China Uplevels Financial Regulatory System to Spur Growth
- China’s financial system has been under significant stress in recent years due to external shocks from the real estate crisis and tech sector crackdown.
- To close regulatory loopholes and address systemic risk, China is launching a new “super regulator,” the National Financial Regulatory Administration, with increased authority that will cut across government ministries and party bodies.
- The restructuring should strengthen China’s long-term financial stability and – coupled with the Government’s pro-business messaging and intensified efforts to attract foreign investment – should help create more confidence in China’s economy coming out of the past three years of Covid closure.
- China is predicting around 5% growth this year, but the country’s longer-term economic outlook remains unclear amid waning exports and weak domestic consumption.
What's New?
In recent years, Beijing has made concerted efforts to de-risk its financial system, including regulatory tightening and attempting to rein in its shadow banking system. But amid these efforts, it has faced shocks from the real estate and tech sectors and growing local government debt – risks to the financial system that have originated externally.
To better see across sectors and anticipate risks to the financial system, the government has established a new “super regulator,” the National Financial Regulatory Administration (NFRA), as part of its restructuring plan unveiled at last month’s Two Sessions, China’s annual legislative and political advisory meetings.
The NFRA, which reports directly to the State Council, will regulate and supervise the entire financial industry, except securities, centralizing functions previously under the China Banking and Insurance Regulatory Commission (CBIRC), the central bank (PBoC), and the securities regulator (CSRC). The move aims to eliminate redundancies and ensure better coordination among government and party stakeholders.
Importantly, the new regulator will be led by Li Qiang who, as Premier, has visibility on and authority over the activities of all ministries, enabling him to coordinate across stakeholders and ensuring that the regulator is not outranked by the entities being regulated. Li is also President Xi’s number two in both the party and government, indicating the importance of this effort to Xi and giving Xi increased influence on financial and economic decision making.
The government’s NFRA will also have mirror organizations within the Chinese Communist Party to oversee key decision making. The newly created Central Financial Commission will assume responsibilities from the State Council’s Financial Stability and Development Committee for financial policy planning, management, and oversight. And the resurrected Central Financial Work Committee, which last operated in 2002, will work to integrate ideology and party-building within the financial system.
Why Does It Matter?
The NFRA’s centralized oversight will close loopholes in financial regulation. China has had multiple regulators overseeing the financial sector, including the CSRC, its securities regulator, and the CBIRC, its banking and insurance regulator. Prior to 2018 reforms that created the CBIRC, China even had distinct banking and insurance authorities. With the entire financial system now under purview of the NFRA’s sole authority, the NFRA will be able to strengthen regulation and oversight on financial institutions’ compliance, operational risks, and investor protection, as well as close previous regulatory loopholes. By delineating regulatory and developmental responsibilities, it will also eliminate conflicts of interest for local entities previously tasked with meeting development targets and supervising financial risk.
Premier Li Qiang’s leadership allows the NFRA to better identify and address risks across sectors. Risks to the financial system have often originated outside of the financial infrastructure. The property market crash, for example, has threatened the entire banking system due to local banks over-leveraged in real estate or developers. Since Premier Li has authority over activities of all ministries, placing him directly in charge of the NFRA allows him to see across all the government and enhances transparency of cross-exposure risks between the financial and non-financial sectors.
A higher status combined with Premier Li’s leadership ensure the NFRA holds sway among other political bodies. Politics can trump prudent financial policy. It has been politically challenging, for example, to allow a bank or state-owned enterprise (SOE) to go bankrupt because political leaders have outranked financial regulators and have been able to overrule politically damaging bankruptcies. Now, key decision-makers on financial impact are at the table. With an elevated status on par with key party bodies and SOE heads, and with Premier Li as its chair, it is now harder for anyone to overrule the NFRA, ensuring that sound financial policy is prioritized.
Some local banks are likely to fail, but the risk is not systemic. Past government interventions have led investors to believe that struggling banks and SOEs will be bailed out. But now that the NFRA has ample authority, the central government wants to send a message that it will not always be there to save state banks. With the real estate crash and over-leveraged small- and medium-sized provincial banks now in crisis, many are likely to be allowed to fail. However, central banks are well-managed and have dealt with the real estate risk, resulting in a banking system that is largely steady. While it may take time for the system to recover fully, these reforms promote long-term health and stability of the financial system.
Where Is It Going?
Creation of this new entity shows how important the government considers the banking system and its long-term commitment to de-risk the financial system. Better oversight and intra-governmental coordination will likely bolster financial stability and improve the investment environment. While roles and responsibilities across new government and party institutions will take time to shake out and result in some amount of regulatory delay and uncertainty, in the long term it should bring greater efficiency and stability to China’s financial system.
The move is a positive development for China’s financial system and for foreign firms as China continues to open its financial services market. Several foreign financial services firms have recently received various operating licenses to expand their business in the market after years of delay and negotiation, and several other Western banks are applying for mutual fund licenses as Beijing continues to relax rules on foreign financial institutions.
Chinese leadership has also committed to open up further to foreign investors and create a more attractive landscape for private and foreign operations. The 2023 Government Work Report prioritized intensifying efforts to attract and utilize foreign investment – China needs foreign capital to boost its economic recovery. In late March, the Ministry of Commerce designated 2023 “Invest in China Year,” and leaders across the party and government continue to push business-friendly rhetoric. In his first press conference as Premier earlier this month, Li Qiang touted that most foreign companies are still optimistic about their development prospects in China, noting that last year China’s utilized foreign investment totaled over USD 189 billion, a record high and almost USD 50 billion higher than three years ago. Similarly, Minister of Commerce Wang Wentao has called foreign firms “family,” and Executive Vice Premier Ding Xuexiang’s comments at the China Development Forum last week have been echoed by multiple officials: “Opening up… is a basic need for national development, just like human beings need to eat, drink, breathe, and sleep.” Finally, Liu He, former vice premier and economic czar, advocates that China “open wider”. He still leads daily affairs of the Central Financial and Economic Affairs Commission so will remain engaged in financial policy for the foreseeable future.
However, increased oversight and influence of the Chinese Communist Party in the financial sector will be important to watch. Creation of the Central Financial Commission – a party body overseeing financial strategy and policy – and resurrection of the Central Financial Work Committee – a party body to integrate ideology and party-building within the financial system – will strengthen the party’s influence over decision making within the financial sector, and beyond, to advance the party’s ultimate goal of stability.
China’s positive economic outlook for 2023 will undergird its efforts to de-risk the financial system but continued growth longer term is an unknown. While some of the small- and medium-sized real estate developers continue to face challenges, Beijing’s recent policy support to the real estate sector is helping to mitigate systemic challenges. Recovery is already underway in the real estate market which, valued at a quarter of China’s total GDP, is helping to turn the economic tides. Analysts expect China’s post-Covid economic recovery to fare better than Beijing’s official target of “around 5%” growth in 2023 – with some predicting 6% – so an improving economy may be just what Beijing needs to reinforce its efforts to upgrade its financial regulators and de-risk the system. The longer-term outlook, however, remains unclear amid China’s waning exports and weak domestic consumption.
