PBoC looks to the future

New law offers template for 21st century central banking

On 23 October, the People’s Bank of China presented several amendments to its governing law. Though the proposal introduced various changes, it also featured one important constant.

Like its predecessor, Chapter 5 of the latest law details the PBoC’s supervisory responsibilities. Chapter 6 is a new section on the supervisory tools at its disposal.

The central bank’s financial stability responsibilities remain unchanged. However, the proposal introduces ‘macro-prudential management’, as well as terms that have become familiar since the 2008 financial crisis, such as ‘stress test’ and ‘counter-cyclical buffer’.

In truth, over the past few years the PBoC has been conducting stress tests as part of its annual financial stability review, and formally introduced a counter-cyclical buffer this year. These instruments are seen as a necessary part of any central bank’s toolkit, but the PBoC felt the need to formalise its legal authority over these practices.

Despite tension between China and many G7 countries, on a central banking level, co-operation and exchanges remain vibrant. In its statement on the amendments, the PBoC openly cited the 2010 Dodd Frank Act in the US and the 2012 Financial Services Act in the UK as setting ‘the trend in international financial regulation’ and highlighted the role of the central bank in preserving financial stability.

Undoubtedly, Chapters 5 and 6 are where the PBoC has concentrated most of its efforts. Its supervisory powers have expanded exponentially, but only because the scale and scope of China’s banking and financial services industry have done the same.

For example, articles 42 and 43 pertain to supervision of payments services and fintech. These  terms barely existed 15 years ago. They are now fields in which China is a global leader. In this respect even with the new law, the PBoC is merely catching up to innovation.

According to China’s governance framework, the PBoC is a government ministry under the State Council. As such, it is no different from other global central banks which are accountable to and receive their remits from their respective governments.

Central bank independence often refers to ‘operational independence’, where a central bank can set monetary policy and engage in other activities without interference.

The PBoC proposal seeks to achieve the same for the Chinese central bank as much as possible. It specifies its ability to ‘independently execute monetary policy, carry out its responsibilities and engage in activities free from the influence or intervention of local governments, government departments across all levels, social groups and individuals.’

However, it continues to define itself as ‘under the leadership of the State Council.’ Having operational independence enshrined by law is, at least in theory, to give the PBoC the power to act in the interests of price stability and financial stability.

The latter is important should situations arise where decisions may prove uncomfortable for certain authorities (e.g., putting a local bank under enhanced supervision).

The PBoC’s leadership has never hidden its scepticism of, even disdain for, quantitative easing and has been increasingly vocal about the side-effects of unconventional policy.

Even if it wanted to introduce QE, the central bank faces legal constraints. Article 32 of the new law is Article 29 of the previous law verbatim: the PBoC may not make an overdraft for the government, and may not directly subscribe or underwrite state bonds or other government bonds.

In contrast, the Federal Reserve Act allows any Federal Reserve Bank to ‘buy and sell…bonds and notes of the United States’. The UK Treasury maintains a ‘government overdraft account’ at the Bank of England, known as the ways and means facility.

Even if the law affords the PBoC enough flexibility to engage in asset purchases, the bank’s leadership would probably see such a step as highly damaging to its credibility and pursue other avenues first to ease financial conditions.

The PBoC law was first established in 1995 and last amended in 2003.

The latest review began last year as the central bank acknowledged that many of its de facto powers and operations were not even foreseeable 17 years ago.

The PBoC has given due deference to G7 peers and merely wanted to ‘catch up’ with legislative and governance terms. Yet, at the same time, it is trying to future-proof itself. The new law could be a good template for central bank governance in the 21st century.

Geoffrey Yu is Senior Europe, Middle East and Africa Market Strategist at BNY Mellon.

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