Graduation Thesis for AMIF

Development and Evolution of China's Banking

Regulatory System

By

Sikandar Anwari GDW2017203

Supervisor: Prof. Henry Haiyun Zhang

School of Banking and Finance

University of International Business and Economics

(February 20, 2019)

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 Table of Contents

LIST OF ABBREVIATIONS AND ACRONOYMS...........................................................................III

ABSTRACT........................................................................................................................................VII

ACKNOWLEDGEMENTS................................................................................................................VIII

CHAPTER ONE: INTRODUCTION....................................................................................................1

1.1. Introduction to Study..................................................................................................................1

1.2. Historical Overview of China's Banking Industry..........................................................................2

1.2.1. Institutional Restructuring Era 1979-984.................................................................................3

1.2.2. Further Institutional Restructuring Era 1985-1994..................................................................5

1.2.3. Banking Commercialization Era 1995-2002............................................................................6

1.2.4. Banking Modernization Era 2003-2010...................................................................................7

1.2.5. Banking Development In the Post Crisis Era 2011- Onward...................................................8

1.3. The Current Industries of Chinese Banking Sector.........................................................................9

1.4. Current Division of Labor Between the CBRC and the PBC........................................................10

1.5. Historical Evolution of the Role of the PBC.................................................................................11

1.6. Historical Evolution of the Role of the CBRC..............................................................................13

1.7. China Banking and Insurance Regulatory Commission (CBIRC)................................................15

1.8. Outline of Dissertation..................................................................................................................16

CHAPTER TWO: LITERATURE REVIEW......................................................................................18

2.1. Bank Regulation...........................................................................................................................18

2.2. The Notion of Banking Regulation...............................................................................................19

2.2.1. Public Interest theory.............................................................................................................20

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 2.2.2. Private Interest Theory...........................................................................................................21

2.3. Rationales for Bank Regulation and supervision..........................................................................22

2.3.1. Systemic Regulation..............................................................................................................23

2.3.2. Prudential Regulation............................................................................................................24

2.3.3. Regulation of Business Conduct............................................................................................25

2.4. Banking System an Object of Bank Regulations and Supervision................................................25

2.5. Evolution of China's Banking Regulations...................................................................................27

CHAPTER THREE: China’s Banks and Banking Sector, Financial Institutions and Markets............30

3.1 China's Financial system................................................................................................................30

3.2 Current Banking Industry..............................................................................................................32

3.3 Role of Banking Industry...............................................................................................................35

3.3.1 Large Commercial Banks.......................................................................................................35

3.3.2 Joint-stock Commercial Banks...............................................................................................37

3.3.3 City Commercial Banks..........................................................................................................38

3.3.4 Policy Banks and China Development Bank...........................................................................39

3.3.5 Rural Small and Medium-Sized Financial Institutions (RSMFIs)& PSBC.............................40

3.3.6 Foreign Banks.........................................................................................................................41

3.4 China's Banking Regulatory Landscape.........................................................................................41

3.5 China's Financial Markets..............................................................................................................44

3.5.1 Stock Markets.........................................................................................................................44

3.5.2 Bond Markets.........................................................................................................................45

3.6 NAFMII.........................................................................................................................................48

CHAPTER FOUR: Development of CBRC’s Regulatory Efforts.......................................................50

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4.1. Development of the CBRC's Regulatory Legal Frame-Work.......................................................50

4.2 Development of Prudential Regulatory frame-work......................................................................52

4.3. The CBRC's Regulatory Cycle (Regulatory Approaches).............................................................53

4.3.1. Authorization.........................................................................................................................54

4.3.2. On-site Examination..............................................................................................................54

4.3.3. Off-site Surveillance..............................................................................................................55

4.3.4. Market Exit............................................................................................................................56

4.4 Annual Development in Prudential Regulation..............................................................................56

4.4.1. Capital Regulation.................................................................................................................56

4.4.2. Corporate Governance...........................................................................................................58

4.4.3. Internal Control......................................................................................................................59

4.4.4. Credit Risk Supervision.........................................................................................................60

4.4.5. Market Risk Supervision........................................................................................................61

4.4.6. Operational Risk Supervision................................................................................................62

4.4.7. IT Risk Supervision...............................................................................................................63

4.4.8. Liquidity Risk Supervision....................................................................................................64

4.4.9. Reputational Risk Supervision...............................................................................................64

4.4.10. Anti-illegal fund-raising.......................................................................................................65

4.4.11. Credit Guarantee Supervision..............................................................................................65

4.4.12. Country Risk Supervision....................................................................................................66

4.5. Institutional Supervision...............................................................................................................66

4.5.1. Policy Banks and PSBC.........................................................................................................67

4.5.2 Large Scale Commercial Banks..............................................................................................67

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 4.5.3. Joint-stock Commercial banks...............................................................................................68

4.5.4. City Commercial Banks and Private Banks...........................................................................68

4.5.5. Small-Medium Sized Financial Institutions in Rural Areas...................................................68

4.5.6. Foreign Banks and Trust Companies.....................................................................................69

4.5.7. Other Non-Banking Financial Institutions.............................................................................69

CHAPTER FIVE: The Coordination of Regulatory Efforts.................................................................71

5.1. Evolvement of The Role of PBC In Respect to Banking Supervision...........................................71

5.2. The Watchdogs Structure of China's Financial Sector..................................................................72

5.3. The Interplay of Monetary Policy and Banking Regulation..........................................................75

5.3.1. Required Reserve Ratio (RRR)..............................................................................................75

5.3.2. Capital Adequacy Ratio (CAR).............................................................................................76

5.3.3. Liquidity Ratio.......................................................................................................................77

5.4. Micro Prudential and Macro-Prudential Regulation.....................................................................78

5.5. Supervisory Coordination and Cooperation..................................................................................81

5.5.1. Domestic Regulatory Cooperation.........................................................................................82

5.5.2. Cross-Border supervisory Cooperation..................................................................................83

5.6. The CBRC's Regulatory Efforts Achievement..............................................................................84

CHAPTER SIX: CONCLUSION........................................................................................................86

China's Financial Regulatory Challenges: Regulatory Vacuum and overlap.......................................88

Bibliography........................................................................................................................................89

Annex I................................................................................................................................................94

IV
 LIST OF ABBREVIATIONS AND ACRONOYMS

Terms Coverage of Institutions

Policy banks and China development bank, large commercial banks, city
commercial banks, urban credit cooperatives, small and medium-sized
Banking rural financial institutions, foreign banks, postal saving banks, banking
institutions asset management companies non-bank financial institutions and Sino-
German Bausparkasse, new rural financial institutions and other financial
institutions under the realm of CBRC.
Policy banks Agriculture Development Bank of China, The Export- Import Bank of
and China China, China Development Bank.
Development
bank
Commercial Large commercial banks, City commercial banks, joint-stock commercial
banks banks, private banks, rural commercial banks, foreign banks.
Large Agriculture Bank of China, Industrial Commercial Bank of China, Bank
commercial of China, Bank of Communications, China Construction Bank
banks
Major Large commercial banks and joint-stock commercial banks
Commercial
banks
China Everbright Bank, Huaxia Bank, China Citic Bank, Guangfa Bank,
Joint-stock China Merchants Bank, China Guangfa Bank, Ping An Bank, Shanghai
commercial Pudong Development Bank, Industrial Bank, China Minsheng Banking
banks Cooperation, Evergrowing Bank, China Zhenshang Bank, Bohai Bank.
Small-and City commercial banks, joint-stock commercial banks and private banks
medium-sized
commercial
banks
Small and Rural cooperatives financial institutions, new type rural financial
Medium-sized institutions
Rural Financial
Institutions
Asset China Orient Asset Management Corporation, China Huarong Asset
management Management co Ltd, China Cinda Asset Management Co Ltd, China
companies Great Wall Asset Management Corporation.
New type Lending companies, rural mutual cooperatives, village or township banks
Rural Financial
Institutions
Rural Rural cooperative banks, rural commercial banks, rural credit
Cooperative cooperatives

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 Financial
Institutions
Non-bank Auto financing companies, trust companies, financial leasing companies,
Financial finance companies of corporate groups, money brokerage firms and
Institutions consumer finance companies.
ABC Agriculture Bank of China
BOC Bank of China
BSCS Basel Committee On Banking supervision
ADBC Agriculture Development Bank of China
BoCOM Bank of Communications
CAR Capital Adequacy Ratio
RWA Risk weighted Asset
CBA China Banking Association
PBC People's Bank of China
CBRC China Banking Regulatory Commission
CCB China Construction Bank
CCAMC China Cinda Asset Management Co, Ltd
CDB China Development Bank
CEB China Everbright Bank
CIRC China Insurance Regulatory Commission
CSRC China Securities Regulatory Commission
CITIC China CITIC Bank
CMB China Merchant Bank
CNAFC China National Association of Finance Companies
LCR Liquidity Coverage Ratio
CPC Communist Party of China
EIBC Export-Import Bank of China
CTA China Trust Companies
FSB Financial Stability Board
IAC International Advisory Council of CBRC
ICBC Industrial Commercial Bank of China
IMF International Monetary fund
LGFPs Local Government Financing Platform
MOF Ministry of Finance
MOFCOM Ministry of Commerce
MOST Ministry of Science and Technology
MOU Memorandum of Understanding
NDRC National Development and Reform Commission
NPC National People's Congress
NPL Non-Performing Loan
PSBC Postal Saving Bank of China
RCCs Rural Credit Cooperatives
UCCs Urban Credit Cooperatives
ROA Return On Asset
ROE Return On Equity
SAIC State Administration for Industry Commerce
SAT State Administration of Taxation

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 SASAC State-owned Asset Supervision and Administration Commission.
SEANZA South East Asia, New Zealand, Australian
EMEAP Executives' Meeting of East Asia Pacific Central Banks
SMEs Small and Medium sized Enterprises
NDRD National Development and Reform Commission
MIIT Ministry of Industry and Information technology
MPS Ministry of Public Security
LCR Liquidity Coverage Ratio
NSFR Net Stable Funding Ratio
SIFI Systematically Important Financial Institutions
CSMC Comprehensive Social, Management Commission
SCLAO State Council Legislation Affairs Office
BSIS Banking supervision Information System
MEP Ministry of Environment Protection
NAO National Audit Office
IAC Industrial Advisory Council
G-SIBs Global Systematically Important Banks
G20 Group of Twenty
UN United Nations
OECD Organization for Economic and Development
APEC Asian Pacific Economic Cooperation
CMG Cross-Border Crisis Management Group
SAFE State Administration of Foreign Exchange
NAFMI National Association of Financial Market Institutional Investors.
SUB Strategic Business Unite
RWA Risk Weighted Asset

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 ABSTRACT
China's financial system has rapidly grown to the second largest economy of the world and
expected to surpass the United States. China's banking sector has rapid growth since
inception of the China's economic reform and opening- door policy in the past few decades.
This thesis is an initial review of the China's banking history, evolution, regulatory
development, domestic and cross border regulatory achievement and current status of China's
banking regulatory system in the light of role of People's Bank of China and China Banking
Regulatory Commission.

The CBRC upon inception took over the regulatory responsibilities of the bank sector in
China which outdid a handful contribution regarding soundness and stability of overall
banking sector in China. A series of regulatory changes and improvements commenced and
implemented in China since the creation of CBRC. In 2018 the CBIRC replaced the CBRC,
aiming to take enforcement actions against violations of insurance and banking sector,
advance the interest of banks in China. Now banking sector in China playing an important
role in financing the real economy and Chinese banks dominated the world top banks by
asset. This thesis examines the implementation of these reforms and potential impacts on
development of China's banking sector. Banks in China help implementation of Chinese
government policies. China's entrance to the WTO has been an alarm for America and
western nations, have became consumers. In another hand foreign participation in China's
banking sector has been controlled and managed to facilitate the development of Chinese
banks. Dominance of banks in China’s financial sector convey that health of China's
economy depends on a properly functioning banking sector and argue that banking regulation
in China is paramount importance and understanding the dynamics of China’s banking
regulation is essential for stability of the rest of the world. The banking regulation in China is
a means supporting the economic policies of the government. Chinese banks and state has
been captured banking regulation and facilities has been widely extended to state-owned
enterprises and private sector has been deprived of such facilities.

Regard to economic strategic goals, the thesis found role of industries in China's banking
sector, benefit of Chinese public from the controlled development of banking sector and

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interests of government which banking sector serves, the development of regulatory efforts,
coordination of regulatory efforts domestically and cross-border supervisory cooperation.

ACKNOWLEDGEMENTS

I feel pride in expressing my deepest sense of gratitude to my thesis project supervisor

professor Henry Haiyun Zhang who is the source of initiation of this project. His scholastic
kind support, consistent advice, immense encouragement, splendid suggestions, personal
interest, dynamic supervision and patient guidance enabled me to write this dissertation. He
has always been the source of prompt feedback sage advice, without his valuable and insights
suggestions and cooperation this research was hard to be accomplished. All of his insight and
suggestions are highly appreciated.

I also express my heartily sincere thanks to the People's Republic of China for providing me
with the chance and opportunity of generous full scholarship to study in China, UIBE's all
professors who taught us during participation in the AMIF-2017-2019 program and whole
staff of the UIBE for fellowship they provided over the whole AMIF experience in this
prestigious university.

I would like to convey my great appreciation and I am extremely thankful to my parents who
support and encouraged me in all aspects of my life. My success is really the fruit of their
devoted prayers and I can never compensate their unlimited kindness and best wishes.

I truly appreciate all the assistance provided for the recognition of my efforts, admiring the
achievers and most importantly encouraging the spirit with conductive environment as
allowed by the constraints.

Last but not least, I am grateful to my best friend Susu san master student in the University
of Science and Technology Beijing (USTB) for her consistent encouragement& assistance in
relation to the graphs.

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 CHAPTER ONE

INTRODUCTION

1.1. Introduction to Study

The sustainability, effectiveness and development of an economy particularly monetary policy is

closely depend on a sound and healthy banking system. Therefore, soundness and smoothly
functioning banking system and supervision regime is one of the cornerstone and fundamental issue
of any financial system for both domestic government and international regulatory organizations.
Banks play a key role as dynamic wheel for economy and function in a dynamic environment.
Banks as dynamic wheel accelerate new technological improvement and innovations and this new
experience bring new rules and regulations to daily activities of banks. Only a stable financial
system, which is one of the key aims of state regulation and oversight can optimally fulfill its
macroeconomic function of efficient and low-cost transformation and provision of financial
resources.

A global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-
connected world. The primary goals of supervision and regulations include protecting depositor's
funds, maintaining a stable monetary system, promoting an efficient and competitive banking
system and protecting consumer rights related to banking relationships and transactions. Banking
regulation basically entails the rules that have to be complied with when setting up banks and
carrying out banking business. The liberalization of the financial markets has created new business
opportunities for banks which can significantly increase their risk.

According to the Basel Committee on Banking Supervision, activities of the financial institutions
determine the economy of the country and influences the global economy. The global financial
crisis of 2008-2009 pointed at the vulnerabilities and close inter-linkages of the financial system
and need of regulation and supervision of financial system. Thus, the stability of the banks is one of
the primary tenants for the sustainable economic development. Consequently, this arguments point-
out that effective regulation and supervision of the financial institutions potentially increase the
credibility of the financial system and protection of the investors and credit businesses, and ensure
the stability of the financial systems and global economy.

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According to Moody's Investment Service, China's banks dominated the world top five banks by
asset in 2017. Therefore, in today's world of international competition and the belief of survival of
the fittest, China as the second largest economy of the world and its economic dealings with the rest
of the world, countries and states are putting their utmost efforts in reaping and generating heaps of
wealth and income and removing trade barriers or entering into trade agreements with China. China
is critically considered important and has significant role to the world’s economic future.
Dominance of banks in China’s financial sector convey that health of China's economy depends on
a sound and stable banking sector and prove that banking regulation in China is significantly
important and understanding the dynamics of banking regulation in China is vital for stability and
soundness of the rest of the world.

1.2. Historical Overview of China's Banking Industry

Prior to the economic reform in China, China's financial system was on the stage of collapse, and
banking reform was an integral part of the China's transformation from planned economy to
market-oriented economy Alicia and Daniel (2013). Until economic reform in China and opening
door policy to the world, China's banking system was a mono bank model where there was only
one financial institution which was the People's Bank of China (hereafter PBC). The current
China's banking system (modern banking system) embodied through the establishment of PBC in
1949. The most priority in economic transformation was given to the banking sector and the
banking transformation was considered as one of the most important parts in the overall economic
reform of China Sun (2006).

After the establishment of PBC in 1949 the central government of People's Republic of China in
1950 nationalized all the pre-1949 capitalist companies and institutions Allen et, al. (2006).

Over half of century, the Chinese banking sector has gone through two distinctive evolutionary
periods: a single banking period which continued from 1949- 1978 and Chinese financial reforming
period from 1979 to present Jiang and Yao, (2017).

From 1949-1979, banking system in China was a single banking system, highly centralized
planned, unitary banking system under authority of the ministry of finance under the control of
central government where the bank was a part of hierarchy. The PBC was the only banks in China
in charge of both central bank and commercial bank activities including regulation of interest rates,

2
controlling monetary policy, handling policy leading and commercial operations Garcia and Daniel,
(2004).

Mono-banking system lasted for 30 years till to when the Chinese government decide to enter to a
progressive transformation form closed economy to open economy Sun (2006).

Based on need the PBC combined the role of commercial bank and central bank and its operation
was subjected to strict cash credit plans set in accordance with the plans of production projects by
the government planning commission Jiang and Yao (2017).

During this mono-banking period a set of state-owned banks consisting the People's Construction
Bank of China (PCBC), the China Construction Bank (CCB), the Bank of China (BOC), the
Agriculture Bank of China (ABC) were created without interfering or challenging the dominant
status of the PBC

In 1978 when the government moved toward economic reform and open door policy, the centrally
controlled banking system broke up and banking system entered to a gradual reform period. The
first milestone of modernized Chinese financial system was began in 1979 by introduction of a
two-tier banking system. Since 1979 Chinese banking system was expanded and in recognition of
need to modernize banking system due to increasing China's interaction with the rest of the world
and in efficiencies of the allocation of capital China's banking system entered to a gradual reform
period and expanded in support of government reform program aiming to break up centrally
planned banking system and restructuring China's financial sector. Reform period in China taken
place in five phase: Institutional restructuring period took place from (1979-1984), China'
specialized state owned banks period took place from (1985-1994), China's banking
commercialization period took place (1995-2002), China's banking modernization took place from
(2003-2010) and lastly China's banking development era Jiang and Yao, (2017).

1.2.1. Institutional Restructuring Era 1979-984

First phase of reform was institutional restructuring period which took place form (1979-1984).
Through the nation-wide conference of the PBC in Beijing in 1979 which is known as start point of
reform era. Along this conference "the four transformation and eight reforms were initiated" within

3
the PBC. Those measures were wide ranging and served as the pilot phase and lead for further
discussion of further reform Wei (2012).

Since the Deng Xiaoping economic reform took place in 1979, banking system expanded and
diversified and single-banking system was not fit anymore for the need of China's economic
development and needed to separate regulatory activities from commercial activities of PBC.
Institutional reform took place in 1979 by introduction of two-tier banking system in to
modernization. Since 1979 the PBC has left the monopolistic role and concentrated on supervisory
functions as central bank and restored other specialized banks as part of eight reform. Since then,
PBC officially took over the position of central bank in 1983 and designed to engage on macro
level decisions with the primary objective of maintaining price stability, enforcing strict
supervision over financial institutions, conducting clearing and issuing bank notes, also in charge of
design and implementation of monetary policy and formulation of credit plan in accordance with
the government national economic plan as whole Jiang and Yao (2017).

In accordance with the decision of State Council in 1982, the PBC was in charge of national
financial macro level decision, administering credit and maintaining the stability of the currency
Wei (2012).

During the period, the PBC took over the central banking activities, and commercial banking
activities assigned to other four specialized state owned banks aiming to increase productivity of
the banking sector. The specialized state-owned banks are composed of Agriculture bank of China
(ABC) was established in 1951 but was ceased and reopened in 1979 specialized in the area of
financing agriculture field, Bank of China (BOC) established in 1979 specialized in the field of
trade financing and foreign currency exchange. The People's Construction Bank of China
established in 1954, changed its name to Construction bank of China (CBC) in 1996 and later in
2004 renamed to China Construction Bank (CCB) specialized in the area of financing infrastructure
and construction, and Industrial and Commercial Bank of China (ICBC) established in 1984,
specialized in financing urban commercial activities and provide specialized services in China. Due
to the lack of stock market and corporate bond market all these four specialized state owned banks
within their realm were the entire source of financing for SOEs and provided the banking services
and products to designed sector Jiang and Yao (2017) and Barth et, al (2013).

All these Big four state owned specialized commercial banks were established to encourage better
services of state owned enterprise (SOEs) and provide services to particular designed sector of

4
economy and were the official source of financing for state-owned enterprises within each assigned
serving scope and increase the overall productivity of banking industry. The four state owned
specialized commercial banks operated under the administrative control of the central and local
government as local agencies in the centralized planed economic system Sun (2006) and Barth et,
al (2013).

1.2.2. Further Institutional Restructuring Era 1985-1994

The second phase of reform which known as further institutional restructuring period, took place
from 1985- 1994. from 1985. In this reform era China has gradually embodied a four- tiered
banking system: state banks, joint-stock commercial banks, city commercial banks and
cooperatives. In mid1980s-1990s banking sector had further developed. New institutions including
joint-stock commercial banks and foreign banks entered to the banking market and specialized
state-owned banks transferred into commercial banks, restrictions on business operation of
specialized state-owned banks were removed and allowed to expand their business realm for the
purpose of competition in the banking market Jiang and Yao (2017) and Wei (2012).

In 1985 Significant changes were made toward banking liberalization. Legislation gradually
removed the restrictions on activities of state -owned specialized bank within a designated
economic sector and the four state- owned specialized banks were institutionally released and
allowed to expand and vary their banking activities and operation scope to compete with each other
aiming to create a competitive maker- oriented banking system, State Council approved the
regulation of foreign banks and joint venture in special economic zones Wei (2012).

In 1993, China started a comprehensive banking reform to transfer state banks into market oriented
banks in order to have an independent banking industry Wei (2012).

In 1995 Central Bank Law and Commercial Bank Law were approved and according to legislation,
PBC lead the role of Central bank and four state- owned banks converted to commercial banks in
accordance with Commercial Banks Law Sun (2006) Jiang and Yao (2017).

Meanwhile in the 1980s, for the purpose of diversifying the banking system and channel funds to
the projects in rural enterprises, agriculture, development projects in rural and urban areas,
government established some rural credit cooperatives (RCCs) and urban credit cooperatives

5
(UCCs) to finance small and medium-sized rural and urban enterprises which played a
supplementary role to the banking sector.

In 1994 Policy Banks Law approved due to that three policy banks established by the Law, to take
over the policy lending activities from state-owned banks. Three policy banks consist of the China
Development Bank (CDB) established for the purpose of long and medium lending to finance
construction projects in infrastructure and in strategic industries, the Import-Export Bank of China
(EXIM) founded to take over the loan to import and export companies, and the Agricultural
Development Bank of China (ADBC) created for the purpose of lending to agriculture sector with
focus on specific policy Xian and Mehta (2001) and Wei (2012).

All three Policy Banks were established under the jurisdiction of the state council. This footstep
was reorientation of the big four state-owned banks from policy lending to commercial banking and
deal with the non-performing loans(NPLs) that had beset them Yao and Jiang (2017).

1.2.3. Banking Commercialization Era 1995-2002

Third phase of reform is known as banking commercialization which took place from 1995-2002.
from mid 1990s, China entered to the second wage of reform aiming to commercialization of
banking sector. National People's Congress in 1995s was enacted Law of Commercial Banks, due
to the Law four big specialized banks enabled to operate more genuine such commercial banks and
separated the business activities of securities firms, operation of banks and insurance companies
and four- stated owned specialized banks were legally converted to wholly state-owned commercial
banks (SOCBs) aiming to operate under the principle of safety, profitability, liquidity as well as
responsible for their own profit and losses Jiang and Yao (2017).

In 1990, due to the need the City Commercial Banks were founded by way of consolidating and
restructuring urban credit cooperatives (UCCs) Jiang an Yao (2017).

In 1995, the Law of Commercial Banks described the framework for business operation of state-
owned commercial banks and the Law incorporated the key provisions relating to the internal
control structure and management of banks. Meanwhile the Law of People's Bank of China enacted
in 1995 set out the role of PBC in banking supervision and these two legislation set out the work
structure for PBC. Wei (2012).

6
In 1995, by the Law of People's Bank of China, PBC was legally defined as the central bank, as
well as reformulated the role of PBC in banking supervision. The PBC regulatory objective was
defined as being maintain the sound operation of the banking sector Wei (2012) and Bart et al.
(2013).

To oversee these separated banking industries, three separate agencies established. Subsequently,
the China Securities Regulatory commission CSRC founded in 1992 to oversee the stock
exchanges and also in 1998s took the responsibility of supervision of the securities market. China
Insurance Regulatory Commission was founded In 1998 the to regulate and supervise the insurance
companies.

In December, 2001 China entered to the World Trade Organization (WTO). The China's admission
to the WTO paved the way and opened the door for foreign banks and presented an opportunity for
having modern international banking system in China Jiang and Yao (2017).

1.2.4. Banking Modernization Era 2003-2010

Banking Modernization period took place from 2003-2010 is the fourth phase of economic reform
in China. China joint the World trade organization (WTO) in December 2001. China's access to the
WTO presented an unprecedented opportunity for building an internationally modernize viable
banking system. In other hand this was an opportunity for foreign banks and lead the foreign banks
to provide banking services in to all Chinese customers. To fulfill this commitments China required
a very deep and extensive reform in banking sector. The Chinese government initiated the second
wave of capitalization in 2003 and this was in the form of capital investment, and primarily, China
targeted the BOC, CCBC,ICBC and ABC in this round. As part of reform. In late 2006 Postal
Saving bank of China was founded as fully owned subsidiary of China Postal Group and it was a
fruitful step towards commercialization of China's postal savings.

During the modernization era, the Law on the People's Bank of China and the Commercial Banking
Law were amended and lead to the foundation of regulatory and supervisory body in banking sector
aimed to strengthening of regulatory framework. As a regulatory and supervisory body the China
Banking Regulatory Commission (CBRC) was established in April 2003, to oversee the banking
sector and took over the responsibilities and functions from central bank to regulate and supervise
banking sector in mainland China. Since establishment, the CBRC started to be responsible for
banking reform to strengthen the banking sector and improve banking capitalization. At the same

7
time revisions to the Law on the People's Bank of China strengthened the PBC's responsibility for
the monetary policy, and liquidity of the financial sector through management of interest rate on
loan and deposits of customers and reserve requirement besides other monetary policy tools. This
specification of functions lead the government's resolution to promote sound, safe and efficient
operation of banking industry through supervision and risk control capacity Wei (2012).

Gradually, for monitoring the ongoing banking reform, the CBRC since, 2004 strengthened the
prudential regulation and supervision through setting 10 requirement for good corporate
governance and 7 performance indicators, along with requirements. The CBRC set out guidelines
on the corporate governance reform and supervision of state-owned commercial banks aiming to
further improve (SOCBs) corporate governance an improve their internal structure (CBRC).

1.2.5. Banking Development In the Post Crisis Era 2011- Onward

After major efforts of overhaul of SOCBs, as part of reform in the post-crisis era, the government
by deep banking reform focused on sound development of the newly modernized banking sector,
advanced regulation and supervision, improving risk management skills, and promoting inclusive
finance, focused on sound development. In 2010 government initiated some pilot programs on
global banking, aiming to explore models for commercial banks to extend operations into the
financial sector. In 2007, Postal Saving Bank Corporation was incorporated and this was a prime
footstep towards commercialization of China's Postal Savings. In 2012, the PSBC was transferred
into joint-stock limited company and ultimately in September 2016, after attracting series of
domestic and international strategic investors to the Hong Kong stock exchange list. currently,
Postal Saving Bank of China is the biggest basic provider of financial service to town and village
residence and has largest financial network all over the country in view to development of rural
society.

Strengthening of financial stability and promotion of financial inclusion in small and medium-sized
banking institutions such as CCBs, UCCs, RCBs, and RCCs was the first priority of reform in this
era. New-type rural financial institutions have also been created namely; village and township
banks, lending companies, and rural mutual cooperatives.

In 2014, authorities launched a pilot project to establish five wholly privately funded bank. By
March 2015, the five pilot private banks namely; The KinCheng Bank of Tianjin (KCB), Shanghai
Huarui Bank, Zhejiang MY bank, Wenzhou Minshang Bank, Qianhai WeBank established to serve

8
the real economy and focus on development of SMEs enterprises. One important feature of these
banks are the deep integration of innovations and information technology into banking business,
which substantially reduces the transaction costs and asymmetric information problems, which in
turn enables high quality, more efficient financial services available to a large number of
individuals and MSEs.

After the recent global financial crisis, internet finance and shadow banking expanded and
diversified prosperously and have become an important integrated part of the financial sector in
China. This financial depression was an opportunity for China and have advanced banking reform
towards a sound, comprehensive, and competitive banking sector to serve the real economy. These
staged impressive achievements have paved the way for future development of the financial system
in China Jiang and Yao (2017).

1.3. The Current Industries of Chinese Banking Sector

The Chinese banking sector, providing a full package of banking services and products in the
economy which is large relative to the size of the Chinese economy and has expanded significantly
over the past decade. Unremitting attempt towards banking sector reform have lead in having a
comprehensive and multi-layered banking system in China. The Chinese top tier banking system
embodied by two regulatory authorities consisting (PBC) and China Banking Regulatory
Commission(CBRC). The fulcrum of the second tier is structured by domestic or internal
commercial banks, Central state-owned controlled large banks, Joint-stock Commercial Banks
(JSCBs), China Construction Bank (CCB), Rural Commercial Banks (RCBs). Policy banks, foreign
banks, rural credit cooperatives, postal saving banks and other banking institutions (financing
companies, new types of rural financial institutions of village or township banks, consumer
financing companies) are important drivers of Chinese banking sector and playing significant in
providing services to the economy with wide coverage Jiang Yao (2017).

Note: China Development Bank Corporation was incorporated in December 2008 as a commercial
bank, while the State Council officially defined it as a development finance institution in March
2015. Thus it is essentially still a policy bank.

Fig.1.1 shows the structure of Chinese banking system.

9
 Source: The Nottingham China Policy Institute

Regarding to the structure of China's banking system, the banking industry in China is composed
of four types of institutions consist of: wholly state-owned banks, commercial banks that are at the
least partially private, credit co-operatives and foreign banks.

1.4. Current Division of Labor Between the CBRC and the PBC

In March 1995, with Promulgation of the Law of People's Republic of China (PRC) on the People's
Bank of China and Commercial Banking Law, the Law, stipulated the PBC's current banking
regulatory structure and stipulated the PBC's scope of functions, responsibilities, organizational
structure and authorization of managing national currency, implementation of monetary policy,
supervision of financial sector and further documented that PBC was independent and state should
not interfere during its implementation of monetary policy. According to Law, the PBC operate
independently and implement monetary policies under the leadership of the state council.
Furthermore, since promulgation, the Law stipulated the principles for overall commercial banks
which is operating in China Allen, et al.,(2017).

According to the article 4 of the Law the mandates or functions of PBC are as follows: Drafting
and enforcing relevant Laws, rules and regulations that re related to its functions, formulating and
implementing monetary policy in accordance with Law; Issuing RMB and administering its
circulation; Regulating financial markets including the interbank markets, the interbank bonds
market, the foreign exchange market and global market; preventing and mitigating system risks to
safeguard financial stability; maintaining the RMB exchange rate at an adaptive and equilibrium
level as well as holding and managing the state foreign exchange and gold reserves; managing the
State treasury as a fiscal agent; making payment and settlement rules in collaboration with

10
relevant departments and ensuring the normal operation of the payment and settlement systems;
providing guidance to anti-money laundering work in the financial sector and monitoring money-
laundering-related suspicious fund movement; developing a statistics system for the financial
industry and being responsible for the consolidation of financial statistics as well as the conduct of
economic analysis and forecasts; administering the credit reporting industry in China and
promoting the establishment of a credit information system; participating in international financial
activities; engaging in financial business operations in line with relevant rules; and performing
other functions prescribed by the State Council Allen, et al., (2017)

Law of the People's Republic of China on Banking Supervision and Regulation was adopted on
February 2004, stated the responsibility, functions and authorized the China Banking Regulatory
Commission (CBRC) to the rights of Regulation and supervision of overall banking financial
institutions. Major Current responsibilities of CBRC are as follows; Formulate supervisory rules
and regulations for banking institutions, Authorize the establishment, changes, termination,
branching and business scope of banking institutions, Conduct fit and proper tests for directors
and senior managers, Conduct off-site surveillance and on-site examinations of banking
institutions, Investigate, penalize and take enforcement actions on activities that violate relevant
laws and regulations, Compile and publish statistics and reports of the overall banking sector in
accordance with relevant regulations, Make proposals on the resolution of problem deposit-taking
institutions in consultation with relevant authorities, Be responsible for the administration of the
supervisory boards of state-owned financial institution, Perform other responsibilities delegated by
the State Council (CBRC).

1.5. Historical Evolution of the Role of the PBC

According to article 2 of the Law of the People's Republic of China, People's Bank of China is the
Central Bank of China. The PBC is countable to the State Council, under Stat Council its is in
charge of formulating and implementation of monetary policy, prevent and mitigate financial risks,
and maintain financial stability (The Law 2003).

PBC established in December 1948 after the victory of the Chinese Communist Party (CCP) and
establishment of People's Republic of China (PRC) via merger of bank of Northern China, Bank of
North sea and Northwest Peasant Bank in Hebei province then to Beijing. from 1949-1979, the
bank was the only state-owned bank and functioned as both Central bank and Commercial bank.

11
The PBC essentially combined the roles of the central bank and the commercial banks and its
operation was subject to lead funds and credit plans set in accordance with the production plans
projected by the State Planning Commission. In September 1983, by establishment of Industrial
and Commercial Bank of China (ICBC), commercial functions was relegated to the industrial and
Commercial Bank of China which was founded for the specific purpose of commercial banking
Cao (2001).

In March 1979 PBC was in charge of transaction related to foreign exchange management.
Meanwhile the State Administration of Foreign Exchange (SAFE) created in same year and took
over the responsibility of the foreign exchange management. Gradually, in 1982 the State Council
called the PBC as central bank and financial regulator under the State Council. This step was the
milestone of building-up of central banking system. In 1982, the Standing Committee of the (NPC)
and the State Council further emphasized that (SAFE) should be separated and further incorporated
into the PBC and in September 1983 the State Council called once again the role of PBC as the
national central bank through document of ten aspects of the mandate of the PBC as follows.
"studying formulating and implementing guidelines, policies and regulation on basic regimes for
financial industry; issuing currency and regulating currency circulation; managing RMB deposit
and loan interest rates and exchange rates; drawing up credit pans and managing credit funds;
managing gold, foreign exchanges and foreign exchange reserve; managing treasury on behalf of
the Ministry Finance approving the establishment or the merger of financial institutions;
coordinating regulating the financial industry, managing financial markets and engaging in
international finance activities on behalf of the government". Interim Measures of Credit fund
Management(IMCFM) announced in 1984 and PBC known as central bank and build-up the central
banking system. State council in 1993 announced the Decision on financial system reform which
further adjust the PBC's responsibility as the central bank Allen, et al., (2017).

In March 1995, with Promulgation of the Law of People's Republic of China (PRC) on the People's
Bank of China and Commercial Banking Law, the Law, stipulated the PBC's current banking
regulatory structure and stipulated the PBC's scope of functions, responsibilities, organizational
structure and authorization of managing national currency, implementation of monetary policy,
supervision of financial sector and further documented that PBC was independent and state should
not interfere during its implementation of monetary policy. According to the Law, the PBC operate
independently and implement monetary policies under the leadership of the State Council.

12
Furthermore since promulgation of the Law, the Law stipulated the principles for overall
commercial banks which is operating in China (Shen 2011 and Allen, et al 2017).

Continuously since the promulgation of the Law and Law of the PRC on the commercial banks
China experienced raped significant development. The most fruitful and significant development
was establishment of banking regulatory authority in March 2003. In 2003 Standing Committee of
the National People's Congress passed the Law to strengthen the role of PBC in the area of
implementation of monetary policy and safeguarding financial stability of China (CBRC).

The Law of the PRC on banking regulation and supervision authorized the China Banking
regulatory Commission to replace the People's Bank of China to take over the major role of
supervision and regulatory responsibilities of banking sector and their business operation in the
country which was given to the PBC before. By of introduction of the CBRC China's financial
sector took over a significant step toward a stronger and more effective banking regulatory
framework. In general, the status and mandate of the PBC were first legally approved in 1995 with
the promulgation of the PBC Law and after amendment of the Law in 2003, the mandates and
indecency of the PBC were strengthened Allen, et al (2017).

The PBC Law assert that PBC functions under the leadership of the State Council and implements
monetary policy independently without interference of local governments, social organizations and
individual.

According to the article 3 of the Law of the People's Republic of China on PBC, the primary
objective of monetary policy is maintain the stability of the value of currency and development of
economic growth. (The Law).

1.6. Historical Evolution of the Role of the CBRC

The first session of 10th National People's Congress on March 10, 2003 reviewed and approved the
proposal for establishment of the China Banking Regulatory Commission. The creation of CBRC
brought a halt to the to the dual roles of PBC which was in charge of financial regulator and
monetary policy and liquidity of the financial sector.

Since then Sixth session of standing committee of 10th National People's Congress on 27,
December 2003 approved the Law of the People's Republic of China on Banking regulation and

13
supervision. Under its authority by the Law, China Banking Regulatory Commission (CBRC) took
over the rights and responsibility of the regulation and supervision of the overall banking financial
institutions and their business operations in People's Republic of China. Aiming at promoting the
safeguard and soundness of the banking industry, fostering and strengthening the China's banking
sector to fulfill the financial need and necessity of the China's rising economy and society,
supporting the customers and protecting the rights of customers and other financial institutions.
Besides this protective functions, the CBRC also engaged to highlight reform and innovation and
trying to enhance the quality of regulation and supervision efficiency and effectiveness in banking
sector.

Law of the People's Republic of China on Banking Supervision and Regulation was adopted on
February 2004, stated the responsibility, functions and authorized the CBRC to the rights of
regulation and supervision of overall banking financial institutions. Eventually, in August 2015, the
Standing Committee of the National People's Congress announced the decision of the Standing
Committee of the (NPC) on amending on PRC commercial Banking Law and amended the
People's Republic of China Commercial Banking Law and the law came into force in 2015. Since
establishment of the CBRC China took a significant move toward pursuing a stronger and more
effective banking regulatory framework and marked a new development point in the area of
banking regulation and supervision. In giving effect to this initiative, the CBRC became the main
regulator of the banking sector, and operated pursuant to an express statutory grant of the National
People’s Congress (CBRC).

Since, then the CBRC conducting consolidated risk- based supervision, strengthening effective risk
management and internal control of supervised institutions to enhance the transparency are the
principles or cornerstone of supervisory philosophy. In order to guide the banking sector, fruitful,
effective and efficient supervision the CBRC has adopted six supervisory standard; Promoting the
financial stability as well as financial innovation at the same time; Improving the competitiveness
of China's baking sector in the global market; set appropriate regulatory framework or requirement
to refrain all necessary controls; encouraging fair and orderly competition and prevent disorderly
competition; clear definition of accountability for both regulator and supervised institutions;
allocation of resources for supervisors in an effective and cost-effective way and four regulatory
objectives (protecting the rights of consumers in order to protect the interest of customers through
effective risk- based prudential supervision; boosting market confidence through prudential

14
efficient supervision; enhancing public knowledge on modern finance through education and
information disclosure; maintain financial stability by combat financial crimes) (CBRC).

1.7. China Banking and Insurance Regulatory Commission (CBIRC)

Following the State Council institutional reform plan, in March 2018, the 13th National People's
Congress approved the plan to further deepen institutional reform and guide the banking and
insurance industry to further improve the quality and efficiency of the service entity economy. The
State Council approved the merger of CBRC and CIRC into China Banking Insurance Regulatory
Commission to bring insurance and banking sector under one ceiling. Ultimately, the CBIRC as the
new regulatory agency officially launched in Beijing on 8 April 2018 via merger of China Banking
Regulatory Commission (CBRC) and China Insurance Regulatory Commission (CIRC) in view to
regulate and supervisory policies for banking sector, regulate market entry and operation and
investigate operations that may be against laws and regulations.

The CBIRC is the central government's financial regulatory agency for both banking and insurance
sectors, operate under the State Council to regulate policies for the banking and insurance sector,
tackle financial risk via ceasing regulatory arbitrage and ensuring better regulatory coordination,
regulate market entry and operation and investigate against laws and regulations, prepare for global
financial integration via modernization of regulatory landscape and resolve existing problems. The
CBIRC is primarily responsible for supervising the establishment and ongoing business activities of
both banking and insurance institutions, taking enforcement actions against regulatory violations.
Furthermore, some responsibilities of CBRC and CIRC such as drafting of regulation and
prudential supervision are entrusted to the PBC.

The restructuring of regulatory system is considered as China's biggest financial regulatory reform
since 2003 and marked the start of " One Bank, One committee and Two Commissions" brought an

China Banking and

Insurance Regulatory
Commission (CBIRC)
Financial Stability and
People's Bank of
Development
China (PBC)
Committee (FSDG)
China Securities
Regulatory
Commission (CSRS)

15
end to the "Three commission and One Bank framework". Fig 1.2 shows China's financial
regulatory framework after restructuring.

The purpose of institutional restructuring is to safeguard against financial risks via ensuring better
regulatory coordination among government agencies. Previously each agencies worked
independently ad sought to expand their respective sectors. This innovation considered to
streamline supervision of banking and insurance sector in the people's Republic of China.

The CBIRC is responsible for overseeing the both banking and insurance sectors as an independent,
responsible for monitoring liquidity levels, capital adequacy ratios, reserve ratio requirements, and
the prevalence of non-performing loans (NPLs) in domestic banks as well as regulating the
insurance market, supervising activities of insurance agencies, and establishing risk control
mechanisms for the insurance industry.

Under new framework, the CBIRC is in charge of compliance with relevant laws and regulations.
while PBC drafts new laws and rules for the banking and insurance sectors, Though PBC is the
principal regulator responsible for China's electronic payment and credit card clearing systems,
CBIRC oversees approval for banks' abilities to offer debit cards and bank-branded credit cards,
oversees state-owned banks, rural credit cooperatives, trusts, and other financial services companies
such as cooperative shareholding banks.

1.8. Outline of Dissertation

There are six chapters in this dissertation, following this introductory chapter, the thesis continuous
with the remaining five chapters, consist of the following parts.

Chapter Two will provide review of literature review of theoretical background of the research.
The literature will focus on concept of banking regulation, the notion of banking regulation, logic
of banking regulation, rationales for banking regulation, banking regulation theory and general
nature of banking regulation in Chinese banking system.

16
Chapter Three focus on China's Banks, Banking sector, financial Institutions and Markets which
enclosed with explanation of the industries in China's Banking sector, the role of banking
industries, Chinese banking regulatory landscape, Interbank markets and other market places that
banking sector and financial institutions participate in.

Chapter Fourth Mainly focus on the development of the CBRC's regulatory efforts including
development of regulatory legal framework, building prudential regulatory framework, regulatory
themes that are unchanged for China Banking Regulatory Commission, CBRC regulatory priorities
over time, CBRC regulatory efforts which has changed the banks and other financial institutions in
china's banking sector, evolution of the CBRC's regulations and rules overtime, and Institutions
reform.

Chapter Fifth Focus on the coordination of regulatory efforts, in particular focus on evolvement
of the role of PBC with respect to banking supervision, financial regulatory watchdogs and quasi-
regulators in china's financial sector, interplay of monetary policy and banking regulation, macro
prudential and micro prudential regulations, China's domestic and cross border regulatory
cooperation and coordination.

Chapter Sixth will be conducted conclusion from the study and China's financial regulatory
challenges.

17
 CHAPTER TWO

LITERATURE REVIEW
In this part of this dissertation I would try to review literature background of available researches
from various authors, overview of banking regulation, object of bank regulations and supervision,
rationales for banks regulation from the celebrated scholars perspectives, evolution of China's
banking regulatory authorities and regulations.

2.1. Bank Regulation

Many scholars stated that bank's regulations introduced for the purpose of protecting the
individual depositors, since there are differences in the information available to them and to the
bank. Bank regulation is one evolving subject and its objective is vary according to context. The
objectives of banking regulation are many faceted. Government regulate banks, and this set up a
certain framework, restrictions, guidelines and requirement aiming to bring transparency between
banks and business partners. systemic risk is always been a headache and concern for banks and
depositors to reduce. Besides these, other factors such as bank confidentiality and credit allocation
requires bank regulation.

Banking and regulation of banks have been a cornerstones in the development and modernization
of financial systems. In keeping eyes to the overall importance of banks in economic development.
There are different reasons to study banking regulation and financial supervision. but two main and
general objectives is prominent: outset in practical, financial transaction is performed via financial
system and this dealing is with banks on frequent basis. therefore knowledge of banking and
information on banking regulation is helpful to accomplish bank transactions. Furthermore,
knowledge of banking regulation will increase the importance and reduce the complexity of
financial system and recent passageway of banking legislation. Second major objectives of
banking regulation is to make sure that this banking regulation protects both the public interest and
foster an efficient competitive banking system. Cost and the benefits of banking regulation are
given attention because of some technological changes in financial system such as internet banking,
electronic banking, developed communication and data processing systems and development of
complex financial instruments and risk management practices. Gradually all these revolution of
technological development and changes are making both customers and banks closer, via paving

18
the way banking operation and financial transactions are conducted and lastly expansion of variety
of banking services and products. Another additional purpose of banking regulation is protection of
consumer interests in diversification aspect of banking relationship. Bank consumer protection
goals can be found in good banking principles. These forms of protection have been implemented
via a series of legislative acts passed over the past few decades Spong (2000).

For the Purpose of satisfaction of Individual depositors, banking regulation arise to provide stable
framework for making payment in a good manner. A safe, accountable and acceptable payment
system is vital to the soundness of economy because of the expansion and variety of number of
transaction is which happens by customers, individual and businesses every day. It is hard to
envision how a complex economic system could function and avoid serious disruptions if the
multitude of daily transactions could not be completed with a high degree of certainty and safety.
Ideally, bank regulation should thus keep fluctuations in business activity and problems at
individual banks from interrupting the flow of transactions across the economy and threatening
public confidence in the banking system. Another features of a well banking system is providing
services and products at a competitive prices and better quality for customer. Therefore one of the
goal of banking regulation is creating a regulatory frame-work which motivate competition and
efficiency that ensure sufficient banking services all over the economy Spong (2000).

2.2. The Notion of Banking Regulation

Regulation is basically considered as state regulation of private enterprise referring to this concept,
regulation defined a series of static rules and a process which is going on. Primarily regulation has
the meaning of rules which it declare rules, described appropriate authority, has general
applicability, legal affection regarding to take action under the control of authority. In another
meaning regulation is any rule passed by state where there is need of compliance by the person or
organization regulated. Secondly, regulation as ongoing process containing of interference and
oversee to the functions of some institutions by some regulatory authorities. It can be identified as
supervision where it ensure that regulation meet with the static rules properly Wei (2012).

Bank regulation by state considered as the certain restrictions among banks and business affairs.
The objectives of bank regulation vary with expansion of banks activates. The main concern is to
diminish potential risk which is faced to creditors and bank business. Other factors are considerable
in this regard that require the bank regulation such as protection of confidentiality, credit allocation
and lastly corporate social responsibility. Basically, there are two requirement for bank regulations

19
firstly, the minimum requirement for bank regulations retention is minimum regulatory ratios
which make a clear frame-work for equity capital for banks in each country. Secondly, next
requirement is reserve that set the rules for minimum reserve of banknotes and demand deposits,
which all banks are required to maintain it Zhao (2013).

Banking regulation is the endorsed rules which is enforceable by regulatory authorities in order to
govern and control the banks activities. In another view bank regulation is interference of
government with activities of banks in order to enforce the goals of legislation polices. Lastly, bank
regulation is consist of formulation of framework and enforcement of rules, polices and standards
governing banking activities Wei (2012).

In order to know why regulation is needed there are two theories of regulation, public interest
theory and private interest theory.

2.2.1. Public Interest theory

The mandatory regulatory objectives of the CBRC reflect the banking regulation under the public
interest theory aiming to protect fair competition between banking industry and promote the
competition between industries, to enhance the safety and soundness of banking industry and
maintain public confidence and protect the interest of depositors and consumers (CBRC).

The Concept of public interest theory of regulation rely on concept of public interest and how this
public interest theory identified. In this theory, regulatory authorities are assumed to be guided by
the public interest and regulatory rules and processes are designed to satisfy and enhance the public
interest. This theory is not static concept, its subject to continuous redefinition to reflect evolving
economy, social and cultural changes. The public interest theory is mainly a positive and reflector
theory on a appropriate regulatory theory and last goal of such kinds of regulation.

There are two components of public interest theory include; firstly, objectives and outcomes which
has public aspect such as common goods, shared opinion, common and public interest and shared
values by public, secondly process and procedure demonstrate to transparency of procedures such
as obtained objectives and outcomes through inclusive, fair, transparent procedures. Therefore, in
public interest theory, regulation should capture both suitable process and suitable outcomes and
regulatory process should fulfill public interest and reflect public values, also try to standardize the
process via including fairness, transparency and equity. government, using regulation, attempts to

20
prevent the exploitation of monopoly power, to minimize the impact of externalities, and to
improve information disclosure conditions. Hence, regulatory intervention aims to avoid or at least
to mitigate the harmful and adverse outcomes of market imperfection, and try to find a remedy for
the market failures of private enterprises.

The notion of public under this theory is an organic concept in banking regulation. From viewpoint
of individual depositors, notion of public expanded to wholesale customers. This concept
transferred towards a more comprehensive and inclusive consideration of the composition of the
public has been accentuated by the global financial crises. Lastly, as conclusion, public interest
theory of regulation has two source economic and social. In this means, regulation is established
largely in response to economic concerns and is created to solve economic and social problems
Wei (2012)

2.2.2. Private Interest Theory

The private interest theory of regulation stand opposite of public interest theory, This assume that
regulation is taken by private interest of state, regulators and lastly regulated entities. This theory
argue that how much government struggle to regulate, same to that will fall inside the control of
specific and self seeking groups in the society. The private interest theory of regulation has two
concept.

One specifically consider on the interest of political parties and politicians, it's in support of
politicians and it explain that via regulation, political groups or politicians make their own demand
to which industries must respond, ultimately political interests pursue their own preferences and
disregard the public good. Another stands of private interest theory define that regulation is
embodied by private industries and its schemed and operated basically for the benefit of those
industries. Based on the private interest theory, banking regulation is firstly designed by the
respective private interests of the government, the regulators, and the regulated institutions.

The second concept of private interest theory of banking regulation stated that banking regulation is
prosecuted aiming of regulated entities, that is the banks themselves, because banks as profit-
making entities lastly try to promote profitability and enhance their returns. Banking regulation that
fails to take account of the incentives and private interests of banks is potentially
counterproductive. Wei (2012)

21
2.3. Rationales for Bank Regulation and supervision

Dewatripont, et al. (1994), the question why banks should be regulated differ? they argue that the
reason is does not lie in the individual functions such as asset transformation or payment system
provision of individuals. however these functions are very important and vital to overall economy,
but these activities are not more important more than supply sector which prudential regulations
doesn't consider there. Neither the sole existence of the deposit insurance programs or government
aid implies the case the a priori banking regulation is caused by the same reasons as the ex-post
bailouts. The truth is that whereas the anticipation of government assistance for banks in distress
situation further reinforce the need for the regulation, whereas it results in moral hazard and
excessive risk-taking, and the same holds for the deposit insurance. However, the core reasons lie
in the key two types of market failure - asymmetric information and the existence of externalities
Klinger (2011).

The mean reasons for regulation of bank arise from the operations which banks function in the
economy. In wide consideration, banks are a lubricant for the economy at large, and bank
instability might impose substantial externalities Matej (2008).

Referring to the logic of bank regulation the main purpose of bank regulation are as follow. The
main purpose of banking regulation is to protect the savings and small depositors in particular and
reduction of potential risk expose for government and taxpayers of having bailouts in order to
bring stability to the system. From the micro economic prospective, changes in banking regulation
have been a tool to making banking sector very competitive and innovative via giving incentives
albeit it can result moral hazard. Bank regulation consider the creditors abilities to oversee the
creditors in order to control lending risk, agency issues, from sides of macro and micro economics,
bank regulation concern maintaining and if it's impossible, control and management of potential
risk and bank crises to keep the stability of banking sector Bigger and Heimler (2005).

Since 1970s, most of countries have already processed with bank regulation, for instance in order
to control lending rated and interest, limitation on investment in financial institutions, line of
business and entrance of foreign financial institutions, monitoring of foreign exchange transactions
and movement of capital internationally. China as the world second largest economy, its banking
regulation no doubt has vital effect not only in china's financial sector, it will positively effect on its
foreign exchange reserve on global market Zhao (2013).

22
Activities of banks in a positive manner ascertain the economic power of a country and penetrate
the global economy, (BCBS 2006). Hence, sound, solid and stable banking sector is the pillar of
endurable overall economic development in a country. Therefore, for having stable banking system
and economic development the need of regulation and supervision arise in financial sector, so
effective regulation and supervision of banks ensure the stability, credibility and protection of
financial sector and world economy by protecting credit investment and investors. Global economic
and financial recession such as Russian crisis in 1999, global crises of 207-2009, Irish crises in
2008-2010, illustrate the need and importance of effective financial servicemen regulation and
supervision models, which is sublime level and sound level of protection in banks and financial
sector to preserve the financial system from potential risk and treatments. Furthermore, growth of
economy, stability and progress of overall economy is distinguished effective risk management
whereas depression of a country's financial system will have a wheel reaction and resulting on
financial crises on the domestic level and international scale Koltsova (2011).

Dale, (1994) researched the model of the international banking system and possible impact of
regulation, the result revealed that there are three main reasons which banking sector to be
regulated internationally: first, reason argue that banks can form new international structures.
Therefore its essential to clarify which organization is in charge of banking regulation of which
authority take over the responsibility of which banks, otherwise banks will abscond regulatory
efforts of all countries of operations. Secondly, whereas the internal banking sub system are linked
whith each other in the global interbank markets, it would be a risk that one country adversely
affected by problems arising elsewhere. Thirdly, the mean motive for supporting banks in domestic
market will decrease the regulatory responsibility in individual countries, this will pose other
jurisdictions in danger and their bank in a fully competitive disadvantages, and it can even conduce
to a race to the bottom, when the competition of regulatory authorities would result internationally
under bank regulation Klinger (2011).

Referring to the rationale of bank regulated Wei introduced three kinds of bank regulation in order
to distinguish regulatory objectives: Consisting systemic regulation, prudential regulation and
regulation on business conduct Wei (2012).

2.3.1. Systemic Regulation

Parallel with the notion that banks are special, systemic regulation is concerned with inherent risk
of systemic failure for the whole economy. Its referred to as "low probability high impact risk". In

23
broad speaking, the probability of failure or collapse of individual bank will lead collapse of
economy in low level, but its social impact is very costly in whole economy. Systemic failure
increase the cost of capital and decrease availability of capital and maybe trigger "bank runs" in
which the inability of one bank to intersect depositors withdrawal demands in turn cause other
banks to fail.

Systemic stability normally falls within the mandate of central banks which retention of power as
the lenders of last resort to banks engaged with the payment system. In the event of systemic
instability, banks can no longer borrow unsecured funds and they are forced to turn to central banks
to replace their lost short term deposit funding. Systemic risk is also regulated through government
deposit insurance schemes which are intended to deter bank runs by alleviating the fear that banks
will default on deposit accounts. Deposit insurance schemes can only be activated once a bank has
defaulted on its deposit payments Wei (2012).

2.3.2. Prudential Regulation

As banking activities are full of risk and elimination of this potential risk needs deep concentration
therefore, prudential regulation basically, enhance the behavior of individual banks with aims of
protection of interest of depositors and fundamentally target the quality of individual banks system
for identifying, managing and monitoring the various risk in banks business operations. As bank
customers are unable to monitor and control bank operations and maintain own interest, therefore
through prudential regulation financial and risk management of set of individual banks are
regulated. In order to protect consumer and retain the individual financial institutions safe and
sound the sense of prudential regulation arise.

Prudential regulation take place parallel with the beginning of bank operation. In order to achieve
license for banking activities and business, respective banks have to satisfy regulators that they will
operate and serve the products and service in accordance to the legislation and regulation to serve
the public interest. prospective banks for leading banking business and activities with prudence,
integrity, competence and properly manner need to illustrate the bank commitment and capacity.
Banks in every situation must have sizable amount of capital to meet other requirement which is
varied. All banks required increase capital ratios in all times to avoid potential risk and losses
which banks encounter.

24
Prudential regulation basically promotes the prudential behavior of individual banks aiming to
protecting the interests of depositors. This regulation fundamentally focus on the quality of
individual bank's system for identifying, managing and measuring the various risks in their business
operations. Primarily prudential regulation is on capital adequacy regulation which is based on risk
of a bank and the quality and level of capital shows that all risk of banks shown on capital frame-
work. Wei (2012)

2.3.3. Regulation of Business Conduct

Regulation of business conducts is the third types of bank regulation. In this type, regulation focus
on banking activities and practice regarding to bank customers. This type of regulation is based on
mandatory information disclosure, the honesty and integrity of banks and human resources, level of
competence of banks on providing financial services and products and lastly well business practice
in common. This kind of regulation ensures consumers possess appropriate information and that
banks comply with proper industry practices. The principle of market discipline through
information disclosure has been a regulatory priority for regulators and allows market participants
to assess key information on banks’ capital, risk exposures, risk assessment processes, and hence
the capital adequacy of banks. To a big degree, information disclosure emphasizes the importance
of market discipline in giving market signals that emanate from risk monitors. This presses banks to
adjust risk-taking behavior and enables market participants to react accordingly. Through this
mechanism, banks with a strong risk management profile are able to differentiate themselves from
those without such processes in place, and stand to gain the most Wei (2012).

2.4. Banking System an Object of Bank Regulations and Supervision

Allen et al. (2004) stated, that financial system play vital role to deliver assets from lenders to
borrowers, it composes of diversified markets, financial institutions, financial services which are
connected with each other globally. Allen, et al, introduced the simple overview of financial system
cycle which illustrate financial system supply funds from lenders ( households, firms, central bank
to borrowers(firms, government, households) through financial markets comprise of money market,
equity market, bond markets or through financial intermediaries such as insurance companies,
money market funds and pension funds. Gleeson (2010) assert that bank as an institution carry out
two functions, first accept deposits from depositors and secondly make loan to the public. Gleeson
argue that the essential reason and need for regulation and supervision of bank is to preserve public

25
reliance and trust in the banking financial sector via adopting international standards for the health
and soundness of the banking sector to avoid the forward risk. In general speaking, banking
financial system is the collection of variety of domestic banks, central banks, national banks,
financial institutions which operate under framework of monetary system in a country koltsova
(2011).

Olsen (2005) declare banks as having “a crucial role in the efficient allocation of savings and
investments in a market economy and are important for the stability of the whole economic
development . Hence, cause of bank failure arise from high level of financial risk, which will
expand rapidly to other financial systems and banks via interbank transactions. Furthermore Olsen
states that regulations and supervision of banks is to maintain banking system from potential risk
and failures, in this regard banking examiners play a vital indirect role in preservation of depositors
versus potential risk and losses derives via failures of individual bank. Banking supervisors could
show the way to managers to perform responsibilities and duties towards shareholders and ensure
the health, soundness and quality of banking sector.

Stolz (2002) expanded his own explanation, that banks as an economic wheel in a country
accelerate the economic development and contribute to the growth of the economy and corporate
governance . From Stolz perspective, lack of sufficient and banking sector in country lead to
negative social and economic problems for a country.

Alexander et al. (2006) investigated and the result indicated that a failure of the bank’s operations
and activities could cause to the chain reaction in the international banking or even in long run to a
world financial crisis. Furthermore, Allen and Carletti (2008) researched on the roles of banks in
financial system and defined that banks collect “demandable deposits and raise funds in the short
term capital markets and invest them in long-term assets. Gleeson (2010) assert that bank as an
institution carry out two functions, first accept deposits from depositors and secondly make loan to
the public.

The form of government intervention in the banking sector is same as in all countries, but the
implantation structure is deferent based on specific form of regulation in a specific country

Koltsova (2011), highlighted the purpose of regulation of banks by government, government obtain
the specific goals by regulating banks. primarily government try to influence on banking system's
strategic planning development and proper management so, government execute policies and laws

26
in different kinds of way, therefore obtain the major portion of capital and truly involve in banking
sector and this involvement open the door for state to avoid the potential risk and challenges poses
to government and solution of economic challenges. secondly, state intervention banking system is
to fulfill the duty of development of banking sector. All these regulation and state efforts is for
the purpose of protection of banking sector from failures in domestic and global economic
difficulties and quiets Koltsova (2011).

2.5. Evolution of China's Banking Regulations

Banking regulatory institutions have given rise to an entire track of modernization in the Chinese
banking industry. Banking regulation reform process started by an improvement in regulation with
international standards since the establishment of China Banking regulatory Commission in several
areas with giving priorities to asset quality, regulatory capital and supervision of banking sector.
Referring to asset quality, the primary steps were taken in 2002 when the people's Bank of China
the high level banking regulatory authority create five- tier asset classification system in
accordance to the profitability of default and similarly to that which is used internally. In late 2005,
CBRC required all bank to classify all their loans in accordance to the standard classification
system and lastly in 2009, all banks were obliged to provision their impaired loans and gradually in
this year CBRC increased the percentage of provisioning coverage to one hundred fifty percent of
impaired loan.

In 2006 in continuation to the improvement of bank regulation, bankruptcy law was improved and
introduced. Besides this improvement new private property law introduced which create a sound
legal framework for collateral securities, and later on CBRC formed countrywide review of banks
credit for local government financial vehicles(LGFVs) to intensively review banks loans and make
report about overall loans to government. In this phase a set of measures were executed to maintain
the growth of local government financing loans to check and eliminate the potential risk which
threat banks loan Daniel and Alicia (2013).

Alicia and Daniel also argue that from point of regulatory capital, China Banking Regulatory
Commission introduced bank regulations same to those of Basel I, principles that were accepted by
all banks at the end of 2008. In this year the Basel II frame-work was adopted with the purpose of
making Basel II operational by end of 2010 which was based on internal medals, if the banks could
not implement or unable to meet with require regulatory capital by that time. Parallel to
improvement of regulatory capital, CBRC in 2010 introduced new package of capital requirement

27
drawing out from the new Basel III frame-work which included capital adequacy requirements,
new liquidity measurements, dynamic provisioning leverage ratio. The CBRC during the financial
crises paid greater attention and importance to the protection of financial consumers and depositors
interests and rights of accounts. Also reinforced supervision referring compliance of banks, market
activities, and introduced series of regulatory issues. However, so far there were no explicit deposit
insurance introduced. Furthermore, the CBRC improved the corporate governance of all banking
institutions by creating shareholders with independent members and strategic investors. Lastly
transparency increased by introduction of external auditors with international accounting standard
Daniel and Alicia (2013).

Banking sector playing an important role in China's overall economic developments since
transformation of a centrally planned economy into a market-based economy, particularly after
banking sector reforms, after the establishment of effective regulatory authorities which plying a
vital role in China's financial stability. However china's banking sector has perambulate and
experienced considerable changes over the time, asset quality structural problems, capital adequacy
problems and profitability problems which encounter challenges to the banking sector. A large
number of scholar have analyzed and written on evolution of development of China’s banking
system, banking reform and a number of researcher has given views on current financial system
and future developments from different perspectives. Significant advancement in china's financial
sector has been arisen in the journey of China's banking sector reform which has embarked upon
since the establishment of China Banking regulatory Commission in 2003 as principle regulatory
authority. Therefore, rise of regulatory institutions were the cornerstone of modernization of entire
banking sector toward having strong and effective banking regulatory frame-work. This movement
toward modernization marked vital step regarding pursuing of regulatory goals and objectives in
China's banking industry, via consolidation of regulatory institutional structure and specialized
regulator Koltsova (2011).

According to statements of Daniel and Alicia it was generally believed that China's financial
system was on the verge of collapse and that in developed countries, the process of financial
innovation process had lowered the overall failure and financial systems risk but today look really
different comparing with past. Developed and industrial countries posed the worst and crucial
financial crisis of decades and yet China, has managed to control external and internal turbulence
even utilized the banking sector to intermediate the wide fiscal stimulus packages in China's
history. Furthermore they give arguments, China would be the head of several developed nations if

28
only financial development were to be measured only quantitative terms. Bank credits which is the
main origin of finance in developing economics as well as in European countries is already more
than hundred percent of China’s total GDP, which is certainly much higher than most countries
with a similar GDP per capita to China Daniel and Alicia (2013).

This evidence paradox is mostly the result of the China's transition from government controlled
economy to a market-oriented economy, as China’s banks primary financing source wheel for
government-owned companies. Although China’s banking sector has became wide and also sound
in terms of solvency and asset quality, it is still characterized by high public intervention in credit
allocation and financial repression, both of which substantially reduce competition. In 1980s vital
development happened in the China's banking sector by establishment of four big special state
owned commercial banks.. Four state- owned commercial banks specialized in the area of financing
and considered a key wheel of economic development and operate as commercial banks, later on
three policy banks set up for the purpose of accumulation of nonperforming loans. Gradually, in
2003 China Banking Regulatory Commission was set up and major responsibility and vigor of
regulation and supervision in the area of financial sector entrusted and transferred to it. On other
hand government plan focused on recapitalization of four special state owned commercial bank and
write off the impaired loans from their balance sheet, by encouraging entry of strategic investors
and list them in stock market. The state owned commercial banks restructure process was carried in
four stage, each stage with four phases. The phase compose of injection of capital by ministry of
finance and central bank. The second phase was the write off nonperforming loans from the balance
sheet of bank and transferring the loans to asset management of companies. The other two phases
introduced firstly to ensure independent management and risk assessment after the creation of the
CBRC to lead the reform, by giving chance to foreigners to purchase stake in Chinese banks and
include their names in the stoke market Daniel and Alicia (2013).

29
 CHAPTER THREE

China’s Banks and Banking Sector, Financial Institutions and

Markets
This Chapter will present wide-range of information about China's financial system, over all
banking sector, evolution of the banking industries, role of banks in china's economic growth,
China's banking regulatory landscape, financial markets and other market places that banking
sector and financial institutions participate in.

3.1 China's Financial system

The financial system plays a key and critical role in economic development of China. China's
financial system has rapidly grown whereas today China is the second largest economy of the
world and expected to eventually surpass the United State. Since financial reform in 1978 and the
introduction of opening door policy China's financial system experienced rapid and significant
development and fast changes. As mentioned in Chapter one single banking regime replaced by
commercial banks, new banking system took over the classic banking system, new financial
institutions established, stock markets, bond markets raised and China set out its regulatory
framework through introduction of CBRC, CSRC, CIRC. In today's financial world the most
financial intermediation between saving and investment is channeled via banking institutions.
However, access to financial institutions is still restricted with private enterprises having
difficulties in receiving credit facilities from banks or receiving fund form capital markets. The
most significant and fruitful development for China's financial system in 1990 was introduction and
growth of two domestic stock exchange market in China (CSRC).

In 1990, stock market were incepted in major cities such shanghai stock market, Shenzhen a major
city in southern of the country. Stock trading mostly took place in shanghai, the most important
aspect of the market is that although the indexed may reach heights and transaction increase, the
fact is that most of the shares are non-tradable. As end 2007 the total capitalization of shanghai and
Shenzhen stock exchanges stood as 133% of the gross domestic product while the tradable market
capitalization was 37% of the gross domestic product Katarzyna (2009)

According to the Foreign& Commonwealth Office, financial service report which released in may
2017 and CBRC annual report, total asset of China's banking sector hit CNY232.3 trillion (USD33
trillion) as end of 2016 which shows 2.8 times national Gross Domestic Product, surpassing Europe

30
to become the largest globally banking system. According to the report, the banking sector
dominated about 70% of social financing in mainland China. The huge fiscal and credit stimulus in
the aftermath of the global financial crisis has been the reason for extraordinary growth in China's
financial system. In the scope of global financial crisis and 2015 total asset in china's banking
industry doubled.

As end of 2015 and 2016 Big Five state-owned commercial banks including Industrial commercial
bank of China, Bank of China, China construction Bank, Agriculture Bank of China and Bank of
Communication respectively monopolized about 39 percent of total financial assets. Joint stock
commercial banks respectively accounted 18 percent. Mid-Small sized rural financial institutions
including village and township banks, rural commercial banks, rural credit co-operations accounted
12.9, urban commercial banks respectively counted 11.4 percent, and lastly foreign banks in China
make up 1.8 percent of total asset of the sector (Foreign& Commonwealth Office, 2017).

Fig 3.1 illustrated the overview of China's financial system.

Fig 3.1 Overview of China's Financial System

source: Annualreviews.org, 2017

31
3.2 Current Banking Industry

The banking sector is considered as the column of China's financial system in serving the economy
with wide services coverage. The industry in Chin's banking sector providing full package of
banking products in the economy which is large relative to the size of the Chinese economy and has
expanded significantly over the past decade. The Chinese top tier banking system embodied by two
regulatory authorities consisting People's Bank of China (PBC) and China Banking Regulatory
Commission(CBRC). The mainstay of the second tier is structured by domestic or internal
commercial banks namely; Centrally state-owned controlled large banks, Joint-stock Commercial
Banks(JSCBs), China Construction Bank(CCB), Rural Commercial Banks(RCBs). Policy banks,
foreign banks, rural credit cooperatives, postal savings banks. Other banking institutions considered
as complementary institutions. (Kurer 2010, Jiang Yao 2017).

The Chinese government has tightened regulation over the industry to ensure the safety, soundness
of financial system and transparency as defusing and elimination of risks is at the priority duty of
government. (Xinhuanet).

According to CBRC latest annual report, as end of 2016, the number of incorporated banking
institutions in China totaled 4,399 with 4.09 million employees. In particular China's Banking
sector composed of two policy banks, One national development bank (CDB), 5 large commercial
banks, 12 joint-stock commercial banks, 134 city commercial banks, 1,114 rural commercial banks,
8 private banks, 40 rural corporate banks, 1,125 rural credit cooperatives, One postal savings bank,
4 asset management companies, 68 trust companies, 39 locally incorporated foreign banking
institutions, Sino-German Bausparkasse, 236 finance companies of corporate groups, 56 financial
leasing companies, 5 money brokerage firms, 25 auto financing companies, 18 consumer financing
companies, 1,443 village or township banks, 13 lending companies and lastly, 48 rural mutual
cooperatives(CBRC 2016). According to the CBRC latest annual report 2016, China's banking
sector maintained sound and robust performance on the whole, with asset, liability and profit
growing steadily. The risk resilience of banking institutions remained stable with sufficient
provision and controllable risks.

Total asset of Chin's banking sector counted 2,322,532 hundred million (RMB 232.3 trillion)
meanwhile the total liabilities counted 2,148,228 hundred million (214.8 trillion). China's banking
sector concentrated by its five large commercial banks, Joint-stock commercial banks, city
commercial banks and postal saving banks by having large portion of the total asset of banking

32
market shares. The profitability of China's banking sector continued to increase, as end of 2016 the
net profit of total banking institutions accounted RMB 2.1 trillion which shows an increase of RMB
73 billion or 3.6%. the net profit of commercial banks accounted RMB1.65 trillion which shows
an increase of 3.54% percent RMB56.4 billion. The return on asset remained at its high levels and
the average of return on asset and return on equity of the banking sector amounted at 1.0 and 12.6
percent and for commercial banks respectively registered 0.9 and 12.61 percent (CBRC). Fig.3.2
gives an overview of total asset and total liability of banking institutions in China over the time.

By types of institutions, five large commercial banks(SOCBs plus Bank of communication) 37.3%,
Joint-stock commercial banks 18,7%, City commercial banks 12.2% and Rural Small and medium-
sized financial institutions 12.9% and policy banks, national development bank, foreign banks
1.26%, non-bank financial institutions 3.4% and other banking institutions dominated the
remaining market share of China's banking sector. Fig.3.3 gives an overview of the market
structure of Chinese banking industry. (CBRC)

Foreign bank having fractional part of asset share of the banking sector, although, the role of
foreign banks is constrained by China's domestic law, to accession requirements can allow banks
for gradual increase in access to the China's domestic market.

33
 Fig.3.2 Total assets and Liabilities of banking Institutions (2003- 2016)

Sourc
e: CBRC annual report 2016

Five state-owned commercial banks with JSCBs and CCBs, dominated nearly 70 percent total
market share of the banking institutions. four State-owned commercial banks(SOCBs) with Bank of
Communication are the potential wheel of financial sector and playing a key role in Chinese
financial sector even though their market share in this sector decreased from 58.03% in 2003 to
37,3% in 2016. Meanwhile policy banks playing more active role with an increase in the market
share in total asset from 2003-2016 (CBRC).

Capital adequacy ratio in Chinese banks is higher than the international minimum standards to fend
off risk. Banks in China by plying key role in supporting the real economy, became increasing
competitive in recent years. In 2017 Chinese banks comprise of BOC and CCB entered to the list of
30 systematically important banks according to Financial Stability Board (Xinhuanet).

34
Figure.3.3 Market share(by asset) of banking institutions (2003-2016)

2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Policy banks & the CDB Large commercial banks Joint-stock commercial
banks
City commercial Rural commercial Rural cooperative
banks banks banks
Urban credit cooperatives Rural credit cooperatives Non-bank financial
institutions
Foreign banks New-type rural financial
institutions & Postal savings bank

Source: Graph based on CBRC annual report, 2016

The balance of total asset and total liabilities in the Chinese banking sector continued to expand
steady and the increase widened. in the meanwhile with macro economic situation stabilizing ,
profit continued to grow at a faster pace, showing a bigger year on year increase comparing to
2015. In 2016 The overall banking sector remained steady and total asset and liabilities increased
(CBRC)

3.3 Role of Banking Industry

China's financial system dominated by the banking institutions providing about three fifth of total
credit facilities to the private sector in contrast with United States banking system where financial
markets and non- bank institutions provide considerable more credit facilities than banks. The
Chinese banking system concentrated with five large commercial banks splitting about half of total
loan in the market. According to CBRC, as end of 2016 outstanding scale of LCY and FCY loan by
Chinese banking institutions stood at RMB112.06 trillion including short term loan and long term
loan. Parallel to loan facilities the outstanding balance of LCY and FCY deposit maintained by
banking institutions increased steadily and amounted RMB155.52 trillion.(CBRC).

35
China's financial system dominated by these types of institutions; large Commercial banks (Big
Five), joint- equity commercial banks, Policy banks and China Development bank, City
commercial banks and City credit unions, Rural small and medium sized financial institutions and
postal saving ban, foreign banks and non-bank financial institutions. Each of these institutions
operating in accordance with law and regulation of CBRC and PBC and serving in their particular
and designed realm and central government goals and strategy by controlling the assets in the
banking industry Katarzyna, (2009).

As end of 2017, the total asset in Chinese banking industry report at RMB 252 trillion or USD 39.9
trillion which shows in increase of 8.7 from 2016, this marked a 88.6 percent increase over past
five years according to the CBRC (Xinhua).

3.3.1 Large Commercial Banks

Large commercial banks which were known as SOCBs in the past founded in 1980s for the sector
policy objectives. In 1995 Law of the PRC on commercial banks enacted and their responsibilities
restricted to commercial purposes, based on the Law the four state-owned specialized banks legally
defined as wholly state owned commercial banks aiming to operate under the principle of
profitability, safety and liquidity, they are still very large banks and they are among the biggest
banks in the world by asset Garcia, et al. (2004).

According to the latest report of CBRC China's banking sector dominated by five large commercial
banks controlling nearly half of the total asset(37.3%) in the banking industry. Large commercial
banks which is known as (Big Five) they are all state-owned commercial banks composed of
Agriculture Bank of China, Bank of China, China Construction Bank, Industrial Commercial Bank
of China plus Bank of Communication. Large commercial banks very active lender to other
financial institutions Katarzyna, (2009).

Agriculture Bank of China(ABC) 1951 provides corporate and retail banking products and services
in the area of agro-business related unit and operates through corporate banking, personal banking
and treasury operations. ABC with total asset of USD 3.09 billion and net profit of USD 29.07
billion is the world's third largest provider in terms of lending institution. As ABC ranked by
Forbes as one of the top ten largest and valuable institutions in the world in 2014 (CFI&
Investopedia).

36
In 2016 in continuation to institutional reform the CBRC implemented of advanced measurement
approach via Agriculture Bank of China and BOC as part of this approach, the government reform
has further advanced in large commercial banks. Agriculture bank of China continued to reform to
finance the agro-business related unit. China Construction Bank launched the pension pilot, lastly
Bank of Communications started reform of its investment banking and online finance business into
quasi business units(CBRC).

Bank of China (BOC)1912 replaced the imperial bank of China and is known as the oldest bank
existing banks in China, in 2009 BOC recognized as the second largest bank in China and in terms
of market capitalization about USD1.5 trillion. In 2015 was among the 5th largest bank in the
world. As end of 2016 BOC reported total asset of USD 2.886 trillion and net profit USD 29.07
billion. In terms of wideness BOC is the most international of all Chinese banks in the world. BOC
engaged in the area of corporate banking, personal banking, treasury operations, investment
banking, insurance, aircraft leasing business and other operations (CFI).

China Construction Bank (CCB) 1954, provides variety of banking related financial services in the
economy, including corporate banking, personal banking and treasury business divisions and
manage some domestic and overseas institutions. As end of 2016, the total asset of the bank
reported USD 3.311 billion and having net profit USD 36.64 billion(CCB& CFI).

Industrial Commercial Bank of China (ICBC) established as limited company in1984 is the largest
multinational bank company in the world, as end of 2014, its total asset amounted over USD 3
trillion . ICBC is the first Chinese bank ever recognized as the world's largest bank, provide variety
of banking products and services worldwide including corporate banking, personal banking, and
treasury operations. As end of 2016 bank reported its total asset USD 3,812 billion and profit of
USD 44,07 billion, ranked the world largest bank(CFI& ICBC).

Bank of Communication (BOCOM) 1908, provides variety of commercial and retail banking
services and products and a key player in the Chinese financial sector through their market in total
banking asset. As end of 2016, the bank reported total asset of the bank with amount of USD 1,325
billion and net profit of USD 10.58 billion.

According to the Moody's Investment Services, latest report China's banks dominated the world top
five banks by asset size. Fig.3.5 world's top 5 banks by asset size.

37
Fig. 3.5 worlds top five banks by asset size

Source: Moody's Investment Service

3.3.2 Joint-stock Commercial Banks

The second largest types of banks are the joint-equity commercial banks(JSCBs) which make up
about 18.7% of total banking assets in China's banking sector (CBRC). Historical evidence shows
that in 1985 government advanced the institutional restructuring aiming to enhance the competition
atmosphere and initiate a competitive banking sector. Therefore, government paved the way of
entering to then market, Majority of joint-equity commercial banks and foreign banks enter to the
banking market. Joint-equity commercial banks operate as commercial banks with the objective of
profit maximization and free to develop business scope and geographical realm. JSCBs are owned
by local governments, State-owned controlled enterprises and mostly private sector Jiang and Yao
(2017).

According to the CBRC annual report 2016, there are 12 JSCBs and regarding to the (EY) latest
outlook report on listed banks in Chin, there are 41 listed banks in China which is composed of 9
National joint-equity commercial banks consisting China Merchants Bank (CMB), Industrial Bank
(IB), Shanghai Pudong Development Bank (SPDB), China Meshing Bank (CMB), China CITIC
Bank (CITIC), China Everbright Bank (CEB) China Zheshang Bank (CZB) Ping An Bank(PAB),
Huaxia Bank (HX) (EY 2017).

38
The JSCBs small and medium state-controlled enterprises with partial private equity capital. or
private ownership. JSCBs has smaller network of operation than SOCBS and their geographical
realm bounded to the region or to the fast growing coastal area, although JSCBs allowed generally
at the national domestic level. JSCBs operate most commercially as accepting deposit, making
loan, engaging with foreign exchange and global transaction services and products and in recent
years their market-oriented activities resulted to own the market share at the expense of the State-
owned commercial banks Jiang and Yao(2017).

3.3.3 City Commercial Banks

According to CBRC, City commercial banks and City Credit Unions dominated the 12.2% of the
total banking asset in China's banking industry. There are currently 134 City Commercial Banks in
China engaged in financial business permitted by PBC including deposits and loan settlements
remittances and intermediate business, serving local communities by focusing on local economy,
urbanization Medium-small-sized enterprises and urban and rural residents and transformed
business models accordingly (CBRC). As end of 2016, total asset of city commercial banks
amounted to RMB 28.24 trillion with increase of 24.5 percent yearly and growth rate of 8.7% point
higher than the average rate of the Chinese banking industry with the profit of RMB 224.45
trillion according to China daily report (2017) and AMTD Equity research report 2018.

In mid 1990s, CCBs were established via merger of Urban Credit Co-operatives UCCs. CCBs
capitals on hand of urban enterprises and local government. CCBs mainly lend to small and
medium-sized, collectives and local residents in their geographical realm and they are not allowed
to do banking activities at the national or regional scale unlike the joint-equity commercial banks,
which the major competitive disadvantage. City commercial banks as biggest provider of inclusive
basic financial services in urban areas have improved the stock equity management and information
disclosure and improved the efficiency of corporate governance by using simple, efficient, practical
and good functioning governance structure Katarzyna, (2009).

3.3.4 Policy Banks and China Development Bank

Specific lending purpose banks or Policy banks founded in 1994. To oversee the policy operation
of SOCBs and to promote the export of mechanical and electrical products the government decided
to establish three policy banks consisting Agriculture Development Bank of China (ADBC),
Import-Export Bank of China (EXIM), China Development Bank (CDB) under the leadership of

39
the state council. According to CBRC, policy banks make up about 8% of total banking assets and
are responsible for funding state-led development projects Katarzyna, (2009).

As end of 2016 there are two policy banks ADBC dedicated to support the development of
agriculture industry primarily by granting and managing loans for rural infrastructure development
projects and agriculture related enterprises in China. EXIM bank committed to supporting China's
foreign trade, investment and responsible for international economic cooperation and green finance,
plus (China Development Bank Corporation was incorporated in December 2008 as a commercial
bank, and the State Council officially defined it as a development finance institution in March
2015, hence it is essentially still a policy bank. Following Institutional reform the amendments to
CDB, the EXIM bank and ADBC articles of association approved by state council due to that now
Policy banks have clear strategies, organizational structure, corporate governance. capital
mechanisms improved (CDB).

In past five years, the policy Banks industry in China has grown up by 7.7 percent and revenue
amounted USD161 billion in 2018. At the same time the business scope of the banks have varied
and grown by 01 percent and number of employees increase by 1.5 percent. In the past five years
policy bank's revenue increased an average of 6.8 percent annually accounted USD 154.4 billion.
This industry growth driven by rising interest rates and increase in the amount of loans issued. Over
five years period the industry has took over reform to accommodate the changing China's economic
environment(IBIS world).

China Development Bank (CDB) is state owned economic development finance institution operate
funder State Council engaged in supporting development in underdeveloped sectors and key
industries. The CDB is considered as the global largest development finance institution and the
largest bank in China for foreign investment and finance cooperation, long-term lending and bond
issuance. CDB is committed to support Chinese companies going abroad through the principle of
mutual benefit, cooperation and win-win process. CDB's total asset increased to RMB 15.96 trillion
by the end of 2017, dedicated to finance major projects in China and contributed to the silk road
fund AIIB and so on (CDB).

3.3.5 Rural Small and Medium-Sized Financial Institutions (RSMFIs)& PSBC

Rural small-medium sized financial institutions such as village and township banks lending
companies and rural mutual co-operatives plying important role in Chin's financial sector and have

40
important complements, playing a significant roles in serving economy with wide coverage. As part
of reform in 2016, 1,222 rural commercial banks had been established, the pilot reform of rural
credit unions provincial associations has been facilitated, 10 provincial associations had been setup
auditing centers, 1519 village or township banks had been established, 67.4% of all countries
covered by village or township banks, 12 province covered by 100% at country level by village or
township banks (CBRC).

As subsidiary of the China Postal Group in 2006 the Postal Saving Bank of China (PSBC) founded.
The PSBC has the largest network of financial services in the rural and urban economies and
societies. Substantially, It is engaged in providing basic financial services to town and village
communities and rural residents to finance the development of the new rural society. As of end of
2016 the PSBC with its RMB 8.28 trillion was recognized the China's largest retail bank. The
PSBC, incorporated in 2007, it was the first step towards commercialization of China’s postal
savings. In 2012, the PSBC was transformed into a joint-stock limited company and subsequently
listed on the Hong Kong Stock Exchange in 30 September 2016 after attracting 10 domestic and
international strategic investors. As part of reform in 2016 the bank was approved to issue tier-2
capital bond. It has further enhanced the management of business agencies by cooperating with
China Post Group. The Agro-related Finance Business Unit has been established to leverage the
bank’s layout network advantages and build a professional rural financial service system (CBRC&
PSBC).

3.3.6 Foreign Banks

China's admission to the World Trade Organization (WTO) in 2001 was the milestone of financial
liberalization, and removed the barriers and restrictions against foreign banks accession to the
Chinese market. Through that China promised to open its market's door to foreign investment.
Since 2003, CBRC allowed banks to have more access to the local market such as conduct local
currency business with local companies, lowered the foreign banks capital requirements to RMB
500 million, full service branches. Now after almost two decades, role of foreign banks in Chinese
banking market is considerable and businesses prospered by rapidly growing financial services
markets and promising prospective of the economy. Katarzyna, (2009).

As end of 2016, there were 37 locally incorporated foreign banking institutions, from 44 countries
and jurisdictions(with 314 branches) operating in 27 provinces. 121 branches form 68 banks from
26 countries, 145 banks from 44 countries and jurisdictions established 166 representative offices.

41
Total asset of the foreign banks reported RMB 2.93 trillion with total profit RMB 12.977 billion
having 1.26 percent portion of the total banking market asset (CBRC 2016).

There are foreign investors over 20 countries invested in Chinese markets, foreign strategic
investors targeting all types of domestic commercial banks in Chinese banking sector, foreign
investors willing to participate in the management of partner banks and influence on the business
developments. On other hand Chinese banks, effected by obtaining of needed capital, management
skills, advanced technology, good structure of corporate governance, operational expertise.
Opening up policy and foreign banks accession to Chinese banking sector achieved win-win
situation among foreign banks and Chinese banks Jiang and Yao (2017).

3.4 China's Banking Regulatory Landscape

To understand how do the PBC and the CBRC regulate these industries, and discover the structure
of China's banking regulatory system, here we need to infer the role of China's banking regulatory
agency. By the Law the is designed for regulation and supervision of all activities of banking
institutions and their business operations in China aiming at protecting the rights of depositor and
other financial consumer and their interest, promoting safety and sound banking sector and lastly
fostering the banking sector to meet financial need of Chinese economy and society as well as
conducting prudential regulation by reducing potential risk in banks. The CBRC since 2003 is the
main regulator of the banking sector. Upon embark of the CBRC the PBC took over the role of
central bank and engaged with responsibility of monetary policy and liquidity of financial sector.
The CBRC and PBC stand on same position and other three state agencies consisting Ministry of
Finance (MOF) the National Development and Reform Commission (NDRC) and the State-owned
Assets Supervision and Administration Commission (SASAC) have different responsibilities and
functions within China's banking sector and accountable to the State Council while CBRC is
accountable to the central government. Despite that the Law of People's Republic of China has not
prevented State Council from control of the CBRC, central government stated that the CBRC
operation is free from local government intervention. Whereas the CBRC is a regulator for business
conduct as well. The main objective of China’s banking regulation is to ensure all banking
operation in accordance with rules and regulatory framework and increasing public awareness
about financial products and services and related risks via education and information disclosure
which is an integral part regulatory reach. Overall, the CBRC takes a broad and rigorous approach
to the regulation of banking products and services Wei (2012).

42
Figure.3.6 Shows the regulatory structure of Chain's financial system, all are operating under the
leadership of State Council.

Figure: 3.6 Regulatory structure China's financial system

Source: Brooking Institute,(www.Brookings.edu)

The Chinese banking regulatory frame-work is embodied with four tiered. First tier is set of
legislation, where the National people's Congress adopted legislation which is very restricted and
limited and there are four set of related legislation including, Law of the People's Bank of China in
1995, Laws of commercial banks in 2003 and Laws of People's Bank of China on Banking
regulation in 2003 which enable legislation for China Banking Regulatory Commission and
fourthly, which was approved by stated council is Regulations of Peoples Republic of China on
administration of foreign banks in 2016 which gives great importance for foreign banks. National
People's Congress has given the authority to the State council to operate an interpretive function in
terms of government administration. The authorities that have the responsibility of foreign banks
rise from low level of legal series and the interpretive power is protect of bank regulator.

The second tier is set of regulatory policies which is designed via regulators and the CBRC. These
policies justified in legislation to stipulated legislative principles. These policies are demonstrate

43
regulatory and supervisory directions over medium term aiming prudential frame-work and to long
term aiming to provide competitive market. Local incorporation policy is more critical to the
entrance and performance of foreign banks, this is oriented to policy initiative in year 2006 which
encourage foreign banks within China to merge locally operate as branch of foreign banks. and
providing associated regulatory incentives to the banks to undertake incorporation Douglas (2013).

Third tier argue the guidance, rules and notice of the CBRC, as well as the third tier of regulatory
initiatives plays role column on China's financial regulation and deal with contemporary regulatory
issues. A series of rules, guidance and notice designed to regulate bank performance and activities,
codes of conduct or practice, banks products, and internal governance. for further illustration,
referring to loan for acquisition of fixed asset, these regulatory rules provide guidance on
processing such as evaluation of application, contract process, risk assessment, disbursement and
post acquisition monitoring.

The fourth tier argue to window guidance measures of the CBRC. The PBC previously, had been
focused on macroeconomic related issues as the window guidance in China to articulate regulatory
intentions, preparing guidance opinions and signal risks which is posed to financial institutions.
Currently, the CBRC has been largely neglected as another employer of window guidance
measures. It is clear that the CBRC also employs window guidance as a powerful regulatory
initiative to keep banks in line with its regulatory goals. Although it is not legally enforceable, the
CBRC claims it to be a assuasive regulatory approach. Wei (2012).

3.5 China's Financial Markets

In this section I would like to examine the interbank market and other marketplaces that banking
sector, financial institutions participated in. China's financial markets consisting the bond market,
the stock market, the real estate market and asset management industry. bond market and asset
management industry experienced rapid growth after the global financial crisis with the
performance of the equity market NAFMII (2015)

3.5.1 Stock Markets

In 1990s, with the inception of China's stock market, in two major cities such as the Shanghai Stock
Exchange (SSE), the Shenzhen Stock Exchange (SZSE) was the most significant step toward

44
development of financial system. Parallel to stock market, real estate market also grew. Another
major stock exchange is Hong Kong Stock Exchange (HKSE).

Currently, after thirty years of financial development, China's stock market is one of the largest
stock market in terms of market capitalization. There are two complementary markets besides the
two main stock exchanges, the Second Tier market (er bank shi chang, similar to the NASDAQ)
which is for SME, and it was designed to lower the entry barrier for SME firms, particularly new
firms in high-tech industries. Third Tier Market(san ban shi chang) established in 2001 to present a
share transferring platform for delisted firm and other Over the Country Transaction(OTC). In
2006, New Third-Tier Market(xinsan ban shi chang) was created to engage with equity transactions
of none-listed shareholding companies in high-tech zone in Beijing. in 2009, China created the
NASDAQ-style Growth Enterprise Market(GEM) to provide for private SMEs, high-tech and small
and medium-sized. In 2010 the SZSE start releasing the indexes of Growth Enterprises Market
(GEM) including ChiNext and ChiNext Composite. Since 2012 China's Stock market development
accelerated such as expansion of New Third Tier Market into the National Equities Exchange and
Quotations (NEEQ) and other developments such as pilot phase of preference shares and possibility
of transforming the approval-based system for IPOs into registration based system. As end of 2013
according to the report of World Federation of Exchanges(WFE), in terms of market capitalization
the SSE ranked the seventh and SZSE ranked the eleventh largest market in the world, and HKSE
was ranked the sixth largest in the word in terms of selected firms from China. No doubt Chinese
financial markets playing increasingly important role in the World Financial markets WFMs.
Figure 3.7 Shows comparison of the performance of major stock exchange around the world as
measured by the buy and hold returns of one unit of currency invested from 1992- 2015, adjusted
for inflation Allen et al, (2017).

45
 Fig. 3.7 Source: CEIC database (ceicdata.com)

As Figure.3.7 illustrated, the market, indicated by the Shanghai Stock Exchange SSE index,
reversed during the next 5 years, dropping from 2,103 in the beginning of 2001 to 1,079 in
December 2005, and then recovered in 2006 and rose to a high of 5,954 by the end of October 2007
Allen, el all (2017).

3.5.2 Bond Markets

China's bond market has thirty years history. Since 1980 the Ministry of finance of China restart the
issuance of treasury bonds. Over three decades of financial development, China's bond market
experienced three stages of development; start up stage or bank counter stage (1980-1990), the
exchange stage (1991-11998) and the interbank market stage (1997-present). The interbank bond
was officially established in June 1997, gradually, in 2001 the interbank bond market outreached
the exchange market in terms of issuance volume, trading volume and worth of outstanding bonds.
Since then the inter-bank market has become the most important primary and secondary market for
debt financing instrument in mainland China. bonds are issued and traded in two different markets;
the exchange market and interbank market. The interbank market is the most important primary and
secondary market in which roughly over 94% of the new issuance of bonds are originated and
traded. Major regulators are PBC and China Security Regulatory Commissions (CSRC). The PBC
is responsible for inter-bank market regulation and CSRC is responsible for Exchange market
(NAFMII).

46
Bond market has three components or types namely; treasury bonds, policy financial bonds and
corporate bonds. All types of these bonds are issued by policy banks which is operating under
leadership of the ministry of finance. In terms of newly issued volume, since 2011 the corporate
bond market has been larger than the treasury bond market. Since May, 2012, unlisted and small
and medium-sized companies have been allowed to issue corporate bonds in the stock exchanges.
Further, in January 2015, the CSRC announced a new reform in the corporate bond market that
removed both the sponsorship and the screening systems for bond issuance. Since then, the
corporate bond issuance system has been very close to a registering system. The volume of
corporate bond issuance increased sevenfold. According to statistics from the SSE and SZSE, the
volume of total corporate bond issuance (excluding enterprise bonds and midterm notes issued in
the interbank market) in 2014 was about RMB 145 billion and in 2015 was about RMB 1,031
billion. By the end of July 2016, China’s domestic bond market capitalization was RMB 41.63
trillion ($6.28 trillion), a total very close to that of the domestic equity market (including both the
SSE and SZSE), which was RMB 46.32 trillion ($6.99 trillion) Allen et al (2017).

In 2016 the overall volume of bond issuances grew rapidly, but it slowed down moderately during
the fourth quarter of 2016. During the year, the total issuance of bonds posted a cumulative
RMB35.6 trillion, surging 55.5% year on year, among which local government bonds, corporate
bonds, and interbank Certificates of Deposit (CDs) experienced rapid growth. At end of 016,
outstanding bonds of all kinds stood at MB63.8 trillion, advancing 30.8 percent year on year
(CBRC).

Outstanding amount and trading volume of interbank call loans increase in 2017. The average daily
outstanding amount of interbank call loan in 2017 registered NT$500.5 billion shows an increase of
2% year on year, meanwhile the outstanding amount of bill issuance in the primary market reached
to NT$ 2.15 trillion, increasing 15% yearly and the bill trading volume in the secondary market
amounted NT$ 38.88 trillion with increase of 3.55% yearly, according to China financial Stability
Report (CFSR 2018) .

Figure.3.8 Shows the interbank call loan market from 2013 to march 2018 and outstanding
amount is based on monthly average of daily data.

47
 Fig.3.8 Source: China Financial Stability Report (CFSR) 2018

As en end of 2017, the outstanding amount of bonds issuance stood at NT$ 12.29 trillion with
increase of 6.98% yearly driven by growth of international bond issuance. In the secondary bond
market trading volume amounted at NT$ 61.58 trillion with decrease of 7.83% yearly.

Figure 3.9 Shows the total amount of bonds outstanding in the primary market. other bonds include
beneficiary securities and foreign bonds (CFSR).

48
 Fig.3.9 Source: China Financial Stability Report 2018

3.6 NAFMII

National Association of Financial Market Institutional Investors (NAFMII) founded in September

2007, under the approval of State Council aiming to promote development of China's interbank
market and propel the development of China Over the Country Transaction (OTC) market. China's
inter-bank market composed of inter-bank bond market, interbank lending market, foreign
exchange market, commercial paper market, gold market and derivative market. In the interbank
bond market registration of assonance, post-registration information disclosure and secondary
market surveillance of non-financial enterprises debt financing instrument entrusted to NAFMII.

As Self-Regulatory Organization (SRO) in China, the NAFMII has members including financial
institutions, non-financial enterprises and intermediaries (Policy banks, Commercial banks, foreign
banks, credit unions, Credit co-operative banks, insurance companies, securities houses, mutual
funds, fund management companies, trust and investment companies, finance companies affiliated
with corporations, credit guarantee institutions, credit rating agencies, accounting firms and
companies in non-financial sectors). As end of 2015, 5,747 market members has joined NAFMII, in
particular there are 814 banks, 3,941 enterprises, 367 other financial institutions, 11 financial
intermediaries,604 intermediaries, one other institutions and 11 individual members.

49
According to NAFMII, by the end of 2015 the outstanding volume of debt financial instrument
totaled RMB 8.8 trillion maintaining an annual incremental outstanding volume of one trillion for
four consecutive years. As end of 2015, there were 1668 enterprises issued debt financing , while
2,197 debt issuers debt financing instrument were still in maturity; the new issuance volume of the
year, cumulative issuance size and outstanding volume of the debt financing instruments were of
RMB 5.4 trillion, RMB 20,3 trillion, and RMB 8.8 trillion respectively accounting for 80.9%,
77.9% and 60.8% respectively of the aggregate amount of corporate debentures in China in the
same year NAFMII (2015).

50
 CHAPTER FOUR

Development of CBRC’s Regulatory Efforts

This chapter mainly focus on development of the CBRC regulatory efforts, including development
of prudential regulatory framework, regulatory measures, the CBRC's regulatory approaches and
regulatory cycle of the CBRC, annual development in prudential regulation, risk-based supervision,
supervisory approaches and institutional supervision.

4.1. Development of the CBRC's Regulatory Legal Frame-Work

The regulatory legal framework sets a clear responsibilities and objectives for banking supervision
in mainland China. Overall legal mandates and responsibilities supported by broad powers which
enabled the CBRC to conduct banking supervision in effective manner with focusing on safety and
soundness. A set of comprehensive regulation and procedures have provide the CBRC with the
necessary tools or properly operationalize its mandates, while strop enforcement power further
support the effectiveness of supervisory actions(IMF 2017).

The CBRC as the regulatory authority with its regulatory themes remained committed to promote
banking sector and better serve the financial stability through its mandates, objectives, based on the
Law, rule and regulations in China. Banking regulation frame-work includes public education,
enforcement, legislation which is the core of this frame-work, and review of rules and regulations.
In order to increase the practical nature of the banking regulatory framework, the CBRC has
invested efforts in upgrading this frame-work in Chinese banking sector. It has done via timely
evaluation of impact of the IFRS and new capital accord, incorporating the experience of other
global regulatory authorities. It has monitored the trend of principles based supervision and the
relationship between rule based and principle based supervision concept. Meanwhile, the CBRC
conduct a useful review of existing rules and regulation and execute a comparative study of the
domestic and international banking regulatory framework. All laid a cornerstone for improving of
banking regulatory frame-work in mainland China. In 2009 the CBRC, developed rules and
guidelines on risk management of banks, fixed asset loans, management of working capital,
management of retail loans and guidelines on project financing. In 2012 and 2013, the CBRC
improved regulatory policy framework by formulation of regulations on capital rules, guidelines on

51
operation of commercial banks and guidance on performance assessment of banking institutions,
participation in the legislation. In 2015, the CBRC enhanced the regulatory legal framework, for
this purpose pushed forward the revision of the Law of the Peoples Republic of China on
commercial banks, drafted the Trust Company Regulations, improved the framework of
supervisory rules and regulations, in the same year the CBRC issued the guidelines to promote the
Law-based regulation in the banking sector, secondly improved the prudential regulatory
framework. Following that in 2016, the CBRC facilitated and included the amendment to the
commercial banks law and the law on banking supervision and regulation into the 2016 legislation
work plan of State Council.

Legislation which make the core of regulatory framework formed by Laws, Administrative
Regulations, Department rules and regulatory rules and guidelines. Since the inception, the CBRC,
has engaged in drafting the Law adapted in 2003 and implemented in 2004, was the first series in
China, which standardized the law on banking supervision and laid the establishment for its
regulatory system. Commercial Banking Law, the Law of the People's Republic of China on the
People's Bank of China. These three Laws lead to the legal framework for commercial bank
performances and banking supervision. In 2006 the State Council amended the regulations of the
Peoples Republic of China on the administration of foreign founded banks which was adopted to
honor China's commitment in WTO, to strengthen prudential regulation, to unify regulatory
standards for foreign and domestic banks, to adjust the scope of application of the regulations and
embody national and regional economic development policies. Parallel to that the in 2006 the
CBRC issued the Rules for implementing the regulations of the Peoples Republic of China on
administration of foreign founded banks. Following rules and guidelines; Promoting risk
management and protecting safe and stable operations of commercial banks. The CBRC
standardized the commercial banks corporate governance and improved supervision through
guidelines on Corporate Governance reform and supervision of state-owned commercial banks,
Guidelines on Compliance management of commercial banks, Guidelines on the Administration of
information system risk management of banking institutions to prevent risks, Encouraging
financial Innovation and Improving Financial Services through guidelines on financial innovation
of commercial banks. In 2010 the CBRC further improved the regulatory policy framework by
improving legal framework, participation in national legislation for drafting of laws and regulations
and in 2014 for the purpose of regulation of banking institutions improved rules for prudential
supervision. Gradually, For further improvement of regulatory framework, the CBRC in 2015, in
jointly coordination with National People's Congress, State Council Legislative Affairs Office, and

52
other ministries formulated Law on the Administration of Tax collection, National Security Law,
Insurance Law, Pricing Law.(CBRC)

4.2 Development of Prudential Regulatory frame-work

Its believed that a well developed prudential regulatory framework is the pillar of prudential and
comprehensive effective banking supervision in any country. In order to realize civil welfare, via
fully utilizing the inflow of foreign capital and domestic savings, this would be based on a
strengthened financial infrastructure. It can be achieved through the strengthening of prudential
regulations and supervision. In 2007, the CBRC had notable development in improving legal
regulatory framework. For building prudential regulatory framework the CBRC sat up fine-tune
new framework for banking rules and regulation through revising and updating regulations, Rule
reviews, rules compiling, rules making plan, post implementation assessment on rules. On the other
hand Standardized regulatory enforcement activities by promulgating administrative punishment
measures, the rules on procedures for implementation of administrative licenses, and the onsite
examination manual, improved public education on banking Laws and regulation in order to
enhance compliance awareness of whole banking industry and public, and took initiatives to
enhance and participated in national legislation on the basis of its regulatory practice aiming to
create a favorable environment for banking regulation.

In 2010 the CBRC, improved practical supervisory framework which integrated Micro-prudential
and Macro-prudential supervision. The frame-work consisted series of simple, effective and
practical supervisory tools. The prudential supervisory tools contained dynamic capital adequacy
requirement to enhance the loss absorbency of the banking industry. Commercial banks required to
meet the minimum CAR requirement of 8%, the core Tier1 capital not be less than 75% of total
capital. Dynamic loan loss provisioning requirement by dynamic adjusting the provisioning
requirement in line with cyclical economic development, Leverage and liquidity requirements
which will give due consideration to off and on-balance sheet exposures, liquidity supervision
aiming to standardize prudential liquidity in accordance with Basel Committee standards on
banking supervision, requirements on bank executives compensation and incentives, and
arrangements for more stringed oversight of Systemically Important Financial Institutions (SIFIs).
Meanwhile, the CBRC formulated the medium to long term strategies aiming to improve the
supervisory effectiveness and roadmap for implementation of Basel II and Basel III in banking
sector (CBRC 2010).

53
In 2015, the CBRC improved the prudential regulatory framework, for this purpose conduct a
review and planning for prudential regulation in China's banking sector, issued 2015-2020 Rule-
making plan for prudential supervision and issued rules on Prudential Regulation Development
Work to further improve work mechanism and roadmap and procedures for prudential regulation
development. Following to the prudential rules in 2016, the CBRC, took action plan to research and
formulate operational rule, issued guidelines on comprehensive risk management for banking
institutions, further strengthened management oversea of the banking institutions operational risk
(CBRC).

4.3. The CBRC's Regulatory Cycle (Regulatory Approaches)

According to the CBRC, on-site examination, Authorization, off-site surveillance and market exit
constitute are the four components of the regulatory cycle of the CBRC. The effectiveness of
regulatory work is dependent on effective and efficient information sharing, collaboration, resource
allocation among these components, and appropriate handling of the relationship between
functional supervision and institutional supervision. For the purpose of covering and formation of
integral foundation for regulatory activities there needed a robust information system to provide a
common supervisory frame-work for supervisors to work jointly in different levels together. For
achieving this goal, the CBRC worked hard for 3 years, gradually in 2006 successfully set out the
banking supervisory information system(BSIS) with the CBRC risk based supervision concept. The
off-site surveillance supervisory information system is one of the core-sub system. Through this
system, it facilitated the automation of approval process, improved the efficiency of on-site
examination in relevant and effective manner, supervisors are able to access consolidated
supervision over banks, and have access on capital adequacy, market risk, credit risk, liquidity risk,
in a timely and effective way, it helps to analyze banking industry condition as a whole and can
conduct comparative analyze between banking institutions. Since introduction of BSIS, the CBRC
has been able to have a common knowledge base, allowing its corporate structure, departmental
functions and personnel management, regulatory processes to be streamlined, thus improving
regulatory resources allocation, enhancing off-site surveillance work and closely integrating this
with on-site examination to improve risk warning capability. The system serves as data source for
on-site examination, off-site surveillance, risk rating and early warning, it facilitated the risk
assessment and IT based supervision and improved the effectiveness of supervision. Figure 4.1
illustrated the BSIS.

54
4.3.1. Authorization

Authorization or issuing license for new banking institutions is the first components of the BSIS
which is the key activity for sound operation of banking institutions and safety of financial system,
an efficient competitive and fair environment of banking operation as well as moving the system to
manage risk on preventive manner. The CBRC is the responsible agency for authorization of new
banking institutions, since the establishment the it has developed the authorization process based on
rules and regulation by removing certain redundant administrative and filing requirement to reduce
regulatory costs. Authorization process has three level; authorization criteria, statuary deadline,
process and procedures.

Fig. 4.1. Banking Supervisory Information System(BSIS)

Sour
ce: CBRC annual report, 2006

4.3.2. On-site Examination

Since the inception the CBRC has focused on the on-site examination and strengthening the
investigation and enforced supervisory measures for non compliance and violation. On-site
examination is the second components of banking supervisory information system (BSIS) which
signify to the business review, risk analysis, and assessment. On-site examination has divided into
two regular and ad-hoc examinations according to the different scopes and focuses of examination.
On-site examination has developed yearly through the development of rules and regulations.

55
According to the CBRC supervisory approaches and criteria, on-site examination is conducted on
each banking institutions one time a year or a year and half if there is any weakness. After
preliminary analysis of systematic and major risks in the banking institutions, the CBRC give the
priority for on-site investigation of banks on asset quality, capital adequacy ratio CAR, liquidity,
profitability, management and internal control, risk concentration, related party transactions and
compliance. Its conducted based on CAMELS+ rating for legal institutions and ROCA rating for
branches, it takes risk based supervisory approaches, whereas more regulatory resources are
allocated to and more frequent on-site examination are carried out at identified financial institutions
with higher risk. The CBRC leverages and consider the result of off-site surveillance investigation
to facilitate a risk base on-site supervision methodology and improve the effectiveness of on-site
examination. Since 2006 the on-site examination has developed through the development of rules
and regulation and modern technology (advanced computer data analysis software) being used to
enhance the quality of on-site investigations and standardized the efficiency of on-site
examination(CBRC)

4.3.3. Off-site Surveillance

Since the establishment the CBRC, has put much efforts on off-site surveillance with building of
banking supervisory information system (BSIS). The CBRC has created a preliminary framework
of off-site surveillance mechanism for banking institution in China aiming to further development
of supervisory process, and internal manual on off-site surveillance, improving off-site reporting
system, building up classified supervision system and improvement of peer group analysis. Also to
better conduct its mandate the CBRC is developed of its supervisory rating system CAMELS+
commercial banks which include both quantitative and qualities factors and early warning
mechanism in supervisory measures. In line with concept of risk-based and consolidated
supervision, the CBRC further developed off-site workflow and resource allocation, create
integrated off-site surveillance system, implemented territorial supervision and coordinated
supervision, implemented CAMELS+ rating, conducted peer group analysis to enable supervision
to be tailored differentially for large, small and meddle sized banks, cooperatives, and non-bank
institutions, enhanced and put in place effective risk early warning for potential risk mechanism,
strengthened the supervision and control over loan concentration and related party transactions,
corporate clients (CBRC).

56
4.3.4. Market Exit

Market exit is the fourth components of the BSIS. Since the creation of the CBRC, the CBRC has
been actively working together with local governments to resolve the problematic mid- and small-
sized banking institutions, and working together with other local authorities to improve the
accounting and taxation policies for a favorable legal environment pertaining to market exit of mid-
and small-sized financial institutions. In particular, the CBRC participated in promulgating the
legislation of the Enterprise Bankruptcy Law, which serves as the legal foundation for the exit of
banking institutions. A healthy exit mechanism is beneficial for minimizing moral hazard and
convoy system in the banking sector, which in turn is conducive to providing a fair competition
environment. The smooth exit of incompetent banking institutions at the minimum cost if possible,
is one of the preconditions for the stable development of the banking industry. The first priorities to
improve the market exit of banking institutions in China are as follow; pushing the legal basis for
the market exit of banking institutions by a bankruptcy ordinances for banking institutions,
establishing market exit mechanism for banking institutions pertaining to the practice in China,
enhancing risk warning and crisis management arrangements, building up an accountability system
and post-projects evaluation system for market exit (CBRC).

4.4 Annual Development in Prudential Regulation

4.4.1. Capital Regulation

Capital is one of the main part of balance sheet and capital regulation is the core elements which all
banking supervisory authorities exercise prudential regulation and supervision. Secondly, it helps to
improve the soundness and safety an financial stability of the banking industry, enhance fair
competition in financial markets and ensure the protection of interest of depositors. In 2006, the
CBRC, enforced capital adequacy rules aiming to diversify banking institutions to expand their
capital founding to make changes their business philosophy and growth models. According to the
Rules Governing Capital Adequacy of Commercial Banks all commercial banking Institutions in
2006 required to set a capital adequacy management system and meet the Capital Adequacy Ratio
(CAR) of 8%, the CBRC forced banking institutions to expand capital funding sources through
measures such as capital injection, fund-raising and issuance of subordinated debt. The CBRC
proposed a phase by phase implementation roadmap of the New Capital Accord, in this regard
commercial banks divided into two groups to implement different capital adequacy supervisory

57
requirements. First group is New Capital Accord Banks and other group was Other Commercial
Banks. In 2007 in respect to reform of capital regulation paid attention on conducting consolidated
and risk based supervision, strengthening internal controls of supervised banking institutions,
require banks to have accurate loan classification, draw adequate loss provision, maintaining
adequate capital. In this year by issuing the guidance promoted the implementation of the new CAR
(Basel II) specified the timetable, methods, objectives, scope, principles and measures of the
implementation. In 2008 the CBRC, urged commercial banks to meet the CAR requirement to
improve risk resilience and to take initiatives for capital injection, support banks to replenish tier-2
capital through subordinated debt. The CBRC, also implement New Capital Accord for this purpose
the CBRC introduced first batch of regulation to carrying out the New Capital Accord. the CBRC,
in 2009, implemented dynamic capital regulation. Through this measurement urged commercial
banks to replenish their capital via issuing new shares controlling asset growth and raise
provisioning, write-off NPLs and prudently paying our dividends. Secondly, set out new rules on
capital replenishment by issuing the Notice on improving the Capital Raising Mechanism of
Commercial Banks decided to emphasize the CAR on the loss absorbent elements of capital.
Thirdly, the CBRC continued efforts to implementation of Basel II (New Capital Accord), for this
purpose the CBRC issued 7 documents to form the basic framework. In 2011 in accordance with
the 12the- five years plan the CBRC, promulgate the Guiding Opinion on the Implementation of
New Regulatory Standards in China's Banking sector aiming to step up a comprehensive set of
prudential regulatory requirement on CAR, liquidity, leverage ratio loan loss provision and
leverage ratio, for this purpose the CBRC reviewed the implementation of New Capital Accord of
some commercial banks to determine those banks are qualified to implement the capital
measurement approaches. Meanwhile the CBRC, for public consultation issued the Regulation on
capital of commercial banks which set out the roadmap for the implementation of new regulatory
standards in banking sector. In 2012 the CBRC, further developed the standards for capital
regulation in line with the requirements of Basel III and encouraged commercial banks to transform
and development pattern and improve the soundness of banking institutions, in this regard issued
capital rules for commercial banks, issued supervisory guidance on capital instruments innovation,
and notice on transitional arrangements for implementation of the capital rules for Commercial
banks. The CBRC in 2014 developed policy framework for capital regulation and urged
commercial banks to annual capital plans for the purpose of risk governance and set out the target
for the (CAR) and for capital replenishment and management of (RWA), for realizing this goals, it
implement the capital rules of commercial, started the pilot phase of the implementation of

58
advanced approach of capital calculation, innovated capita instruments by commercial banks.
Following the implementation of capital rules of commercial banks the CBRC in 2015 improved
capital regulation as end of the year majority of commercial banks meet the Capital Adequacy
Ratio requirement.

4.4.2. Corporate Governance

from1994 to 2002, the fundamental banking rules and regulations were formulated, and accordingly
certain actions were taken to address the disordered financial market. Over these nine years, the
commercialization reform of China’s banking sector was further pushed forward, with a special
focus on mitigating risks and resolving historical burdens; and from 2003 onwards, the corporate
governance reform of large commercial banks and the restructuring of other banking institutions
was completed. In these fifteen years, the accumulated risks were addressed and the banking
industry witnessed a progressive development. (CBRC2008)
Since 2006, the CBRC, set out risk based supervision through strengthening corporate governance,
internal control, credit risk supervision, market risk supervision and operational risk supervision.
In 2006, all commercial banks required to set a modern corporate governance to diversify their
ownership and shareholding structure. For this purpose commercial banks required to strengthen
the functioning of Board of Directors and improve internal and external monitoring. In this regard
the CBRC issued the Guidelines on the Corporate Governance Reform and Supervisory of State-
Owned Commercial banks, all state-owned commercial banks required to establish sound corporate
governance structure. In 2008, the CBRC, further improved the corporate governance, in this
respect, required commercial banks to improve the corporate governance for sound business
growth. Meanwhile the CBRC urged banks to create and optimize internal control framework and
pushing forward the transformation to SBU-based banks and approved guidelines for banking
institutions for the purpose of improvement of internal control. In 2009, corporate governance
considered as essential elements in prudential supervision and dynamic counter cyclical supervision
and base of systemic risk prevention. The CBRC made efforts in rule making via issuing guidelines
to enrich the regulatory framework to strengthen the corporate governance banking financial
institutions. The CBRC, required commercial banks to perform duty of care and fiduciary duty to
oversee the bank's business activities and to handle business development. To bring the bank'
compensation practices under the supervision issued Supervisory Guidelines on Compensation
Practice to provide supervisory guidance on banks activities in management and designing
compensation. In 2010 made efforts to further improve corporate governance framework, featured

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by sufficient checks and balances, defined responsibilities and accountabilities, sound and domestic
decision making process and timely information reporting and disclosure. Besides that, Issued rules
to improve supervisory rules governing corporate governance, strengthened supervision on duty
performance, strengthened the supervision on compensation practices through issuing guidelines. In
2011, and 2012 considering corporate governance as one of the key supervisory focus or element,
all banks required to develop corporate governance arrangements, specifically banks urged to have
well-established organizational structure, effective internal control and risk management, scientific
development strategies sound incentive and restraint mechanism, efficient information disclosure
system. For this purpose the CBRC optimized rules and regulations for guiding supervisory board
of commercial banks, strengthened supervision on duty performance of Board of Directors and
special committees of banks, improved internal controls and independence of internal auditing
through on-site examination and off-site surveillance and supervisory meetings. For further
improvement of corporate governance, the CBRC in 2013 and 2014 enhanced the policy
framework by promulgation of Guidelines On Corporate Governance of Commercial Banks,
improved the functions of the board of supervisors and board of directors, improved on-site
examination via considering corporate governance as integral part in onsite-examination and
internal control reviews.

4.4.3. Internal Control

Ever since its establishment, the CBRC has made it clear that conducting consolidated and risk-
based supervision, strengthening internal controls of supervised institutions and enhancing
transparency are the cornerstones of its supervisory philosophy. In 2006, the risk-based regulatory
framework was further improved. The supervisory legal framework was refined with respect to
corporate governance, internal controls and compliance management. (CBRC2006)
In 2006, the CBRC, required all commercial banks to create an effective and robust internal
control system, with the foundation and implementation of intergraded policy, procedures and
schemes to asset and control/mitigate risk. In this respect the CBRC issued Guidelines on
Compliance management of Commercial banks which promote the risk management structure,
urged banks to strengthen the internal control through series means of on-site examination, off-site
surveillance and regulatory ratings on the internal control measures, continued efforts to intensify
AML. In 2007 the CBRC issued guidance on internal control of commercial banks, with clear
definition, objective and requirements for internal control system, urged commercial banks to
improve internal control system. In 2008, urged commercial banks to establish internal control

60
system and pushed forward the transformation to SBU-based banks. following to the enhancement
of internal control in 2009, the CBRC urged commercial banks to strengthen internal control and
required banks to improve infrastructure, management information system, enrich compliance
culture, besides, banks required to have a dynamic control mechanism covering risk monitoring,
measuring and mitigation should be established. For better control of internal control in 2010 the
CBRC issued risk alerts immediately upon risk finding during daily examination and off-site
surveillance, strengthened internal auditing through guidelines on internal auditing of banks which
set out the requirements on number of internal auditors as percentage of total bank headcount,
improved supervisory oversight of the competence of bank's internal control functions. All
commercial banks in 2012 urged to enhance internal control through conducting self examination
on loan classification and financial products underwriting. Through issuing guidelines on internal
control of commercial banks the CBRC, in 2014 improved policy framework to standardize internal
controls by issuing Guidelines on Internal Control of commercial banks (CBRC).

The CBRC in 2016 based on the development in internal control examination of banking sector
with reference to international best practice, revised and issued the guidelines on the internal audit
of commercial banks for better control of internal control. Besides, efforts was invested to promote
the long-term mechanism for compliance. (CBRC)

4.4.4. Credit Risk Supervision

Crucial challenges for banking institutions is credit risk and credit risk always been a headache for
financial institutions, sometimes this risk resulting crisis for banks and financial system at whole.
The CBRC started credit risk supervision with the examination of evaluation of quality of credit
assets, followed by unveiling accurate risk profile of assets, examining and evaluating banks' credit
management procedures, policies and activities, and proposing remedial action plan. In 2003 the
CBRC issued the Notice on Further Promoting and Improving the Loan Classification encouraged
banks and all banking institutions required to apply risk based loan classification method (five
category loan classification system), currently The CBRC is uses the system. In 2005 through
issuing Notice on Promoting Loan Classification in Rural Credit Cooperatives, required all
cooperatives financial institutions to apply five- category loan classification system. In 2006 the
CBRC through issuing Guidelines on the Credit asset Classification for Rural Cooperative
Financial Institutions required rural cooperative financial institutions to adopt five category loan
classification system namely, pass, special mention, substandard, doubtful, and loss. In 2007 the

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CBRC guide commercial banks to improve risk management system and policies on loan
classification improved the credit authorization system, promote supervision of credit risk on large
clients. In 2008 the CBRC, urged commercial banks to further prevent risks arising from cross
sector business among capital market and banking sector, penalized the rule-banking institutions
and identified illegal credit funding to the market, improved credit risk supervision in key
industries to urge commercial banks to optimize credit portfolio in compliance with
macroeconomic policies, required commercial banks to tighten relevant strict credit policies for
credit issuance. In 2009, the CBRC issued Provisional Rules Governing the management of fixed
asset loan and the Guidelines on Project Financing to guide banks in the area of loan management
practice. In 2010 made efforts to mitigate risk related to LGFPs which strengthened supervision of
bank's exposures to LGFPs. Besides, Introduced stringent requirement to strengthen supervision on
lending to the real estate markets, mitigate risks related to the economic restructuring, mitigate
concentration risk by issuing guidance, strengthened credit managements, and strengthened the
supervision on business cooperation between commercial banks and rust trust companies. In 2011
and 2012, for the enhancement of Credit risk supervision, the CBRC, made efforts on mitigation of
risk related to LGPFs, risk related to real estate loans, risk related to private financing,
concentration risk by incorporating bonds, loans, off-balance sheet risk, guarantee and loan
commitments. Therefore, the CBRC, attached great attention on supervision of off-balance sheet by
standardization of business cooperation between trust companies and banks, improve wealth
management supervision through regulation on the sale of wealth management and product
management business of commercial banks, also strengthened the credit management. Following to
the LGFP loan the CBRC in 2015 improved the comprehensive local government debt management
and preventing risk associated with LGFP loan. Also prevent the credit risk associated with the real
estate sector, promote the establishment of social credit system and signed the MOU on
collaborated supervision and jointly disciplinary action against dishonest enterprises with NDRC,
SAIC,SAT, CSRC for jointly disciplinary action against dishonest enterprises prevent, and lastly
controlled the risk of off-balance sheet business (CBRC)

4.4.5. Market Risk Supervision

Since the opening- up of the banking industry and reform of exchange and interest rate, commercial
banks in China faced to market risk. To improve the capacity and improve the tools of commercial
banks for management of market risk, the CBRC issued Guidelines on Commercial banks Market
Risk Management in 2004 and the manual for on-site examination on the market risk of

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commercial banks in 2005 and lastly in 2006 the CBRC issued the Notice on Further Strengthening
the Market Risk Management of Commercial Banks. In 2008 the CBRC, further improved
supervision of market risk through enhancing the market risk management mechanism. In 2009 to
further improve the market risk supervision the CBRC, issued guidelines on further strengthening
risk management of derivatives transaction between banks and corporate clients, Notice on risk
management of bond investment of commercial banks and notice. For the first time, in 2010 the
CBRC, conducted the first on-site examination on the interest rate risk management on commercial
banks and in 2011 banking institutions encouraged to enhance market risk management and policy,
improve applied analysis of market risk indicators, develop market risk tools and mechanism, and
elevate the professions of market risk management. For further improvement of market risk
prevention, in the year 2015 all banks were urged to develop market risk management and market
risk analysis framework, implement risk responsibilities.

4.4.6. Operational Risk Supervision

Operational risk highlighted since the inception of the CBRC. The CBRC include the information
technology as banking operational risks. By issuing the Guidelines on Administration of
Information System Risk Management of Banking Institutions, which has included the information
risk management and information security procedures in to the overall risk management of system
of commercial banks and required all commercial banks to add internal and external audit over IT
system. In 2008 the CBRC issued the Guidance on Regulatory Capital Measurement for
Commercial Bank's Operational risk which required banks to calculate capital for operational risk
through the New Capital Accord and took step to prevention and control of fraud. For this purpose
the CBRC create Bureau of Criminal Investigation or Bureau of Banking Securities to investigate,
prevention and control and security management of banking sector. In 2011, and 2012 the CBRC
paid great attention to operational risk supervision, with strengthened ex-ante mechanism on capital
regulation and internal control, made efforts to crack down frauds and crime in banking sector. in
this regard, reinforced the examination on operational risk of fiscal accounts and in banks and
inherent foreign banks, build up effective and sustainable work manual for resolution of banking
cases to handle fraud and crimes of banking institutions. For the purpose of operational risk
supervision, bank case prevention cracking down frauds and crimes, the CBRC in 2012, facilitate
the development of long- term mechanism for operational risk supervision, in light of capital rules
commercial banks urged to improve operational risk capital measurement approaches and create
innovative operational risk management tools. The CBRC, for further management of operational

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risk urged banks to enhance operational risk management and banking risk prevention, build up
long term compliance based on mechanism with legal persons of banking institutions bearing
responsibilities. For having powerful supervision on banking operation the CBRC, in 2015 has
targeted three respects; improved the prevention and control mechanism for operation risk of
banking institutions, urged banks to clarify responsibilities of the case owners, continued the high
-handed posture for case prevention and enhanced the investigation into critical cases (CBRC).

4.4.7. IT Risk Supervision

The CBRC in 2007 launched the information technology risk supervision. All commercial banks
required to implement information technology (IT) risk management system and promote internal
and external audit on information technology risk through adaption of Notice of the CBRC on
improving the risk management and service of internet banking business.

The CBRC in 2008 with improvement of IT regulation, promoted the IT risk supervision, the
CBRC issued the Notice of China Banking Regulatory Commission On implementing the
Provisional Rules Contingency Management of Key Information System in the Banking Sector to
include the IT risk in to risk management framework of banks. In 2009, the CBRC build
mechanism by requiring banks to have sound system and procedure for operational risk
management, define the responsibilities of the department. made efforts for fraud prevention and
control, build mechanism for IT risk supervision through guidelines. In 2010 officially issued the
guidelines governing the data of commercial banks , for further improvement of operational and
fraud risk supervision, improved management system of banks, established ex-ante supervision
mechanism(dedicated department) to handle the work of cracking down on banking frauds and
crimes , issued IT risk supervision to carry out the routine IT risk supervision. In 2012, set out the
IT risk supervision framework, developed the regulatory structure, and developed the IT
supervision team building through promulgation of supervisory guidelines on the IT outsourcing of
banking institutions. set up the Banking Information Technology Supervision Department(BITS) to
improve rules and standards and empower IT risk supervision for banking sector. In the area of IT
risk, the CBRC improved supervisory mechanism by standardization of internal procedures for the
IT supervisory ratings of commercial banks, promulgate the guidelines on the IT to standardize IT
outsourcing of banks.(CBRC)

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4.4.8. Liquidity Risk Supervision

In 2007 rise of asset price and frequent hike of reserved requirement ratio put banks at high
liquidity risk. Therefore, banking institutions posed challenges of liquidity management.
Considering the situation the CBRC informed banking institutions of potential liquidity risk on
timely basis and encouraged commercial banks to conduct regular stress tests on liquidity and asset
liquidity risk comprehensively. In 2008, volatility of the real estate market, capital market,
particularly monetary policy resulted in a rapid change of banking liquidity. Therefore, in 2008 the
CBRC, issued the guidelines on liquidity risk management of commercial banks. Commercial
banks required to strengthen liquidity risk management, for the purpose of potential liquidity risks
management. To response to the potential liquidity challenges of foreign banks the CBRC proposed
to develop contingency plan to prevail liquidity risks individual banks in timely effective way.
Hence, the CBR in 2009 required foreign banks to put in place sound contingency place for
liquidity risk. Meanwhile the CBRC guided commercial banks in reinforcing liquidity risk
management through guidelines on liquidity risk management. In 2011, for the purpose of
strengthening liquidity risk supervision, the CBRC issued two standards for liquidity regulation
( Liquidity Coverage Ratio) and (Net Stable Funding Ratio) into off-site surveillance, to introduce
the Basel latest supervisory standards on banking supervision. Besides that, for the purpose of
improving risk management of commercial banks the CBRC issued consultative paper of
Regulation on Liquidity Management of Commercial Banks. Also in 2013 it drafted the rules on
liquidity risk management of commercial banks which defined scope of implementation and
transitional arrangement, introduced the Basel III liquidity standards and solicited public opinions.
The CBRC in 2015 for reinforcement of liquidity risk supervision revised the rules on risk
management of commercial banks, adjust the loan to deposit ration form regulatory indicator to a
liquidity risk management indicator, developed the rules on information disclosure of liquidity
coverage ratio of commercial banks, improved the mechanism for liquidity support between banks,
organized liquidity risk stress testing, strengthened the stress testing and early warning for liquidity
risk. (CBRC)

4.4.9. Reputational Risk Supervision

In 2009, the CBRC following the promulgation of supervisory guidelines on reputational risk
management of commercial banks, required all commercial banks to embody reputational risk
management framework and developed methodology and approaches to deal with reputational risk.

65
To safeguard financial stability and protect customers interests all commercial banks required to
maintain risk management system that include reputational risk. In 2006, the CBRC issued
provisional guidelines on off-site surveillance, incorporated the supervisory requirement
approaches on reputational risk and made reputational risk as part of supervisory concentration. In
2010 continued efforts to explore the tools and approaches to strengthen the supervision of the
reputational risk management of banks, for this purpose the CBRC, highlighted the role of market
discipline in fostering the reputational risk management of banks, directed banks to underpin their
reputational risk management by improvement of corporate governance structure. And in 2011 the
CBRC paid great attention to reputational risk through urging banks to strengthen reputational risk
management with reinforced institutional arrangements, team building and personal training, build
case studies of the reputational risk management of the banking industry (CBRC).

4.4.10. Anti-illegal fund-raising

The CBRC as leading authority in the inter-agency taskforce to combat illegal fund raising,
endeavored and coordinated with the related state agencies in 2009. This endeavor resulted to
achieved sustainable development. Hence, the CBRC sat out sound coordination mechanism for
combating illegal activities and violation investigation, the CBRC promulgate regulation on illegal
fund raising. In 2010 the CBRC fulfilled its role as leading authority in the inter-agency taskforce
to combat illegal fund raising under the light of State Council. In this year the CBRC established
steering team to battle with illegal fund raising within local governments. The CBRC paid great
attention through inter-agency meetings in respect of prevention of illegal fund raising. For the
purpose of combat with illegal fund raising the CBRC in 2012 in contribution with the
Comprehensive Social Management Commission (CSMC) under the CPC central committee,
issued notice on conducting appraisal on comprehensive social management with respect to combat
illegal fund raising to resolve it effectively.

4.4.11. Credit Guarantee Supervision

Decision to set up inter-agency taskforce on credit guarantee activity announced by State Council
in Feb 2009, with promulgation of Notice on Further Clarifying the Supervision Responsibilities
Pertaining to Credit Guarantee Activities. Taskforce are composed of National Development and
Reform Commission (NDRC), Ministry of Industry and Information Technology (MIIT), the MOF,
MOFCOM, the PBC, the State Administration of Industry and Commerce (SAIC), the CBRC, and
the Legislative Affairs Office of the State Council. The CBRC appointed as the leading agency of

66
the taskforce. This agency took over the responsibility for drafting and issuing business
development polices and supervisory guidelines, coordination with related government agencies in
addressing business concerns, and to guide local states in the credit guarantee activities and lastly
resolution of associated risks. In Sept 2009 the CBRC, founded credit Guarantee supervision
department to take over the leading and coordinating the supervisory endeavors regarding to credit
guarantee activities. In 2010 and 2012 played an active and leading role in the inter agency
taskforce on the credit guarantee activities supervision. In the same year CBRC jointly with above
agencies issued a series of regulations aiming to signify the CBRC's resolve to step up its efforts in
provide guidelines coordination and training to ensure the compliance of credit guarantee
companies. (CBRC)

4.4.12. Country Risk Supervision

In 2010 and 2012 the CBRC issued the Supervisory Guidelines on the Management of Country
Risk of Banking Institutions in need of China's banking institutions to develop oversea business
activates. The guidelines specifies the responsibilities of the country risk management functions
within banking institutions, specifies requirement for country risk identification, measurement,
monitoring, control and provisioning requirement against country risk exposure. the guidelines sat
out the globally recommended principles with unique circumstances of the Chinese banking
activates. In 2011 the CBRC, required banking institutions to implement the guidelines on country
risk management banking institutions, created country risk management systems compatible with
their strategic objectives, complexity and risk exposure for their overseas business, and optimize
their country risk assessment, monitoring and mitigation mechanisms since then in 2015 all banks
required to incorporate country risk management in its comprehensive risk management framework
following the guidelines, strengthened the institutional development for country risk provisioning
and improve country risk management framework, improved information database for risk
associated with the parents banks of foreign banks, improved on-site examination on banks
(CBRC).

4.5. Institutional Supervision

For the purpose of institutional reform to monitor risk condition and to improve the overall risk
management and qualified financial services the CBRC in 2015 and 2016, paid great attention to
institutional reform and advert on institutional mechanism reform perfected the supervisory

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measures, continued monitoring of risk conditions in key areas and improved off-site surveillance
approaches, urged banks to strengthen the creation of long-term risk prevention and conduct
comprehensive and in-depth reform and control mechanism aiming to improve the overall risk
amendment and quality of financial services.

4.5.1. Policy Banks and PSBC

Since then the CBRC has started supervision and reform on Policy banks and postal saving bank of
China to find out their position and conduct comprehensive reform to enhance risk prevention and
control. The CBRC, urged China Development Bank to strengthen the reform spirit and leverage its
advantages of supporting national strategy, riding on credit support, following the market-based
operation, maintain small profit while covering cost to promote operational models of CDB as
development institution and setting reasonable business scope. The EXIM bank of China
encouraged to reinforce its functional position as policy bank, improve capital strength found the
standard corporate governance structure and decision making mechanism for playing active role in
promotion of sound growth, international trading and economic restructuring and lastly impalement
the strategy of going global. Also ADB required to target its policy functions, create constraint
mechanism based on capital adequacy ratio, improve outlet management, clarify the responsibility
and risk compensation mechanism, and rectify the staff operation violation to strengthen and
operation risk control. The PSBC also guided to introduce more strategic investors form both
domestic and oversea markets, laying a solid foundation for its transformation into modern
commercial banks. With the formulation of supervisory opinion on prudential operation and sound
development of PSBC, the PSBC required to accelerate the creation of modern commercial bank
mechanism enhance risk management and control, improve business operation, make long-term
plan to serve MSEs and agro related development and promote inclusive finance (CBRC).

4.5.2 Large Scale Commercial Banks

The CBRC promoted the reform and development on large commercial banks in three levels; firstly
the CBRC promoted the implementation of advanced measurement approaches to capital
management of large commercial banks to optimize the management process and explore to
incorporate advanced measurement approaches to their daily operation and management. Secondly,
improved the supervision for Systemically Important Financial Institutions (SIFIs), for this purpose
held supervisory meetings on ICBC,ABC and BOC and achieved deep understanding of large-scale
commercial banks oversea businesses and updated oversea regulatory landscape. The BCRC

68
established the cross border crisis management group. Thirdly, improving the capability for
comprehensive risk management. The CBRC formulated the overview of institutions for large-scale
commercial banks, improved the monthly and quarterly regulatory report as well as the quarterly
report on advanced measurement approaches AMA implementation of large-scale commercial
banks, thus enhancing data analysis and risk alert (CBRC).

4.5.3. Joint-stock Commercial banks

To promote the reform and supervision on joint-stock commercial banks, the CBRC improved the
regulatory framework and enhanced the risk prevention, promote the transformation and
development of joint-stock commercial banks, support financial innovation prudently. The CBRC
evaluated the compliance and risk of innovation business to urge lawful and complaint innovation,
support eligible joint-stock commercial banks to implement the international expansion strategy,
advanced the pilot phase of asset securitization of joint-stock commercial banks.

4.5.4. City Commercial Banks and Private Banks

Following the Institutional supervision and reform, the CBRC accelerate the restructuring of city
commercial and private banks, urged city commercial banks to enhance equity management,
information disclosure, corporate governance, and to supplement capital through various means of
capital and expanding equity, capital instrument issues, domestic and oversea listing in view of
deepening the differential development and improved risk prevention and disposal. The CBRC
impalement the Avant Gard Program and formulated differentiated supportive policies to
understand the distinctive and development needs and let them to play leading role. The CBRC
perfected the supervisory framework for private banks in view of safe and sound development,
encourage private banks to define their position in the segmented market, optimize their business
models and achieve dislocation competition with other commercial banks.(CBRC)

4.5.5. Small-Medium Sized Financial Institutions in Rural Areas

For the purpose of reform and development the CBRC strictly focused on the real economy to
promote the reform and restructuring of these institutions. The CBRC promoted the foundation of
rural commercial banks, conduct overall assessment of performance for 25 provincial association,
pushed forward the development of village or town ship banks, improved the supervisory quality

69
and efficiency in view of strengthening supervisory quality and guidance, supervisory meeting
mechanism to address risk issues in these institutions.

4.5.6. Foreign Banks and Trust Companies

In continuation to institutional reform the CBRC improved the efficacy of supervisory performance
in foreign banks. Foreign banks supervision department of CBRC implemented its responsibility of
regulatory for three foreign banks in area of establishing Tier I branches , also deepened the
cooperation on cross-border supervision of foreign banks, expand working level consultation
mechanism, established foreign banks supervisory information sharing mechanism, support foreign
banks differentiated positioning and distinctive development, urged foreign banks to set forth clear
development strategies and business plan and required foreign banks to learn good practice from
their parents banks promote the development of green industry.

The CBRC, also established classified management mechanism and guided trust companies to
develop supervisory rating to promote the implementation of trust companies fiduciary duty and
coordinating and strengthening of the development of trust companies. In second hand founded a
comprehensive supervisory evaluation mechanism, established trust business classification system,
off-site surveillance reporting system, risk supervision index system.

4.5.7. Other Non-Banking Financial Institutions

To promote the reform and institutional supervision, in non banking financial institutions, the
CBRC, promoted the reform and development of financial asset management companies to finalize
their plans for transformation and restructuring. Improved the policy environment to promote the
development of financial leasing, actively guided finance companies to stick their position as
centralized treasury centers of their groups, promote the development of consumer finance
companies and promote the sound development of auto finance companies and money brokers.

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71
 CHAPTER FIVE

The Coordination of Regulatory Efforts

The chapter mainly present the coordination of regulatory efforts focusing on Role of People's
Bank of China in respect to banking supervision, other regulators and quasi-regulators in China's
financial markets, interplay of monetary policy and banking regulation, coordination of macro and
micro prudential regulation and China's achievement in the area of supervisory coordination.

5.1. Evolvement of The Role of PBC In Respect to Banking Supervision

As I have briefly mentioned in first chapter of thesis, till 1978 Chinese banking system experienced
mono-banking system and was highly centrally planned system, unitary banking system dominated
by the PBC, and the PBC was only bank in the country, in charge of nearly all supervisory and
financial functions, including the formulation and implementation of monetary policy and foreign
exchange policy, foreign reserve management, deposit taking, commercial lending, and investment.
The PBC served as central bank as well as commercial bank in accordance with the central plan of
the Chinese government. This mono-banking system ended in 1979 through the opening up policy
in China when PBC stripped off its commercial operations and assigned to four specialized state
owned banks Barth, et al. (2013).

In 1982 PBC known as central bank and financial regulator under the control of the State Council,
this step was the milestone of building-up of central banking system. Continuously since the
promulgation of the Law and Law of the PRC on the commercial banks China experienced raped
significant development.

In 2003 the CBRC established. Creation of CBRC brought a halt to the to the dual roles of PBC
which was in charge of financial regulator and monetary policy and liquidity of the financial sector.
Since then standing committee of NPC in 2003 approved the Law of the People's Republic of China
on Banking Regulation and Supervision. The Law of the People's Republic of China on Banking
Supervision and Regulation stated the responsibility, functions and authorized the China Banking
Regulatory Commission to the rights of Regulation and supervision of overall banking financial
institutions Under its authority by the Law, CBRC took over the rights and responsibility of the
regulatory and supervisory of the PBC in overall banking financial institutions and their business

72
operations in People's Republic of China aiming at promoting the safeguard and soundness of the
banking industry, fostering and strengthening the china's banking sector to fulfill the financial need
and necessity of the china's rising economy and society, supporting the customers and protecting
the rights of customers and other financial institutions, besides this protective functions, the CBRC
also engaged to highlight reform and innovation and trying to enhance the quality of regulation and
supervision efficiency and effectiveness in banking sector. Over past 15 years the supervisory
responsibilities of PBC were shifted to CBRC and CSRC, since then CBRC became the main
regulator of the banking sector, and operated pursuant to an express statutory grant of the National
People’s Congress. Now the main task of PBC are formulation and implementation of monetary
policy, prevent and resolve financial risk, and safeguard financial stability. Besides these functions
PBC also maintains the banking payments, clearing, and settlement systems, takes responsibility
for anti-money laundering work and mange China's official foreign exchange and gold reserves in
cooperation with State Administration of Foreign Exchange (SAFE) for setting foreign exchange
policies (PBC).

The Law of the PBC asserted that the PBC functions under the leadership of the State Council and
implements monetary policy independently without interference of local governments, social
organizations and individual. Article 3 of the Law of the People's Republic of China on People's
Bank of China assumes that the objective of monetary policy is to maintain the stability of the
value of currency and thereby promote economic growth, to implement monetary policy the PBC
may engage in financial operations in accordance with the relevant provision of which is mentioned
in IV of the LAW (The Law).

5.2. The Watchdogs Structure of China's Financial Sector

Until 1978 Chinese banking system experienced mono banking system which was highly centrally
planned, unitary banking system dominated by the PBC. The PBC was in charge of both central
banking as well as commercial banking activities in accordance with the central plan of the Chinese
government. This centrally banking system ended in 1979 through the opening up policy in China
when PBC stripped off its commercial operations and assigned to four specialized state owned
banks Barth, et al. (2013).

These Four specialized state-owned banking institutions took over the commercial banking
functions in particular designed area which was provided by the PBC before. The central

73
government designed PBC as central bank of People's Republic of China and responsible for the
regulation and supervision of banking sector. To improve commercialization of the banking system
and more modernized financial system in 1980 government allowed four specialized banks to
expanded their commercial operations which they were specialized, lastly, in 1995 the National
People's Congress passed the law of PRC on commercial banking, due to that big four State owned
specialized banks (SOSBs) renamed to wholly state owned commercial banks (SOCBs)to widen
their operation. Jiang& Yao (2017).

The Law enable the four big banks to function purely and separate the commercial operation of
banks, securities, forms and insurance companies. Parallel to this restructuring, other new
commercial banks and non-bank financial intuitions were created such as joint stock commercial
banks and urban commercial banks within their realm. In 1994, the Chinese government
established three policy banks namely; Agriculture Development Bank of China, China
Development Bank, the Import-Export Bank of China to take over the policy lending activities
engagements from wholly state-owned banks. This segregation of business operations of banks
subsequently resulted to the creation of three separate particular regulatory agencies to oversee
each industry Barth, et al. (2013).

Figure.5.1 illustrate the regulatory Structure of China's financial industry.

Sour
ce: Milken Institute

74
Regarding to above chart, China's financial sector extensively regulated and supervise by broadly
types of regulators and quasi-regulator. Banking sector is mainly full scale regulated by China
Banking Regulatory Commission (CBRC) till to 2018 to oversee the banking industry.

According to the China Banking Regulatory Commission there are four domestic financial
regulators including; The Peoples Bank of China, Chin Insurance Regulatory Commission, China
Security Regulatory Commission, State Administration of Foreign Exchange, The ministry of
Finance.

China Securities Regulatory Commission(CSRC) created in 1992 to oversee the China's Capital
Market. The CSRC, is the responsible for the regulation and supervision of the securities and future
markets, and it is the supervisory body of China's capital market which set the rules for markets,
regulate the behavior of stock exchange, listed companies, securities house, futures companies,
funds, brokers and settlement institutions; overseeing the insurance trading, custody and settlement
of various instruments on the market; supervising information disclosure related to the capital
market; and investigating and penalizing activities that violating the securities and future laws and
regulations and it's also in charge of supervisory of security market.(CSRC)

China Insurance Regulatory Commission(CIRC) was created in 1998 to administer, supervise,

regulate oversee China's insurance industry. Insurance companies and their branches, insurance
groups, and insurance asset management companies and insurance intermediaries. The CIRC is also
responsible for market admission, management qualification and setting of industry standards for
the insurance market China's Banking regulatory Commission(CBRC) and People's Bank of
China(PBC) are high level authorities which are responsible and highly engaged with the regulating
and supervision of banking industries and have important role in stability of banking financial
sector, this two authorities currently has specific and separate responsibility and important role in
stability of china's financial sector.(CIRC)

The China Banking and Insurance Regulatory Commission (CBIRC) replaced CBRC in early
2018. The CBIRC is the supervising agency for the banking and insurance institutions intends to
improve the efficiency and coordination of Chinese financial regulation, as well as better deal with
the increasingly "integrated" nature of China's financial sector the overlap between banking and
insurance operations, accelerate the implementation of insurance and banking industry's opening to
outside world''. Since creation the CBIRC is primarily responsible for supervising the establishment
and ongoing activities of banking and insurance institutions, taking enforcement actions against

75
regulatory violations. However some responsibilities of CBRC and CIRC regarding rules and
regulations and prudential supervision entrusted to the PBC.

5.3. The Interplay of Monetary Policy and Banking Regulation

Since 1984 with the promulgation of the PBC Law, the PBC under the leadership of State Council
took over its status and mandates, to formulate and implement monetary policies, guard against and
eliminate financial risk and maintain financial stability. The 2008 financial crisis declined the trade
and surplus of capital and posed liquidity problems in China's financial system. Slowing down of
economic growth and facing the changing external environment in China, the monetary policy
framework has improved. In first hand, new monetary instruments incorporated in the framework
since 2013, such as short term liquidity operations, pledged supplementary lending, the standing
lending facility and the medium lending facility, complementing the current tools in actively
providing and managing liquidity and guiding market interest rate of PBC. In second hand the
PBC incepted to reinforce the macro-prudential management by introduction of dynamic adjusted
differential deposit reserve system into the instrument toolkit. Lastly, the PBC made efforts to put
forward interest rate liberalization and RMB exchange rate regime aiming to improve effectiveness
of monetary policy transmission. The monetary instruments of the PBC composed of Open Market
Operations (OMOs), deposit Reserve Requirement Ratio(RRR), interest rate, central bank lending
and rediscount and lastly window guidance. (PBC& CBRC)

5.3.1. Required Reserve Ratio (RRR)

Required reserve signify to deposit of financial institutions at the central bank in proportion to total
deposits. It is the powerful instrument of monetary policy of the central banks, because if the
central banks change the policy and decide to increase the required reserve ration on that time
financial institution have to increase their deposit in the central bank. Parallel to that decrease the
lending. These deposit reserve of financial institutions is composed of excess reserve and required
reserve and function as payment, settlement and liquidity adjustment. Excess reserve is the deposit
of financial institutions in central bank in excess of required reserve which mainly usable for the
purpose of settlement and liquidity management or stand by assets. The PBC pay high interest on
both types of required reserve and deposit reserve. Since the establishment of PBC the RRR
adjusted and intensively deployed as regular policy through the reform on reserve requirement
system by incorporating accounts for required reserves and excess reserve while also adopting by

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uniform interest rate , for instance in 1998 RRR was 8% it changed to 17.5% in 2008. The PBC in
2004 introduced the differentiated reserve requirement rate system, which linked the indicators
such as asset quality or capital adequacy ratio with required reserve.

According to the differentiated RRR system the required reserve ratio differ in financial
institutions. For financial institutions with Lower capital adequacy ratio required reserve ratio is
lower, for financial institution with higher capital adequacy ratio, required reserve ratio is higher.
The banks in the category that did not meet certain standards in terms of the loan quality and capital
adequacy were subject to a reserve requirement of 8%, half a percentage point higher than the
standard required reserve ratio. In 2008 the PBC adopted the formal two tier reserve requirement
system and in 2010 introduced the pilot scheme of dynamic differentiated RRR on continues case
by case basis and guide banks to operate prudently and to pace credit supply from a counter
cyclical perspective by subjecting credit growth to the capital level in a macro-prudential sense
and by taking into consideration the systemic importance and soundness of the financial institutions
as well as the business cycles (PBC).

5.3.2. Capital Adequacy Ratio (CAR)

In 2006, the CBRC ,strengthened the capital resource in banking institutions and improved their
capital structure and monitored the risk assets and all banks meet the CAR regulatory requirement
of 8%. In continuation to the reform in the long run in 2013 rules for the Capital Adequacy Ratio
of Commercial banks abolished and capital rules of commercial banks was implemented to drive
commercial banks to improve their capacity of risk management and capital planning and expand
resources for capital replenishment, and enhance capability of robust operation of commercial
banks. In 2015 following the implementation of the Capital rules of commercial banks, capital
regulation further improved, pushed commercial banks to improve capital planning capability and
risk management, expand capital replenishment channels and boos stable and sound banking
operation in China. Since then banks made efforts to improve their risk management and capital
management capabilities. Following the capital rule, the CBRC conducted comprehensive
investigation and assessment in banking institutions in respect of implementation of the capital
rules and achieved outstanding progress. Table 5.1 shows annualized CAR requirements from
2013-2018.

According to the CBRC by the end of 2016 Capital Adequacy Ratio (CAR) of commercial banks
reported at 13.3, Common equity Tier1(CET-1) CAR,10.8% and core Tier 1 CAR reported 11.2%

77
and net capital stood RMB14.7 trillion, Risk weighted assets RMB 101.2 trillion, market risk
weighted assets RMB 1.2 trillion and operational risk RMB 8.4 trillion, according to the CBRC
latest annual report (CBRC).

Table.5.1 Annualized CAR requirement from 2013- 2018

Sour
ce: CBRC Annual report 2016

5.3.3. Liquidity Ratio

Liquidity measures the power of banks and liquidity risk always been a big problem for financial
institutions, liquidity risk is the crucial risk for financial institutions and pose financial institutions
to the verge of collapse and in general it result to the financial crisis domestically and globally. The
CBRC as member of Basel Committee on Banking Supervision(BCBS) actively cooperated to
improve liquidity management in financial institutions and develop liquidity risk supervision to
ensure the liquidity management of China's financial institutions. For the first time the CBRC in
2009 issued its guidelines on liquidity risk management of commercial banks, to strengthen
liquidity risk management, set specific requirement on banks liquidity management and urged
banks to hold more asset to overcome the liquidity risk. To ensure the capability of liquidity in
China's financial sector the CBRC started the monitoring and inspections of liquidity risk in
banking industry by imposing regulatory requirement, required banks to implement the stress
testing and take preemptive measures, required foreign banks to prepare contingency plan for
liquidity risks. The CBRC since 2006 conducted onsite examination and off-site surveillance in
view to assess the potential liquidity risk of financial institutions including domestic funded banks
and foreign funded banks. Table 5.2 illustrated the liquidity ratio of China's financial institutions,

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in 2016 liquidity ratio is 49.1, it has decreased comparing to 2015 by 0.2%. The excess reserve
ratio of banking institutions is 2.7 and excess ratio of commercial banks is 2.3% which increase up
by 0.23% comparing to 2015.

Table 5.2 Liquidity Ratio of China's financial institutions form 2013-2016

Source: CBRC annual report 2016.

5.4. Micro Prudential and Macro-Prudential Regulation

Micro- and Macro prudential regulation are two key phrases that now have gained acceptability
among supervisors and regulators over the world following the global financial crisis. The
significance and need to reinforce prudential regulation of the banking system have been arisen
aftermath of recent global financial crisis. In the current global financial system, prudential
regulations have been an essential option under consideration. The importance of macro prudential
regulation tools has been increasingly recognized as it is realized that convention key policy
interest rate manipulation is too blunt in ad instrument. Currently, financial regulations and banks
supervision are basically micro-prudential in nature, they pay great attention to limit the risk of
institutions Ekpu (2016).

The prudential regulations focus on risk of financial institutions in view to limit the risk-taking
behavior of financial institutions and guard against financial crisis. Macro and micro prudential
perspective vary in terms of objective and understanding on the nature of risk and the most key
objective of both macro and micro- prudential policy or regulation is mitigation of risk in financial
system. Bothe macro and micro prudential policies generally complement and assist each other in
order or achieve their respective goals and objectives.

The prudential policy or tools which are applied on individual financial institutions are macro-
prudential, while policy or instruments which are applied to entire financial system are macro
prudential. Micro prudential regulations focus on the safety and soundness or welfare of individual

79
financial system and protect key stakeholders in the financial system, including investors
depositors, and financial consumers, while the Macro prudential regulation seek to enhance the
safety and soundness of entire financial system it aims to counter and relive systemic financial risks
in overall and countercyclical context. The macro prudential regulations ensure safety and
soundless of the overall banking institutions. Success of or failure of Macro prudential policy is
depends on micro prudential policy to a great context. Meanwhile both of Macro and micro
prudential policies depend on liquidity and capital tools that are deployed on the level of individual
institutions.

Central banks play a critical role in macro prudential regulation, even though macro prudential
framework differ between countries. The PBC as the central bank of the country plays a key and
critical role in macro prudential regulation in the country. The PBC currently lead the China's Joint
Conference on Financial Regulatory and Coordination with membership of CBRC, CSRC, CIRC
SAFE which is the main channel for financial research that reinforce the coordination of financial
regulation policy, instruments and implementation across the markets to help improve financial
stability and facilitate systemic financial risks. After the recent financial crisis the CBRC, has
started the innovation of macro prudential tools and strengthened macro prudential measures in
2009. For the purpose of strengthening of macro prudential regulation, in 2011, introduced the
dynamic provisioning system aiming to link commercial banks credit supply with their capital,
systemic importance and the stage of macroeconomic cycle. The PBC in recent year has
implemented a set of macro prudential regulation, improved its dynamic provisioning system and
lastly, in 2015 further developed it to a more general macro prudential assessment system (MPA),
including indicators for capital and leverage, liquidity, pricing, asset quality, asset and debt, risk of
cross-border financing and the implementation of credit policy. (BIS)

Since 2015, The PCB has further reinforced macro prudential management of cross-border capital
flows, through introducing measures such as provision for the forward sale of foreign exchange,
imposed deposit reserve for offshore RMB deposit onshore, increased commission charges for
speculative RMB trades. lastly, in May 2016, extended the scope of macro prudential management
for cross-border financing to all financial institutions and companies inside the country and also the
PBC in 2016 created the loan to value ratio on residential property loan. (BIS)

On the other hand, macro prudential policy interacts closely with monetary policy, micro prudential
policy and fiscal policy, and is coordinated with them. On the other hand, these policies focus on
different areas. Both macro prudential policy and monetary policy are based on macro and

80
countercyclical adjustments. Macroeconomic policy is closely connected with microeconomic
policy in its tools and target, which is to prevent risks, but policy features obviously differ. As a
result, information-sharing is necessary in the process of policy implementation. Micro prudential
policy aims to regulate a single institution with a view to ensuring stability, compliance and
transparency, while macro prudential policy usually opts for countercyclical measures based on the
analysis of macroeconomic situation by smoothing the pro cyclical fluctuations of financial system
and preventing risk contagion across markets. (BIS)

After the global financial crisis the rise of macro-prudential regulation has obscured the boundary
line of CBRC and PBC. Via incorporation of regulatory measures, macro prudential regulation
ensures the stability of the entire financial system in the country. The CBRC and PBC as regulatory
authorities under the leadership of State Council apparently committed to macro prudential
regulation, its stated in the Law, the PBC is in charge of financial market stability. As capital
control is important part of macro prudential regulation thus dealing with that PBC is responsible to
serest the capital control measures. However those measures are within the realm of the CBRC as
macro prudential regulator. Since the PBC regulate the financial sector, its believed that it would be
better for CBRC to take over the macro prudential regulation. The PBC has made efforts to place
macro prudential regulation under the PBC approaches and all branches has implemented on-site
surveillance and carried out macro prudential regulation in this respect. As it can be found that
CBRC has important role in macro prudential regulation and has long involvement in systemic risk
supervision. (CBRC)

To build an affective macro-prudential regulation the CBRC in 2008 urged banks to implement
Macro-economic control policy or prudential supervisory policy. Against this challenges the CBRC
paid attention on prudential risk management requirement and improve policy instruction and
guidance in view to improve commercial banks credit portfolio in line with national industrial
policy to have stable and rapid economic growth. For this purpose the CBRC issued a package of
tool to help banking sector development and overall economic growth, developed the early warning
system and risk monitoring aiming to maintain stable banking industry. Following to this efforts in
2009 the CBRC issued a package of polices to promote sustained economic development used
supervisory tools to mitigate risk in banking financial institutions through introduction of counter-
cyclical capital buffer, introduction of leverage ratio, improvement of liquidity supervision
maintained vigilant against systemic risk. (CBRC)

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The CBRC has made efforts to improve macro prudential supervisory practice such as counter
cyclical economic measures. The CBRC in 2009 required commercial banks to increase their
counter-cyclical capital buffer. For the enforcement of this requirement the CBRC issued a package
of polices to promote sustained economic development and used supervisory tools to mitigate risk
in banking financial institutions through introduction of counter-cyclical capital buffer, introduction
of leverage ratio, improvement of liquidity supervision maintained vigilant against systemic risk.
Small and medium banks required to maintain their capital adequacy ratio higher than 10 percent,
systematically banks required to maintain set above 11 percent. Parallel to this policy macro
prudential stress tests are implemented by banking institution. For implementation of this policy the
CBRC issued guidance on commercial banks stress test in 2007, through the guidance, urged
commercial banks to conduct stress test in view of evaluation of the exposure of banking system to
the real estate market. Since implementation of Macro-prudential supervision the CBRC provide
strong support on economic development in China. (CBRC)

5.5. Supervisory Coordination and Cooperation

The legal and regulatory framework have enabled the CBRC to set up a sound framework for
cooperation and collaboration with domestic agencies and international supervisors. Coordination
is a way or a means, through that related organizations or authorities shares the respective activities
of each others for the purpose of minimizing the dissonance and effect the same regulatory objects.
Among related organizations coordination is an accepted process. The Law of the PBC required the
State Council to establish a financial regulatory coordination system and implementation of
relevant rules for its operation. Meanwhile, Law of the PRC on banking regulation and supervision
and Law of PBC, the CBRC and PBC and other financial regulators are required to establish
sharing regulatory information system. A sound regulatory information sharing system ensure a
basis for more complex coordination between the two regulators, but does not itself lead to
coordination in relation to regulation. In 2008 a political endeavor was made to address the
regulatory dissonance. The State Council obliged PBC to create coordination mechanism and
establish joint committee with other regulatory authorities such as CBRC with respect to regulatory
rules Wei (2012).

Since the establishment the CBRC paid great attention to regulatory cooperation, in this respect the
CBRC has active and close communication with other foreign counterparts to utilize from
international standards and coordinate its supervisory efforts. The CBRC improved coordination

82
with domestic financial supervisory authorities and macro-economic regulators. Cooperation with
other oversea financial regulators is critical for effective banking supervision. In this respect the
CBRC actively worked with CSRC and CIRC on the establishment of a tripartite coordination and
cooperation mechanism through signing MOU on functional division and cooperation of the
CBRC, the CSRC, and the CIRC in the field of financial supervision. In 2008 the CBRC, further
improved regulator cooperation domestically and with international overseas financial authorities.
(CBRC)

5.5.1. Domestic Regulatory Cooperation

In domestic regulatory coordination the CBRC intensified coordination within the CBRC through
supervisory meeting, seminars and so on, strengthened the coordination with domestic agencies on
macroeconomic policies, the CBRC promote the cross-sector coordination mechanism between
financial regulators and improve the information exchange and sharing. The CBRC signed the
MOU on Deeping bank Insurance Cooperation and cross sector supervisory cooperation with
CIRC, IT with PBC, Guidance of CBRC and CSRC on Contingency Plan for the Information
System across banking and securities industries. In 2009, expanded policy coordination with other
institutions such as PBC, MPS, SAIC. For this purposes issued a joint notice on strengthening the
Security of Bank Cards and Combating Bank Card-Related Crime. Secondly, improved supervisory
cooperation through cross-border supervisory cooperation and information exchange between
financial regulatory authorities for the execution of this the CBRC and CIRC issued the joint rules
on Pilot Equity Investment by commercial banks in insurance companies aiming to supervise the
equity investment activities in question. For further regulation of business operations of financial
institutions and improvement of quality of service delivery the CBRC in 2011 jointly issued the
relevant documents with NDRC, MOF, MOC, PBC,CSRC, CIRC and National Audit Office
(NAO). Jointly with CIRC issued the guidelines for supervision of the Bancassurance business of
commercial banks aiming to maintain the order of Bancassurance market. In Cooperation with
CSRC conducted examination on the safety of information system for cross sector business and on-
site examinations of fund selling activities in view to further improvement of supervisory
cooperation. In 2016, the CBRC further enhanced the cooperation and information sharing with
domestic regulatory authorities and local governments such as PBC, MOF on supervisory of global
systemically important banks(G_SIBS) and joined Crisis Management Groups for China's G-SIBs,
created information sharing system with CSRC on regulation of trust companies, jointly issued

83
relevant instruments with NDRC, MOST, the MIT and the MPS and PBC to guard financial risks in
the key areas and capability of financial sector in serving the real economy.(CBRC)

5.5.2. Cross-Border supervisory Cooperation

In cross-border supervisory cooperation the CBRC signed bilateral MOU agreement on supervisory
cooperation other countries and regions. The CBRC, held the bilateral and multilateral regulatory
meetings on regular bases such as Sino- US Banking supervisory Bilateral Conference. The CBRC
maintained the relation with regional and international regulatory activities such as World Bank,
IMF, BCBS, EMEAP, SEANAZ, and engaged in the group of G20 leaders meetings for the
purpose of strengthening international cooperation, integrity in financial markets, and reforming
international banking institutions. In 2009 and 2010 the CBRC, promote bilateral supervisory
cooperation by signing MOU on Cross-strait Banking Supervisory and Regulatory Cooperation
with financial supervisory authorities in 36 countries. In 2011 and 2012, the CBRC further
improved the cross-border supervisory coordination through, signing agreements with international
supervisory authorities from 48 countries, holed bilateral consultation and meetings with
international banking supervisory agencies, hold meeting on International Advisory Council (IAC)
meetings and supervisory college, cooperate with supervisory authorities to carry our cross border
on-site examinations and off-site surveillance on locally incorporated foreign funded banks in
China, participation in international financial reforms.

In 2014 cross-border supervisory cooperation further improved by signing bilateral supervisory

cooperation with African, Asian, Arabic and European supervisory authorities, of 60 countries. The
CBRC further enhanced supervisory consultations and set out a cross department work group to
held discussion with supervisory authorities of international counter parts and implement the result
of high level dialogues. Coordinate with the host regulatory authorities for overseas Chinese banks
through signing agreement on division of supervision with foreign counterparts, communication
and coordination with regulatory authorities in home jurisdictions of foreign banks in China,
actively participate in the international financial reform as member of Financial Stability Board
(FSB) and member of Basil Committee on Banking Supervision (BCBS). In 2015 China further
improved the cross border supervisory cooperation and exchanges through, signing MOU on cross
border bilateral supervisory cooperation with international supervisory counter parts in 63
countries, further improved supervisory consultation with supervisory authorities of respective
countries, actively participated in multilateral and regional cooperation mechanism including

84
World Bank, IMF, and G20 countries, coordination with regulatory countries where Chinese banks
has been operating, communication and coordination with home supervisory of foreign banks
operation in China, and actively participation in international financial reform. The CBRC in 2016
further improved the cooperation and exchange with foreign regulatory authorities; improved
bilateral cooperation with foreign regulatory authorities by singeing MOU with more than 67
countries, participate in cross border regulatory talks and meetings in multi-lateral and regional
cooperation mechanism with IMF, World Bank, G20, countries, UN, OECD, APEC. Further
developed the collaboration with the host regulatory authorities for foreign offices of Chinese
banks by organizing cross border crisis management group meeting for four G-SIBs including
ICBC, ABC, BOC, CCB, the CBRC facilitated eligible Chinese banks to go globally and open
offices in certain foreign counties and address the needs for cross-border operation in respective
countries. the CBRC also further enhanced the communication and cooperation through working
meetings with home financial regulators of foreign banks in China, actively participated in various
plenary meetings, working groups, research projects in international financial regulatory reforms
and refined the prudential regulatory reform for Banking sector in China.(CBRC)

5.6. The CBRC's Regulatory Efforts Achievement

In this section we are going to point out what has CBRC done in the area of supervision and
regulatory developments. The CBRC since 2003 has considerable achievements in the area of
further deepening of reform, steady opening-up of the market, encouraging financial innovation,
contribution to economic and social developments.

Further deepening of reform; Since the inception the CBRC has adverted on major reforms in the
large commercial banks and small-medium sized rural cooperatives, which simultaneously lead and
promote structural changes in the management and operation of the banking system. Now
commercial banks are trying to improve their overall competitiveness and streamline corporate
governance structure. In the area of non-bank financial institutions new breakthroughs have been
achieved in their reform particularly progress in their corporate governance.

Steady opening-up of the market; since the opening up of China's banking sector has played a key
and positive role in development of the national economy and driving of reform. the CBRC during
the opening up process implemented the four principle of national sovereign interest, win-win
benefits, controllable risks and cooperative competition, giving priority to the nation's economic

85
and financial safety and interest of financial consumers aiming to promote reforms and
development though opening up. Especially China's accession to the WTO in 2001, banking
industry in China has witnessed high level of foreign in a wide range of areas, number of foreign
financial institutions increased, improved performing results driven by foreign capital and capital
diverse offerings of financial products and services.

Encouraging financial innovation; in past fifteen years the capacity of banks in financial innovation
and risk management systems has upgraded and increased dramatically. Under the leadership and
guidance of the CBRC Chinese banks have improved their financial innovation and made
comprehensive development in the incentive mechanism and corporate risk culture for financial
innovation. to enable the banks and customers to conduct hedging, new innovative products have
been introduced.

Contribution to economic and social development; the CBRC in past fifteen years has played active
role in supporting the economic and social developments and has improved the services mechanism
and capacity to allocate financial service. In the past years the progress was made in expanding the
banking system in view of covering the households and under-banked areas, capacity of the
banking sector. Majority of banking institutions engaged in the practice of cross-sector operations,
establishing pension and fund management subsidiaries, exploring the ways to enhance cooperation
between banking and insurance, and annuity management business with corporate customers. The
banking sector has developed to meet the demand of corporate and individual customers and banks
have made efforts to adhere to the national macro-economic measures to achieve stable financial
development. By reviewing the credit stance, avoiding credit flowing to asset market and tightening
credit to heavy polluting energy consuming and excess capacity industries, banking institutions
have been responded to the macroeconomic adjustment policies. The CBRC through guidelines on
green lending , guided banks to manage their risk in the lights of government initiatives (CBRC).

86
 CHAPTER SIX: CONCLUSION

Over the past decades, China's financial system has rapidly grown, from being underdeveloped and
agriculture-oriented country and internal political conflict, into highly developed second largest
economy in the world. Since economic reforms, China's financial system has developed
considerable and economic growth rate remains high relative to other countries. Banking sector in
China has grown rapidly over the past decades in a association with the expansion of the economy.
Currently banking sector in China includes the world largest banks. According to the Moody's
Investment Services latest report, China's banks dominated the world top five banks by asset size.
Over past decades Chinese banks have become more commercially oriented and the government
retain considerable interference and influence over their activities. The stability of the banking
sector and financial sector is the primary objective of the Chinese government for sustainable
economic development, control of the government is dominant, and banking regulation is a
disclosure of its aims economic and social stability and development. Ultimately, a sound and
developed regulatory framework result to effective supervision and effective supervision and
regulation of financial sector potentially increase the credibility of financial system and protect
investors and credit business and ensure the stability of financial system and global economy as
whole.

China's regulatory structure, developed since the inception of the CBRC and relegation of
supervisory responsibilities to the CBRC. Since the creation of the CBRC as principle supervisory
and regulatory body within the banking sector under the leadership of State Council China's
banking regulations has developed rapidly with a view to create specialized regulatory
environment. Creation of CBRC and separating monetary policy and regulatory supervision, China
stepped up forward toward a strong and regulatory framework. As we found during the research,
China uses two approaches to control over the banking sector. Firstly, through the regulatory
agencies such as PBC and CBRC and lastly CBIRC. Second approaches is using technique of state
ownership which is more direct. This approaches has assisted China to manage economic in sound
manner, sustain economic growth, transform backward Chinese banks to developed and modern

87
banks which has led Chinese banks more profitable and to the world second largest successful
economy.

The CBRC's rules and regulations has developed yearly such as development of corporate
governance and internal control, risk control, innovation and banking regime has developed with
international standards regarding systematic and prudential regulations which has resulted the most
powerful and profitable banking system in terms of earning. The legal regulatory framework set
clear responsibilities and objectives for banking supervision in China these legal mandates and
responsibilities have enabled the CBRC to conduct supervision in effective manner.
Comprehensive set of rules and regulation have led the CBRC to operate its mandates properly,
while strong enforcement powers further support the effective supervisory actions. The CBRC
through both on-site examination and off-site surveillance focused on the effectiveness of corporate
governance of banks. developed the risk management system, set up a comprehensive and
proportionate approaches to its capital regime, by adopting Basel III for banks operation and
prudential framework, developed stress testing system.

The CBRC, through its regulatory approaches including on-site examination, off-site surveillance,
authorization and market exit which is called regulatory cycle conduct risk-based supervision on
individual banks year to year. Banking regulation is a means for central government which lead the
economy to the designed goals and power of government to control the economy is exercised
partly via regulators. Banking regulation can be identified with grasping the interest between the
Chinese banks and Chinese government which is used to serve the interest of the government.
Banks Primarily driven via government's interest.

The PBC plays a crucial role in the China's macro-prudential regulation, and has put in places set
of macro-prudential tools and developed its macro-prudential assessment system. The PBC through
Macro-prudential policy which is closely interacts with monetary policy, fiscal policy and micro-
prudential policy prevent the accumulation of risks in financial sector and strengthening the
financial system resilience.

The legal regulatory framework have enabled the CBRC to set up a sound framework for
cooperation and collaboration with domestic and international supervisory agencies. Since the
establishment, the CBRC paid great attention to regulatory cooperation, in this respect has active
and close communication with other foreign counterparts to utilize from international standards and
coordinate its supervisory efforts. The CBRC improved coordination with domestic financial

88
supervisory authorities and macro-economic regulators. Cooperation with other oversea financial
regulators is critical for effective banking supervision. In this respect the CBRC actively worked
with CSRC and CIRC on the establishment of a tripartite coordination and cooperation mechanism
through signing MOU on functional division and cooperation of the CBRC, the CSRC, and the
CIRC in the field of financial supervision. Since 2008 the CBRC, further improved regulator
cooperation domestically and international overseas financial authorities.

China's Financial Regulatory Challenges: Regulatory Vacuum and overlap

The sustainability, effectiveness and development of an economy particularly monetary policy is

depend on a sound and healthy banking system and sound and smoothly functioning banking
system can be addressed in having a powerful supervisory system which is cornerstone and
fundamental issues of any financial system. Therefore, with rapid development of cross market
financial activities since 2001 the China's current regulatory system has become problematic.
Regulatory inconsistency across sectors has lead to a supervision vacuum, in other hand lack of
effective supervision in those sectors has posed big risk to the economy as a considerable fraction
of credit provision arises from these shadow banking channels. There are some complexities where
transactions, financial products and other activities subject to regulations of more regulators, led to
potential conflicts and problems in compliance, a prime example is bond markets. There are five
types of issuance regulators for various types of borrowers. Rise of these conflicts among
regulators are unavoidable and regulatory judgment is rampant. The segment regulatory structure of
the bond market has been associated with many abnormalities in market. These regulatory vacuum
and overlap in long run will lead to regulatory arbitrage activities and potential threats for financial
stability of China's financial sector.

All these challenges posed all financial regulatory agencies. As prominent example is overlap
between China Insurance Regulatory commission and China Banking Regulatory Commission
which both of these agencies have corresponding authority. In view to resolve this overlapping
functions and for ceasing regulatory arbitrage, ensuring better regulatory coordination,
modernization of regulatory landscape, and resolving existing problem and complexities Chinese
government has taken positive step towards modernization of regulatory system to safeguard
against financial risk via ensuring better regulatory coordination among government agencies by
replacement of CBIRC to CBRC to bring ongoing and business activities of both banking and
insurance sector under one ceiling.

89
As is often said in other parts of the world, "when the United states sneezes, the world catches
cold". As a final word I can argue that soon China will surpass United states as the world prime
largest economy and the financial capital of the world. Soon will say "When China Sneeze, the
world catches cold".

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Annex I

List of Figures:
Fig.1.1 the structure of Chinese banking system.
Fig 3.1 Overview of China's Financial System
Fig.3.2 Total assets and Liabilities of banking Institutions (2003- 2016)
Figure.3.3 Market share(by asset) of banking institutions (2003-2016)
Fig. 3.5 worlds top five banks by asset size
Figure: 3.6 Regulatory structure China's financial system
Figure 3.7 Comparison of the performance of major stock exchange around the world

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Figure.3.8 Interbank call loan market from 2013 to march 2018
Figure 3.9 Total amount of bonds outstanding in the primary market.
Fig. 4.1. Banking Supervisory Information System(BSIS)

List of Tables

Figure.5.1 Regulatory Structure of China's financial industry.

Table.5.1 CAR requirement from 2013- 2018
Table 5.2 Liquidity Ratio of China's financial institutions form 2013-2016

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