How does China try to prevent a financial crisis?
And what does the newly-formed Central Finance Commission has to do with it?
There has been a major reshuffle in China's financial regulatory regime. The 5-year-old 银保监会 China Banking and Insurance Regulatory Commission (CBIRC) has been folded into the newly formed 国家金融监督管理总局 National Financial Regulatory Administration (NFRA). On top of that, the State Council's 金融稳定发展委员会 Financial Stability and Development Committee, the previous super organization in charge of overall finance-related decision-making and coordination, has been replaced and elevated to a body directly controlled by the Party Central Committee: the 中央金融委员会 Central Finance Commission (CFC).
How to make sense of these changes? Why is the Party directly taking over the leadership of finance work? What policies will CFC work on? At BigOne Lab, the data engine that powers this newsletter, we systemically scan through policy documents to look for investment ideas, new clues and context. Interestingly, we have spotted an article penned by now defunct CBIRC's party committee, that can shed light on this topic. The article was dated May 16, 2022, possibly around the time when deliberations for the current reshuffle were being made, so it should have echoed the core spirit of the reshuffle. We believe in the middle of current global financial turmoil surrounding SVB and Credit Suisse (and possibly with more to come), the message contained in this article might be worth listening to.
As always, you will find our take at the bottom of this translation.
The article is titled, Persistently preventing and defusing major financial risks. It starts with six key points summarized from Mr. Xi's statements on finance, essentially setting up the basic principles regarding financial regulation. The highlights at the beginning of each paragraph are done by the author, while other highlights are what we believe to be of special interest to you. The six principles are:
Serving the real economy is the inherent mission and purpose of finance. General Secretary Xi pointed out that the economy is the body, and finance is the bloodline, and both are interdependent and mutually prosperous. Throughout history, finance, once separated from the real economy, becomes a sourceless water and a rootless tree. Serving the real economy is the origin of finance. We must not "just talk about finance", let alone engage in excessive derivative transactions that deviate from reality. We must always put the development of financial services for the real economy in the first place, properly position financial work, and promote the virtuous cycle and healthy development of the economy and finance.
Finance is an important tool for resource allocation and macroeconomic regulation. General Secretary Xi emphasized that the financial system is an important basic system in economic and social development. Our country has long used financial regulation as an important means of macroeconomic management, coordinating the management of currency issuance and the circulation of important materials. At the beginning of the founding of New China, our party quickly won the "Silver Yuan Battle" and "Rice and Cotton Battle" in a short period, curbed speculation, stabilized prices, and protected national and people's livelihood. Comrade Mao Zedong assessed that its significance was no less than the Huaihai Campaign. We must deeply understand the significant role of finance in economic and social development, strengthen the coordination and cooperation of monetary, financial, industrial, technological, employment, and regional policies, and jointly serve the overall situation of economic and social development.
Managing currency and credit well is the basic guarantee for a healthy economic cycle. General Secretary Xi pointed out that no matter how many tricks we try, it is useless if we cannot control the currency. To prevent and resolve financial risks, we must manage the total valve of currency and credit well and avoid excessively loose total amounts. Otherwise, it may lead to detachment from the real economy, speculation, and arbitrage, increase the fragility of the financial system, and also slow down the pace of structural reforms. After the outbreak of the COVID-19 pandemic, developed economies such as Europe, the United States, Japan, and the United Kingdom expanded their basic currencies and implemented extremely loose fiscal and financial stimuli, causing global high inflation. We must adhere to a prudent monetary policy, accurately expand effective demand while preventing "flooding" [of credit], solidifying structural distortion, increasing debt and leverage levels, and weakening the momentum of sustained economic growth.
Financial security is an important part of national security. General Secretary Xi emphasized that maintaining financial security is a strategic and fundamental issue related to the overall development of China's economy and society. Since the reform and opening up, China's financial development has experienced several major risk tests. The fact that we have not experienced a comprehensive financial crisis is largely because we have insisted on prevention first, taking precautions, preparing for the worst, and striving for the best results, eliminating risks at the budding stage and early stages. At present, we need to proactively deal with various risks and hidden dangers, adhere to early identification, early warning, early detection, and early disposal, avoid serious concentrated "big shocks", and effectively safeguard economic and financial security and social and political stability.
Financial development must always adhere to a people-centered approach. General Secretary Xi emphasized the need to always adhere to the people-centered development concept and better meet the diverse financial needs of the people and the real economy. We deeply understand the political and people-oriented nature of financial work, enhance our sense of responsibility for the financial service of the country, and strive to maintain the fundamental interests of the broad masses as the starting point and foothold for financial supervision work. On the one hand, we guide financial institutions to strengthen financial support for small and micro enterprises, "three rural" areas, poverty alleviation, and optimize financial services for new citizens, continuously improving the coverage, accessibility, and satisfaction of financial services. On the other hand, we insist on "群专结合 mass-specialist integration," giving full play to the combined efforts of enterprises, communities, various social organizations, and professional regulatory agencies, focusing on mobilizing the masses and making them important participants in risk prevention and a powerful force in curbing chaos. Practice has proved that the legitimate financial rights and interests of the people have been more effectively protected, financial literacy and awareness of the rule of law have generally improved, and they have played an important role in combating illegal fundraising and other illegal financial activities.
Strengthen the centralized and unified leadership of the Party over financial work. General Secretary Xi emphasized that to do well in financial work under the new situation, we must adhere to the centralized and unified leadership of the Party Central Committee over financial work, and ensure that financial reform and development go in the right direction. The Party Central Committee clearly requires the establishment of a major fiscal and financial risk disposal mechanism for which the main leaders of local Party and government are responsible. The central financial regulatory authorities must assume the main responsibility for supervision in accordance with their statutory duties, and the dispatched institutions must consciously obey the leadership of the local Party committees and governments, actively give full play to their professional advantages and fulfill their industry management responsibilities, and closely cooperate with and coordinate with the local Party committees and governments to work together.
The second part of the article is where the author listed six major achievements in preventing and defusing major financial risks since the Fifth National Financial Work Conference in 2017. Essentially, by understanding what the regulator considers as achievements, you can actually have a better understanding of what exactly are considered as "major financial risks". It reads:
The trend of financial assets deviating from the real economy towards virtualization has been reversed. By resolutely cleaning up activities that deviate from the real economy, increase leverage, and speculate with money, the quality and efficiency of the financial system serving the real economy have been significantly improved. From 2017 to 2021, the annual growth rate of total assets in the banking industry was 8.1%. During the same period, bank and insurance institutions increased credit loans and bond investments by 72.3 trillion yuan and 25.7 trillion yuan, respectively, of which infrastructure and manufacturing loans increased by 13 trillion yuan and 6.5 trillion yuan, respectively. The annual growth rates of credit to technology companies and green credit exceeded 15%. Inclusive small and micro-enterprise loans grew at an annual rate of 25.5%. Financial poverty alleviation has achieved significant results, with the coverage of basic financial services exceeding 99%. Insurance claims have become an important source of funds for post-disaster recovery and reconstruction, and major illness insurance has covered 1.22 billion urban and rural residents.
The contagion and spillover of various prominent risk points have significantly contracted. The risks of several illegal financial groups have been prudently resolved, and the risk management and reform reorganization of small and medium-sized banks such as Baoshang Bank, Jinzhou Bank, Hengfeng Bank, and Liaoning City Commercial Bank have proceeded smoothly. In the past five years, more than 600 high-risk financial institutions have been recovered and dealt with. Resolutely punish the concealment of bad assets and crack down on false accounting. The risk of shadow banking continues to decrease. By the end of 2021, the scale of high-risk shadow banks has dropped by about 25 trillion yuan from the historical peak, with a significant reduction in interbank investments and non-standard financing, and guaranteed investment and non-compliant short-term investment products are close to zero. Implement the long-term mechanism for real estate, reasonably meet the financing needs of the real estate market, and fundamentally reverse the trend of real estate bubble and financialization. The risk of local government's hidden debt is initially controlled. A number of large-scale corporate debt risk events involving huge amounts of debt and wide-ranging impact have been smoothly handled. By the end of 2021, the market-oriented and legalized debt-to-equity conversion has reached 1.9 trillion yuan.
The social financial order has basically achieved the transition from chaos to governance. Strictly crack down on illegal financial activities, issue regulations to prevent and deal with illegal fundraising, and strengthen systematic and source governance. In the past five years, 25,000 illegal fundraising cases have been investigated and dealt with, involving an amount of 1.56 trillion yuan. Deepen the special rectification of P2P online lending, and about 5,000 P2P online lending institutions have ceased operations, and all unlicensed internet asset management institutions, payment institutions, equity crowdfunding platforms, and online mutual aid platforms have been cleared. Resolutely prevent disorderly expansion of capital in the financial field, normalize the special rectification of equity and related transactions of banking and insurance institutions, and focus on cracking down on illegal shareholders who maliciously hollow out financial institutions. All financial businesses of internet platforms are brought under supervision according to law. At present, the overall rectification of platform companies is progressing smoothly. In the past five years, regulatory authorities have cumulatively punished 16,000 banking and insurance institutions, with a total fine of 12.2 billion yuan.
The long-term mechanism for preventing and resolving financial risks is gradually being consolidated. The leadership of the financial system by the Party continues to strengthen, with significant progress in the establishment of modern corporate systems and increasing maturity of the financial market. Efforts are being made to establish a sound professional manager market mechanism, adhere to "strong politics and excellent business," and "bankers run banks." The financial talent pool has been launched. Central and local financial regulatory institutions and systems continue to improve, with local party and government responsibilities gradually being implemented. The construction of a normalized risk disposal mechanism is continuously advancing, and the legislative process for financial stability law is accelerating. The basic framework of the financial stability guarantee fund has been initially established, with the first batch of 64.6 billion yuan in funds raised, deposit insurance system strengthened, and the management measures for insurance guarantee funds and trust industry guarantee funds are being revised and improved. At the same time, the risk resistance capabilities of the banking and insurance industries continue to increase. By the end of 2021, the capital adequacy ratio and provision coverage ratio of commercial banks had significantly improved compared to five years ago. The average comprehensive solvency adequacy ratio of the insurance industry reached 232%.
Financial anti-corruption and risk disposal are being promoted simultaneously. Corruption issues behind risk chaos are resolutely investigated and punished, and various regulatory violations and criminal acts are severely punished. In regulatory work, a series of rules and regulations are strictly implemented to prevent "relying on and benefiting from supervision," and the "zero material contact" iron rule is strictly enforced. As the intensity of financial anti-corruption and governance has significantly increased, a strict atmosphere of "strong supervision and strong regulation" in the financial field is forming. A number of major cases with severe market impact have been decisively investigated, and a group of corrupt elements involved in collusion between officials and businesses, illegal interest sharing, and illegal occupation have been brought to justice.
The transparency and level of rule of law in financial supervision are continuously improving. The coordination of financial supervision has been significantly enhanced, and under the unified leadership of the State Council's Financial Committee, cooperation between departments and central and local regulators has been significantly strengthened, with a significant reduction in regulatory blind spots, regulatory gaps, and regulatory arbitrage. The behavior of financial institutions is becoming more rational. The legal and regulatory framework for supervision is being improved, and prudent supervision rules such as capital management, corporate governance, and regulatory ratings are continuously being refined. Actively participate in the cross-cycle design of macro policies and counter-cyclical adjustments, and strengthen the coordination and cooperation between financial supervision policies and other policies. Adhere to the basic national policy of reform and opening up, strengthen international financial governance coordination, and actively promote multilateral and bilateral regulatory cooperation. At the same time, continuously enhance the ability and level of the regulatory team to supervise according to law, strictly rectify the regulatory team, formulate and implement non-public contact and personal investment and financing behavior regulations, build a "close" and "clean" relationship with regulatory targets, and strive to create a loyal, clean, and responsible regulatory iron army.
The last part of the article deals with the future. Since the author of this article, the CBIRC, will folded into the newly formed NFRA, while the NFRA will serve under the leadership of CFC. So crucially, this part essentially spells out for you what the priority areas of the CFC will be. It has 7 key prescriptions, including the last one, "comprehensively strengthening party leadership", essentially foreshadowing the birth of the CFC:
Actively respond to the spillover effects of developed countries' macro policies and laws. Currently, the risks and challenges have increased due to the COVID-19 pandemic and the Ukraine crisis, and the US and European economies have entered a period of high inflation and weak growth, with a significant increase in the risk of recession. As the US Federal Reserve's policy shifts into high gear, the international monetary and financial environment is undergoing significant changes, and the severe "after-effects" of Western countries' extreme monetary easing policies are accelerating [BAiGUAN: Yes, that's right]. We must proactively prepare to respond to external shocks, take preventive measures ahead of time in anticipation of changes in the market and the monetary policies of major countries, and work hard to create an international financial environment that is favorable to us. We must strengthen our bottom-line thinking, properly respond to external risks, and effectively implement the Anti-Foreign Sanctions Law. We must use a systematic economic and financial legal toolbox to deal with sanctions, resolutely oppose "long-arm jurisdiction," and ensure that entities within our jurisdiction do not comply with foreign legal restrictions."
Prudently prevent and resolve risks of small and medium-sized financial institutions. In recent years, the reform and risk mitigation work of small and medium-sized financial institutions has made positive progress, ensuring the stable operation of urban and rural financial systems, and overall risks are preventable and controllable. However, there are also issues such as actual risks being higher than book levels, difficulty in disposing of stock risks, and regional risks being relatively concentrated. We must improve the financial risk disposal mechanism with local party and government leaders taking responsibility, and promote the implementation of local stability maintenance and risk resolution responsibilities. We must adhere to "one policy per institution" and "one policy per company," and continue to do a good job in disposing of high-risk institutions in key regions. Promote multi-channel capital replenishment for small and medium-sized banks, and make good use of policies for local governments to issue special bonds to supplement capital for small and medium-sized banks. We must hold financial institutions responsible for risk disposal, let shareholders and creditors bear risk losses according to the law, and strictly prevent moral hazards. Support market-oriented mergers and restructurings, promote regional integration of small and medium-sized banks, and reduce inappropriate intervention. Further build a talent pool of commercial bank executives, and support the open, transparent, and market-oriented selection of directors, supervisors, and executives of small and medium-sized banks.
Efforts should be made to prevent the risks brought about by the rebound of the leverage ratio. Due to factors such as the sporadic outbreak of COVID-19 and the proactive implementation of policies, the pressure on the macro leverage ratio has increased. We must strengthen the response to the risks related to the rise in the macro leverage ratio, especially to prevent the risks brought about by the rapid growth of debt in non-financial enterprises and local government departments. We should monitor and give early warning of large-scale corporate debt defaults, develop follow-up financing and debt restructuring plans in advance, and properly respond to the rebound of non-performing assets. Adhere to the principles of marketization and legalization, resolutely crack down on debt evasion, and maintain regional credit environment and financial order. Adhere to the principle of "housing is for living, not for speculation," support local governments in improving real estate policies based on local conditions, support rigid and improvement-oriented housing demand, and promote the stable and healthy development of the real estate market. Coordinate with local government's hidden debt risk prevention and resolution, and support urban investment companies in reasonable financing according to laws and regulations.
Focus on promoting a virtuous cycle in the national economy. Stable economic operation is the cornerstone of preventing and resolving financial risks. We must focus on expanding effective demand, increasing and improving financial supply, supporting comprehensive infrastructure construction, and leveraging the pulling and driving effects of consumption on the economic cycle, providing convenient financial services for the stable development of foreign trade. Further improve the financial service level for new urban residents, effectively meet the financial needs of new urban residents in entrepreneurship, employment, housing, education, training, medical care, and elderly care. Implement and refine various financial relief policies, support the smooth flow of transportation and logistics, and strengthen financial services for small and micro enterprises and the "three rural" areas. Improve the financial support system for innovation, better serve the tackling of key core technologies and 专精特新企业 "specialized, refined, and novel" enterprises, and increase medium- and long-term financial support for advanced manufacturing and strategic emerging industries. Innovate green financial products and services, focus on promoting clean utilization of coal, support energy and resource supply and price stability, and prevent financial risks in the green and low-carbon transition.
Continuously deepen the reform and opening up of the banking and insurance industries. The focus and difficulty of risk prevention lie in resolving deep-seated contradictions and problems behind risks through reform measures. We must continue to improve the corporate governance of financial institutions, prevent insider control and major shareholder manipulation, resolutely correct various irregular related-party transactions, and show zero tolerance for violations. Implement the "one province, one policy" approach to promote the reform of rural credit cooperatives, promote the classified and segmented reform of policy banks, deepen the reform of state-owned commercial banks, and promote the accelerated transformation and development of trust companies. Strengthen the insurance protection function, standardize the development of the third pillar pension insurance, improve health insurance services, and deepen the comprehensive reform of auto insurance. Promote the digital transformation of the banking and insurance industries, encourage large banks to accelerate the export of risk control tools and technologies to small and medium-sized banks. Guide trust, wealth management, and insurance companies and other financial institutions to establish long-term investment concepts and support the stable operation of the capital market. Orderly expand two-way financial opening, continue to introduce high-quality foreign institutions with professional characteristics, and optimize the global layout of Chinese financial institutions.
Actively guide the healthy development of capital in the financial sector. Adhere to the "Two Unwavering" principles [BAiGUAN: the principle that boosts both public and private capital at the same time], maintain fair competition according to law, resolutely oppose monopoly, and give full play to the positive role of capital in financial activities. Combine the prevention of wild growth of capital with the promotion of orderly development of capital, setting up "traffic lights" for capital in the financial sector. Build a "firewall" between industrial capital and financial capital, strengthen the penetration supervision of shareholders, and prevent bank and insurance funds from being used for blind "leverage". Insist that all financial activities are subject to supervision, adhere to the licensing rules for financial businesses, crack down on "driving without a license" behavior, and resolutely prevent regulatory arbitrage [BAiGUAN: regulatory arbitrage, or 制度套利 within China's context means play around different rules and institutional frameworks in order to maximize financial leverage]. Complete the special rectification of the platform economy, implement normalized supervision, and promote the healthy development of the platform economy.
Be adept at using the rule of law thinking to improve administrative capacity according to law. Adhere to promoting the modernization of financial supervision and governance capabilities on the track of the rule of law. Make good use of the financial stability guarantee fund, give full play to the active role of the deposit insurance system and industry guarantee funds, and weave a dense financial safety net. Enrich enforcement means, strengthen cooperation with discipline inspection, supervision, judicial, auditing, and other departments, and explore new models such as "disciplinary and legal connection" and "joint auditing." Improve law enforcement effectiveness, perfect the risk monitoring and early warning system, enhance the deterrent effect of off-site supervision, better play the role of on-site inspection as a sharp weapon, and severely crack down on various illegal financial activities. Increase the cost of violations, maintain a high-pressure situation of administrative penalties, standardize the exercise of discretionary power, and strive to achieve a balance between procedural justice and substantive justice according to the principle of proportional punishment.
Comprehensively strengthen the Party's leadership and Party building in the financial system. The Party's leadership is the greatest political advantage in doing financial work well. We must strengthen the centralized and unified leadership of the Party Central Committee on financial work, and consciously maintain a high degree of consistency with the Party Central Committee with Comrade Xi at its core in terms of ideology, politics, and action. We must strengthen the construction of leading groups, cadres, and grassroots party organizations, and effectively play the role of party organizations in guiding direction, managing the overall situation, and ensuring implementation. Resolutely shoulder the political responsibility of central inspection and rectification, go all out to do a good job in the "second half" of inspection, and make inspection and rectification a new driving force for the high-quality development of banking and insurance industry supervision. Uphold the tenacity of being "always on the road," strengthen the construction of party style and clean government in the financial system and the fight against corruption, adhere to no forbidden zones, full coverage, and zero tolerance, and resolutely investigate and deal with corruption issues behind various financial risks and chaos. Continue to strengthen the construction of a clean financial culture, adhere to the unity of punishment and deterrence, institutional restraint, and raising awareness, promote the state of not daring to be corrupt, unable to be corrupt, and not wanting to be corrupt, and lead the industry to create a clean and upright political ecology.
So why is the Party directly taking over finance work? The common reflex in the west, as exemplified by this tweet by Stephen Roach, is that the Party is trying to diminish the role of the State Council by doing it on its own.
This kind of viewpoint gives the wrong impression that the Party did not already control the financial industry.