China makes sweeping reform to financial sector regulation

Dramatic changes should not undermine globally accepted standards

While the world is preoccupied with the stability of the western banking system, China has been busy overhauling its financial regulatory architecture. The dramatic changes are China’s fourth major reform in the past two decades, bringing the financial regulatory system under the tight, centralised control of the Chinese Communist Party.

China’s financial sector is working to establish itself as a safe and efficient system. The country has been building its supervisory capacity since 2003 to address the fault lines. It has undergone reviews by the International Monetary Fund, the Financial Stability Board and the Basel Committee. In 2017 and 2018, two new state institutions were added to the regulatory architecture to strengthen financial stability coordination and supervision of banks and insurers.

With a major new reform announced on 7 March, this work has gone even further.

Tight grip on policies and governance

China has announced plans to create a new regulatory body – the National Financial Regulatory Administration – to replace the China Banking and Insurance Regulatory Commission. Responsibility for regulating China’s financial sector will move to this new administration and away from the People’s Bank of China, CBIRC and the Financial Stability and Development Committee.

The reform targets four broad areas: the financial stability framework; supervision, consumer and investor protection; functioning of capital markets; and organisation of the central bank.

It aims to oversee money, markets and financing to ensure China becomes a ‘moderately developed state’ by 2035 (an avowed purpose of the National Parliamentary Committee). The party will tightly control the financial sector’s policies and governance, including resources and salaries. In other words, China has made it explicit that the financial system is an arm of the state – more a ‘utility’ as opposed to a commercially orientated, market-based system.

While China has always been a state-dominated economic system, the March 2023 shift is a regime change. It raises uncertainties about vital daily interactions, such as regulatory governance and prompt enforcement of corrective action, financial sector policies, macroeconomics and entry of foreign economic agents into the domestic market, alongside integrating Chinese financial firms into global finance.

China as a global superpower

It is atypical for China to implement such sweeping reforms. It prefers a well-staged approach to win party-level support. While the complexity of the financial sector grows, the financial markets have witnessed several episodes where hidden risks have abruptly amplified. An empowered, centrally controlled architecture may help avoid this in future. The central bank must also rid itself of legacy functions to focus on monetary management, payments, financial technology and internationalisation. Political economy considerations, however, have dominated the push for the new reform.

For a long while, the party’s preoccupation has been with China’s future as a global superpower, with social harmony at home. A view building up within the party since before the 2008 financial crisis is to regard economic (and financial) security as an instrument for national security and China’s global ambitions. Such thinking prompted the setting up of its first sovereign fund, with banks and state-owned enterprises taking on a larger global footprint and China becoming the number one non-traditional sovereign lender to other sovereigns.

The March 2023 economic and financial governance reform aims to ‘modernise’ economic administration in China. The party believes the current architecture is not fully aligned with building China into a modern socialist market economy. Therefore, the party’s leadership will guide and be accountable for the socialist modernisation of the financial regulatory and institutional set-up.

Guard railing the financial structure  

The reformed regulatory architecture will depart from the principles outlined in various international financial standards. While it remains China’s prerogative to oversee its financial sector the way it sees best, formal clarifications and communicating the operating details of the new arrangement will help to reassure that, despite a regime shift, the financial industry will retain its strengths and that party politics and non-economic provincial interests will not override the effectiveness of regulation and supervision.

China cannot set aside the practices enshrined in globally accepted standards for effective regulation and supervision. Given that China is seeking the status of a moderately developed state by 2035, using the financial sector for political and social priorities – and national security goals – must not divert attention from continuing to clean up and stabilise the financial system.

The world will watch how the party achieves its broader goals and effectively regulates the financial sector. China knows that prudential rule-making responsibilities will only grow with the rising complexities of climate-related exposures, rapid financial technology developments and artificial intelligence and machine learning use in the financial services industry.

The expectation from the international standard-setting community is for China to continue advancing its participation. Maintaining a transparent, operationally effective and high-quality regulatory regime is the best way for China to attain its broader economic and strategic goals.

Udaibir Das is the former Assistant Director and Adviser of the Monetary and Capital Markets Department at the International Monetary Fund. He is a Non-Resident Fellow at the National Council of Applied Economic Research, a Senior Non-Resident Adviser at the Bank of England, a Distinguished Fellow at the Observer Research Foundation America and a Distinguished Visiting Faculty at Kautilya School for Public Policy.


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