Two Sessions 2023: Reforming China’s Financial Governance

China aims to transition from a period of rapid economic growth to an economy that is geared towards high-quality development. Over the past years, the country has reformed the governance of its financial system to better serve its development path. In 2017, the 5th National Financial Work Conference concluded on the principles that financial governance shall (1) steer finance to serve the real economy, (2) improve the structure of the financial system, (3) strengthen supervision, and (4) fully leverage market forces in the allocation of financial resources.

In this month’s meeting of the National People’s Congress and the Chinese People’s Political Consultative Conference, the so-called two sessions, the country has taken further steps in that direction. We identify four financial reform areas where decisions were taken during the two sessions or in the preceding months: organizational restructuring, the new financial stability law, changes to capital markets regulations, and structural monetary policy tools.

Legislators at the National People’s Congress approved an overhaul of the organizations that supervise the financial system. The China Banking and Insurance Regulatory Commission will be replaced by a national financial regulatory administration. The new financial watchdog gains additional powers from the People’s Bank of China (PBC), namely consolidated responsibility over financial consumer protection and supervision of financial holding companies. It also assumes responsibility over investor protection from the China Securities Regulatory Commission (CSRC).

The Financial Stability and Development Commission (FSDC), which since 2017 oversaw and coordinated the banking, insurance, and securities regulators along with the central bank under the State Council, will be abolished. In its stead, a new Communist Party organ, the Central Financial Commission, is set to coordinate financial sector policy and supervision. Amidst reporting that the former FSDC was constrained in its work at local levels, financial supervisory bureaus set up by local governments will focus solely on regulatory duties. Additionally, financial policymakers and supervisors from central departments will provide local governments with capacity and guidance. The PBC will also be restructured to strengthen policy administration in local areas and expand its regional branches from nine macro-regions to 31 provincial branches.

China’s securities authority, the CSRC, will be granted greater regulatory authority over the bond market. Previously, the CSRC and the National Development and Reform Commission (NDRC) shared responsibility for regulating corporate bonds. Notably, the NDRC oversaw the issuance of enterprise bonds and its sub-category, municipal corporate bonds – a debt instrument issued by local government financing vehicles (LGFVs). LGFVs are a form of state-owned enterprise set up by local governments mainly as a channel to finance infrastructure projects. As an important source of funding for local governments, LGFVs have been increasingly under regulatory scrutiny, as their debt levels have reached unhealthy proportions.

A new financial stability law complements the reform of China’s supervisory authorities. Under examination during the two sessions, the draft law clarifies the responsibilities of central supervisors and local governments in preventing and resolving financial risks. It also seeks to provide a unified rulebook and strengthen market-based bankruptcy mechanisms to reduce regulatory arbitrage, and to counter expectations that the state will bail out failing financial institutions.

The rules that govern capital markets have been on the reform agenda in the months leading up to the two sessions. China’s financial system is still largely centered around banks and loans. In 2022, China’s aggregate financing to the real economy (AFRE) flows consisted of 62.9% loans, 28.7% bonds, and 3.7% equity financing on the domestic stock market by non-financial enterprises. While banks often channel savings to traditional industries, China lacks “innovation-oriented capital”, according to CSRC Chairman Yi Huiman. Companies face a streamlined process for listing on domestic stock markets that places greater importance on public information disclosure. Previously, they underwent a lengthy approval process by the CSRC itself, now individual stock exchanges approve or reject listings based on CSRC rules.

Moreover, the PBC continues to fine-tune monetary policy to guide financial flows towards prioritized areas while seeking to maintain market mechanisms. During the economic slowdown related to its property sector and Covid restrictions, China refrained from providing large-scale monetary easing. Instead, the PBC rolled out a range of structural monetary policy tools that provided financing at lower interest rates for selected segments, such as small businesses and the property sector. While support areas are predetermined, eligible banks make their own loan decisions and conduct their own risk management. The PBC Governor Yi Gang indicated that, at 15% of the PBC’s balance sheet, the size of its structural monetary policy tools is at an adequate level that the central bank aims to maintain.

In sum, after decades of fast-paced but indiscriminate growth, China’s top policymakers are engaged in a new round of reforms. Beijing has adjusted monetary policy and reformed capital markets to improve financial support for development. The two sessions oversaw additional measures to streamline financial governance by adjusting the legal framework and changing the organizations that supervise the market. To what extent these reforms will improve financing conditions and risk management in China remains to be seen.