulatory Standard in ChinaCore Tier 1 Capital

Tier 1 Capital

Tier 2+Tier 1 Capital

Core Tier 1 Capital

Tier 1 Capital

Tier 2+Tier 1 Capital

Minimum Requirement (1) 4.5% 6% 8% 5% 6% 8%

Conservation Buffer (2) 2.5% 2.5%Buffer (2)(1)+(2) 7% 8.5% 10.5% 7.5% 8.5% 10.5%

Countercyclical Buffer 0-2.5% 0-2.5%

SIB S h N t t ttl d 1% (T t ti )SIB Surcharge Not yet settled 1% (Tentative)Transition

Period until the end of 2018 until the end of 2016


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Liquidity Basel III Regulatory Standard in China

≥100% ≥100%effective in 2013

• Commercial banks with assets LCR

effective in 2015 MORE THAN 200 billion Yuan are subject to LCR minimum standards• Phase-in period consistent with pBasel III

NSFR≥100% ≥100%

effective in 2018 effective in 2016effective in 2018 effective in 2016

LTV ≤75%Liquidity

ratio ≥25%


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ratio


Basel III Regulatory Standard in China

3% 4%

Leverage Ratio3%

Final adjustments 2017

4%

SIBs: until the end of 2013

Non-SIBs: the end of 2016

Provision Ratio

Provision–to-Loan Ratio > 2.5%

Provision-to-NPL Coverage Ratio >

150%Provision Ratio

(Stick to the stricter one)

SIBs: until the end of 2013

Non-SIBs: the end of 2016 or 2018


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Non SIBs: the end of 2016 or 2018

Ending too-big-to-fail

ChinaFSB

Strengthened national resolution regimes;

Resolvability

In addition to FSB’s standards, China has some special measures: Resolvability

assessments and improved recovery and resolution plans;

measures:Continuously improve

governance structureBolster capital Surcharge(1% )resolution plans;

Cross-border cooperation

Bolster capital Surcharge(1% )Strengthen the quality,

integrity of database and IT tarrangements;

More intensive and effective supervision

systemStrengthen intrusive and

forward-looking supervision


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p

Transforming shadow banking

FSB, BCBS and IOSCO

Reduce risks and

China Substance over form: Banks are required Reduce risks and

increase transparency in repo and securities lending markets.

to book their business precisely, which means some channel business’ risk weight will be enhanced from 20% or 25% to 100%g

Address the risks from banks' interactions with

100%. Ring-fence: The accounting and risk taking

of inter-financial institution businesses such as lending, repo and CD should be

shadow banks. Agreed reforms to

money market funds

g, pcentralized in specialized units in institutions.

Firewall: Micro-credit company can get f di f th 2 i l

yand the alignment of incentives in securitization.

funding from no more than 2 commercial banks, within the limit of 50% of the company’s own capital.

Fill the gap: New regulation on booming


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Fill the gap: New regulation on booming internet financing activities.

Structural reform and organic change

Others

Organic Change

China State council vice-premier’s meetingOrganic Change

US：FSOC, CFPB

Inter-ministerial joint meeting, chaired by PBOC governor to coordinate financial regulation

UK: FPC, PRA, FCA

EU ESRB EBA

PBOC, CBRC, CSRC and CIRC have established Consumer Protection Bureau EU：ESRB, EBA

Structure Reform

Deposit insurance system is on its way

Adopt ring-fence approach to Volcker Rule Vickers Report

Adopt ring fence approach to separate high-risk businesses, e.g. inter-FI, WMP (implementation may need more time than prudential


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Liikanen Reportneed more time than prudential requirement)

Global Regulatory Reforms and Their Implementation in China

Conclusion:•In spite of some minor differences in detail, China fully supports allh l b l l f i i i ithese global regulatory reform initiatives.•Since joined BCBS and FSB in 2009, China continues to acceleratethe implementation of international regulatory rules and change ourp g y gregulatory frameworks.•In the process of implementation, we are more capable of forward-looking risk evaluation and locating risks at their early stageslooking risk evaluation and locating risks at their early stages.•In spite of being at different stages of development, the generalprinciples for risk management are the same. By steepening ourl i bl t d l d d t tlearning curves, we are able to upgrade people, process and data tobetter address issues such as systemic risk and shadow bankingactivities.


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Unintended Consequences Need to Be Considered in Regulatory Reforms

(2) Shadow Banking

CN: Quasi-Loans

Q i LCapital Requirements

Reserve Requirements

Quasi-Loans (Channel Business):Trust,

Unintended Consequences

Loan to Deposit Ratio

Loan Size Limit

Entrusted Loan, Off-Balance Wealth Management Products ……


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Shadow banking

The estimated scale of China’s shadow banking (in Trillion RMB)

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27

30

2

30

35

21

24

15

20

25

13

5

10

15

0

5

FSB（by the end of 2012）

IMF（by the end of 2012）

CITIC Securities（by the end of

CASS（by the end of 2013）

S&P（by the end of 2013）


2012）

Composition of Aggregate Financing To The Real Economy

100%

Real Economy

Others

60%

80%Equity Financin

Net Financing of C t B d

40%

60%

91.9 81.1 79.2 78.5 73.8 70 3 69 0

Corporate Bonds

Undiscounted Bankers' acceptances

Trust Loans

20%

60.970.3 69.0

56.7 58.252.0 51.4

ust oa s

Entrusted Loans

-20%

0%2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Foreign Currency Loans

RMB Loans


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20%


(3) Unintended Consequences in other areas• Capital Requirements: Actually lower the • Capital Requirements: Actually lower the

capital quality in China (e.g. other Tier 1 capital instruments)

• New Liquidity Ratios: Banks may have incentives to chase after certain types of deposit

d l lti i k t di t ti Gi and loans, resulting in market distortion. Given the current balance sheet of Chinese banks, only adopting LCR and NSFR actually lower the adopting LCR and NSFR actually lower the liquidity standard.


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The root cause of unintended consequences: Institutions care the P&L, but not the systemic y

impact of the individual activities. Institutions don’t realize that we move into a brave

new paradigm, in which we need to prevent new paradigm, in which we need to prevent systemic risk, not to prevent innovation and functioning of financial market.

Examples Examples For one individual bank, 60% concentrate in real

estate loans can be acceptable if the bank has the robust manage skills. But if most banks have 60% concentrate in real estate loans…

30% down payment for first house,70% down


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p y ,payment for second house. But if material collapse of property market occurs…


Solutions:1. Enhance comprehensive dialogues and reach p g

consensus between regulators and financial institutions.

2 Through dialogues consider the effective 2. Through dialogues, consider the effective supervisory policy transmission mechanism in advance.

3 Th h di l th d i t ti f 3. Through dialogues, the concern and intention of regulators to prevent systemic risk can be passed to and internalized in financial institutions, which

ll h l h l bcan really help to reach regulatory objectives.


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Some Key Risks in China’s Financial Sector

Shadow banking: The estimated size ranges from USD 300bn to 5tn. Only 3% of the world, but increased by 42% (FSB 2013)42%. (FSB, 2013)

Too-big-to-fail: In 2012, TOP 5 Banks’/ Financial Holding Companies’ Assets to GDP: 121% (China) VS. 55% (US).Companies Assets to GDP: 121% (China) VS. 55% (US).

Real estate loans: Real estate related loans accounts for 40% of the total of loans in Shanghai by the end of Q1 40% of the total of loans in Shanghai by the end of Q1 2014. And the nation-wide percentage is 38% by the end of 2013.

Liquidity risk: O/N SHIBOR hit 13.44% on June 20 2013; banks are much more relied on whole-sale funding, the percentage of inter-bank liability to the total liability l t d bl d i th t 7 (13 26% f Q1 2014


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almost doubled in the past 7 years(13.26% of Q1 2014 VS. 7.35% of Q1 2007).

Some Key Risks in China’s Financial Sector

Conclusions: The balance sheet of financial institutions is a The balance sheet of financial institutions is a

mirror of potential risks within growth model. Problems are there, it is the regulator who is the first one to identify, measure and address them.

The overall risk is controllable and no crisis yet, however, more bold actions and reforms have been taken to minimize the impact, including BASEL III’s p , gimplementation, structural regulatory policy, deposit insurance regime, interest liberalization……

Structural and holistic change is badly needed Structural and holistic change is badly needed, joint efforts from relevant government departments and all kinds of market participants are crucial.


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The financial system has become increasingly complex over recent years In order to address this complex over recent years. In order to address this complexity, more sophisticated and complicated modeling and risk management strategies are i t d d b l b l l t f introduced by global regulatory reforms.

But whether complexity outperforms simplicity? But whether complexity outperforms simplicity?

Simple approaches can usefully complement more complex ones. And in certain circumstances, less can be more.


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Example

A real story in Shanghai, a large exposure from ea sto y S a g a , a a ge e posu e obanks to steel traders (use steel as collateral to borrow money from banks), the business model is a complicated picture, e.g. loan, bank notes, L/Cs. complicated picture, e.g. loan, bank notes, L/Cs.

We use 3 simple indicators (price, turnover ratio , trade volume) to analyze potential risks. ) y p

The estimated financing demand is 150 billion RMB, but the outstanding balance is 300 billion RMB indeed.

So we immediately send a signal to the banks to cont ol the isk 2 ea s ea lie than the est of the


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control the risk, 2 years earlier than the rest of the nation.


In China context, the financial system will become more complex in the future.

The history tells us simple approaches rather than e sto y te s us s p e app oac es at e t acomplex ones help us escaped from the global financial crisis.

In the future, whether simplicity can help us again is still unknown.


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Unintended consequences in Asian countries

(1) The Implementation of Basel III in Asian Countries

Asian banks are well capitalized and many Asian jurisdictions have moved beyond Basel III. Nearly half of all jurisdictions currently implementing half of all jurisdictions currently implementing Basel III are Asian.

But, the more stringent Basel III requirements for , g qliquid assets may trigger unintended consequences in terms of reallocation of funds at the sectoral level that penalize bank lending for the sectoral level that penalize bank lending for trade finance, small and medium sized enterprises (SMEs) and infrastructure projects – all critical to

’ f h中国银行业监督管理委员会China Banking Regulatory Commission

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Asia’s future growth.

Unintended consequences in Asian countries

Trade Finance: The new leverage ratio treatment (still under discussion) may lead to a significant increase in capital requirements, thus driving up the costs of conducting trade finance business.

SME: The requirement on a higher level and quality of equity capital will squeeze banks’ capacity to lend to SMEs SMEs.

Infrastructure Projects: Banks may be disincentivized to hold long-term assets under Basel III, given the higher capital and Net Stable Funding Ratio (NSFR) requirements.


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( ) q

Global Regulatory Reforms and Their Implementation in emerging economy

Capital requirementCapital requirement • Financial infrastructure inefficiency, e.g. capital market bond market. • Financial inclusions tops the agenda, e.g. government injects the capital.

Global Standards VS Local Constraints in EMDEs

Liquidity requirementLiquidity requirement Limited qualified liquid assets.

Leverage ratioLeverage ratio Corporate less self-disciplined and get financed outsideLeverage ratioLeverage ratio Corporate less self disciplined and get financed outside banking sector.

Corporate GovernanceCorporate Governance Difficult to find qualified board directors.

Structural measuresStructural measures Risky activities may be driven to unregulated areas.

CrossCross--Border Border Resolution RegimesResolution Regimes

Lack of communications between home and host regulators.

G i F t tiG i F t ti • High “global cost”


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Growing FragmentationGrowing Fragmentation • High global cost• Regulatory differences create incentives for arbitrage

Source: The Global Financial System: Fixing many old problems, Creating some new ones. World Economic Forum Global Agenda Council on the Global Financial System, Dec 2013.

Global Regulatory Reforms and Their Implementation in emerging economies

Conclusion: For all EMDEs, we should embrace these reforms, especially the p y

philosophy and rationale behind them. Having a common language with the global community is the right path.

We do not have a once-size-fits-all solution for 200+ economies. It isWe do not have a once size fits all solution for 200 economies. It is objective to exercise judicious national discretion in tailoring Basel III implementation that is risk-appropriate for individual economies.

The aim is not to dilute prudential regulations but to ensure that the The aim is not to dilute prudential regulations, but to ensure that the complex Basel III regulations are fit for purpose, and commensurate with the different stages of development and risks in different countries.

D ring the process of establishing global reg lator r les e sho ld During the process of establishing global regulatory rules, we should also listen to EMDEs' voices and views; pay more attention to the effects of new rules and standards to EMDEs; and if possible, leave some flexibility and grace-period especially for a large number of small


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some flexibility and grace-period, especially for a large number of small and medium banks.

Diversity and difference can be turned into d d i i f t th f t d energy and driving force to the safety and

soundness of global financial system.


中国银行业监督管理委员会China Banking Regulatory Commission中国银行业监督管理委员会China Banking Regulatory Commission

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Documents

Progress and Impact of the Global Regulatory Reform …siteresources.worldbank.org/FINANCIALSECTOR/Resources/Liao.M...2014 Global Financial Sector Reform: Five Years on ... and Impact