Deepening reform of the financial system

Governor of the People’s Bank of China Zhou Xiaochuan examines the Central Committee’s proposals set out in the Thirteenth Five-Year Plan of national economic and social development
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The financial system is an essential component of a socialist market economy. Since its reform and opening up, China has established a socialist market system as well as a financial system that matches the requirements of a market economy. Financial macro management and financial regulatory systems have also been improved steadily. Financial resources are the core resources of a modern economy and the market should play a decisive role in resource allocation.

The proposals of the Central Committee in the Thirteenth Five-Year Plan of national economic and social development, approved at the fifth plenary session of the Eighteenth CPC Central Committee, clarified future goals and requirements in terms of financial system reform in the next five years. This is based on the development environment at home and abroad during the period of the Thirteenth Five-Year Plan and focused on innovative, coordinated, green, open and shared development.

Following the guidelines of the fifth plenary session of the Eighteenth CPC Central Committee, we will stick to our development goals in the process of financial system reform. We will set up new systems for financial opening up and development, raise the efficiency of finance in serving the real economy, improve the framework of macro management and prudential management, stick to the ‘bottom-line' mentality, and ensure national financial security to promote the balanced, sound, secure and sustainable development of the economy and finance.

Innovation is key

The philosophy of innovative development should be upheld to enhance the economic efficiency of financial service entities:

Innovation is the primary driving force for development. China should improve macro management, accelerate financial system reform and step up the establishment of an investment and financing system that facilitates innovation and development. There are three key elements:

1. The system of financial institutions should be improved and a new mechanism for financial development established.

Specifically, efforts should be made to build a system of financial institutions with a rational division of labour and complementarity among commercial finance, development, policy and cooperative finance. A multi-level, extensive and differentiated banking institution system should also be established. Efforts should be made to deepen reform of China Development Bank, Export-Import Bank of China and Agricultural Development Bank of China; enhance capital constraints and improve governance mechanisms so that development and policy finance can play a better role in facilitating growth and restructuring; and enhance support to key areas and weak links in the economy.

Efforts should be made to consolidate the reform outcomes of commercial financial institutions, optimise the shareholding structures of state-owned financial institutions, improve the corporate governance mechanism of financial institutions, set up modernised corporate systems for financial firms, and put in place an effective mechanism of decision-making, enforcement and checks and balances. Efforts should also be made to promote the rapid and sustained growth of Chinese-funded financial institutions with international competitiveness and the capacity of cross-border allocation of financial resources. Relying on cooperative economic organisations, efforts should be made to guide sound development of cooperative finance and to set up an extensive, sustainable and supplementary system. China should elevate the quality of service provided by financial institutions and lower the cost of corporate financing. The management of state-owned financial capital should also be enhanced to improve the vitality, control and influence of state-owned financial capital.

2. Financial innovation should be used to nurture new driving forces for economic development.

China should promote innovation-driven development strategies backed by finance and establish an inclusive policy system to support innovative finance. Enhanced efforts should be made to set up a technology and IP trading platform and build up financing models to promote technological innovation from research and pilot tests through to production. China should expand its diversified financing channels catering to scientific and innovative development and promote financing via high-yield bonds and the combination of equity and bond financing.

zhou-xiaochuan-iffZhou Xiaochuan

Efforts should also be made to enhance the support of capital markets in technological innovation, encourage crowd entrepreneurship, crowdsourcing, crowd support and crowdfunding, and develop angel investment, venture capital and industry investment. Also, China should explore new methods of promoting scientific innovation with indirect financing and improve its financing system through the coordination of banks, venture capital and equity investment institutions. China should step up developing technology insurance and push forward pilot programmes related to patent protection. It should also accelerate the building of a credit-enhancing mechanism that promotes technological innovation.

3. China should improve its macro management approach by adopting new thinking and new policy instruments.

Macro management will be improved by adopting both aggregate management and targeted policies, coordinating short-, medium- and long-term goals, incorporating domestic and international situations, while also balancing reform and development. China will adopt discretionary and well-targeted measures and take forward-looking fine-tuning measures. More efforts will be made to expand employment, stabilise prices, restructure, raise efficiency, prevent risks and protect the environment.

China should be updated in terms of policy thinking and policy instruments. Targeted macro management measures will be enhanced on the basis of range-based management to make macroeconomic policies better targeted, precise and forward-looking. A policy system based on fiscal and monetary policies with the coordination of industrial, regional, investment, consumption and pricing policies should be enhanced, and ‘big data' technology should be better tapped to acquire more timely, scientific and precise information on economic operation.

Market-oriented exchange rate and interest rate reform will be further promoted. The market will play a more decisive role in the formation and movement of the renminbi exchange rate with enhanced flexibility. Efforts will also be made to select and nurture the central bank's policy rate system and improve the transmission mechanism of monetary policies. Communication mechanisms at the central bank should also be enhanced to guide market expectation and enhance effectiveness of monetary policy.

The coordinated development of finance is an important guarantee for balanced and sustainable development of the real economy
Zhou Xiaochuan, People’s Bank of China

Efforts should be made to deepen reform of the investment and financing system, put into full play the leveraging role of fiscal funds and be innovative in improving infrastructure investment and financing systems. Meanwhile, it is also important to improve the coordination between fiscal and monetary policies, promote the combination of fiscal and financial resources and put the role of investment into full play in boosting growth. China should establish a comprehensive, well regulated, open and transparent budgetary system, and improve government budgetary systems and local government debt financing systems to reduce the impact on liquidity brought by volatilities in treasury funds.

Coordinated development

The philosophy of coordinated development should be upheld to establish a balanced and sustainable financial system:

Coordination is an inherent requirement for sustained and sound development and the coordinated development of finance is an important guarantee for the balanced and sustainable development of the real economy. There are three key elements:

1. The proportion of direct financing should be raised to establish a financial market system featuring the coordinated development of direct and indirect financing.

To this end, China should actively promote the development of a transparent and healthy capital market. The overall financial structure in China is still dominated by indirect financing through banks, while the capital market system is still immature. With a rather low proportion of direct financing, the macro leverage ratio remains high and economic and financial risks are concentrated in the banking system. During the Thirteenth Five-Year Plan, China should strive to improve the investment functions of the multi-tier capital market and optimise the corporate debt and equity financing structure. The ratio of direct financing, especially equity financing, should be elevated markedly. It is estimated that, from 2014 to 2020, the ratio of direct financing of non-financial corporations to total social financing will rise from 17.2% to 25%. The ratio of outstanding value of bond market to GDP will rise to around 100%. Reform of stock and bond issuance and trading systems will be pushed forward by taking full information disclosure as a core goal and reducing the examination and judgment on the qualification of issuers by securities regulators.

It should also improve post-regulation and enhance the market exit mechanism to protect the lawful rights for investors. China should deepen the reform of GEM Board and New Third Board, and improve the multi-tiered equity financing market. The bond market based on qualified institutional investors and over-the-counter (OTC) markets will be developed by setting up a multi-level capital market system characterised by the orderly stratification of OTC and exchange markets, full varieties, complementary functions and unified regulation.

2. Private capital should be encouraged to enter the banking sector to establish a financial service system with balanced property right, mixed ownership and effective competition.

China should promote the positive role of private capital by expanding investment channels for private capital and reducing access barriers, while improving relevant regulations and encouraging all market participants including private capital to enter the banking sector, in accordance with the law with an equal treatment. China will create a sound institutional environment where economic and financial entities from diverse forms of ownership could use production factors on a level playing field in accordance with the law, participate in market competitions fairly and openly, and are protected by the law.

3. Internet finance should be developed under proper regulation to establish a financial system featuring the coordinated development of mainstream and new business formats.

In recent years, mainstream business formats such as banks, securities companies and insurers developed rapidly by leveraging internet technologies. In the meantime, new business formats represented by internet enterprises sprang up. It has been a trend for the financial sector to adopt an information-based business model providing integrated financial services. Following the development of information technologies, China should support and regulate third-party payment, crowdfunding, peer-to-peer lending platforms and other internet finance formats. Financial institutions with favourable conditions should be encouraged to conduct comprehensive operations in a prudent and sound manner. Meanwhile, China should also promote the establishment of big data platforms for different financial institutions and set up standards and regulations for big data.

Green development

The philosophy of green development should be upheld to establish a green financial system:

Green development is a necessary condition for sustained development, with green finance an important approach towards green development. Through innovative arrangements of the financial system, China will guide and encourage more social capital to flow to green industries including environmental protection, energy conservation, clean energy and clean transportation. The key changes are:

1. China should guide commercial banks to establish and improve the green credit mechanism.

Through green finance central bank lending, fiscal subsidies and guarantees to green loans, and green ratings for commercial banks, China will encourage commercial banks to push forward green credit. The credit information system should play an incentivising and binding role in environmental protection and commercial banks should be encouraged to set up green finance divisions. All in all, China should encourage the development of green credit, which allows emission rights, pollution discharge rights and carbon income rights to be used as collaterals (pledges).

China should develop its investment and financing mechanism for energy use rights, water use rights, pollution discharge rights and carbon emissions rights – and establish respective trading markets
Zhou Xiaochuan, People’s Bank of China

2. The financial market should play its role in promoting green financing.

China should develop its investment and financing mechanism for energy use rights, water use rights, pollution discharge rights and carbon emissions rights – and establish respective trading markets. It should support and encourage the issuance of green bonds by banks and enterprises. It should also further clarify the standards for identifying, categorising and disclosing information on green bonds, cultivate third-party assessment agencies for green bonds and raise their rating capabilities. It should promote the securitisation of green credit assets, develop a green stock index and relevant investment products, and encourage institutional investors to invest in green financial products.

Arrangements should be made requiring public-listed companies and issuing corporations to disclose environmental information. Green industry funds should be established. Carbon financial products such as carbon rent, carbon funds and carbon bonds should also be developed.

Opening up

The philosophy of open development should be upheld to establish a financial industry open in both directions:

Openness is the way to a country's prosperity. All-round opening up is essential for financial development. Promoting two-way opening of the financial sector will enhance the orderly flow of factors domestically and internationally, efficient allocation of financial resources, and deep integration of financial markets. This includes:

1. Two-way opening up of the financial sector

China should put into force a management system for pre-establishment of national treatment plus negative lists, open up the service industry in an orderly way and expand market access for banks, insurers, securities companies and those offering elderly care. China should expand the opening of the financial industry in both directions. Specifically, it should alleviate and gradually remove the quota of domestic and overseas investment, enhance openness of the stock and bond markets, and relax the restrictions on renminbi bond issuance in China by overseas institutions. The type and geographic scope of domestic institutional bond investors should be expanded and restrictions to issue renminbi bonds by overseas institutions should be relaxed. China should also establish accounting standards, rules, laws and regulations that are adapted to the international financial market, and promote the financial market at an international level.

Financial cooperation among the Chinese mainland, Hong Kong and Macao – and between the Chinese mainland and Taiwan – should also be deepened. China should support Hong Kong in consolidating its status as an international financial centre, bolstering its efforts to participate in China's two-way opening-up and the Belt and Road initiative. Efforts will be made to strengthen Hong Kong as a global offshore renminbi business hub and to promote its financial services sector as high end and high value-added. Efforts will also be made to support Macao in setting up a platform to carry out business and trade cooperation with Portuguese-speaking countries. China should further open the mainland's financial market to Hong Kong and Macao, and accelerate the establishment of a financial cooperative platform among Qianhai, Nansha, Hengqin, Hong Kong and Macao. It aims to promote cross-strait financial cooperation and two-way investment by building economic zones on the west side of the strait and a Pingtan economic and financial cooperation platform with Taiwan. In doing so, China will foster a new landscape of economic and financial opening up, and a new pattern of deep integration and mutually beneficial cooperation.

2. The convertibility of capital account should be achieved in a well-organised way.

China should change the approach of foreign exchange management and use from ‘positive lists' to ‘negative lists', relaxing restrictions on overseas investment remittance, on requirements for enterprises and individual foreign exchange management, and on the operation of funding by multinational corporations. It should allow more qualified foreign institutions to finance in the domestic market. China should strengthen the supervision, analysis and early warning system on the balance of payments, and cross-border capital flows in particular. It should also enhance prudent management and examination on anti-money laundering and anti-terrorist financing. In this way, China will improve the management system of foreign exchange reserves and also make use of foreign exchange reserves in a diversified way.

To promote the Belt and Road initiative, China should also enhance its collaboration with international financial institutions, take an active part in the establishment of the Asian Infrastructure Investment Bank and the New BRICS Development Bank, and promote the role of the Silk Road Fund to attract international funds in creating diversified win-win financial cooperation. Efforts will be made to establish a diversified global financial framework to achieve global distribution of financial assets.

3. China should promote inclusion of the renminbi in the special drawing rights (SDR) basket and make it a convertible and freely useable currency.

Confidence in the renminbi should be established by promoting its inclusion into the SDR and making it a convertible and freely useable currency. Bilateral and multilateral monetary and financial cooperation should be further enhanced. China should take trade investment and value chain optimisation as top priority, consolidate the renminbi's status as a settlement currency and promote its use in transactions and international reserve. China should facilitate the use of the renminbi in neighbouring countries and emerging markets, and expand its use in international financial centers and developed countries. It should develop the direct trading of renminbi with foreign currencies to better serve cross-border renminbi settlements. By the end of the Thirteenth Five-Year Plan, cross-border receipt and payment of renminbi is expected to account for one third of total cross-border receipts and payments in China, while the renminbi will become an international currency.

4. China should be more active in global governance by taking part in the global economic and financial governance system in an inclusive manner.

China should follow the trend of economic globalisation and enhance international coordination in terms of macroeconomic policies, to balance the world economy and to promote financial security and stabilised growth. It should encourage the equal participation of developing countries in international economic and financial governance. It should also promote reform of the international monetary system and financial regulation, as well as adjustments of the international economic and financial order towards equality, fairness, cooperation and a win-win direction. Overall, China should take an active part in global economic and financial governance as well as public goods supply to have a bigger voice and international influence in global economic and financial governance.

Shared development

The philosophy of shared development should be upheld to promote financial inclusion:

Shared development is an essential requirement for socialism with Chinese characteristics and also an effective way to narrow the income gap and promote sustainable development of the economy. Inclusive finance can provide all kinds of appropriate, convenient, high quality financial services at a reasonable price whenever it is needed. Key elements are:

1. Improving the delivery of financial services to small and micro enterprises, rural areas and especially to poverty-stricken areas.

An inclusive financial organisation system should be developed with multi-tier, wide-covering and differentiated banking institutions. The different roles of financial policy and commercial finance should be brought into play and various resources should be integrated to pursue poverty reduction and open up new funding channels for poverty alleviation and development. China should deepen rural financial reform and encourage state-owned financial institutions to open up markets for farmers, the agricultural sector and rural areas as well as for small and micro enterprises. Governance and services of rural credit cooperatives should also be improved.

Small and micro enterprises should be encouraged to raise funds through the multi-level capital market and to enhance the issuance of various non-financial enterprise debt, collective bonds and private placements by small and micro enterprises
Zhou Xiaochuan, People’s Bank of China

Various financial institutions should be established to provide low cost finance, remittance, settlement, payment and other basic financial services in an efficient way. Small and micro enterprises should be encouraged to raise funds through the multi-level capital market and to enhance the issuance of various non-financial enterprise debt, collective bonds and private placements by small and micro enterprises. The development of innovative, professional and community-based financial businesses such as mobile payment and microfinance should be supported and put under proper regulation. A national land equivalent ratio accounting and quota trading system should also be established to serve national food security, modernisation of agriculture and new urbanisation. A mix of fiscal, taxation, monetary and regulatory policies should be adopted to guide financial institutions to channel more credit to farmers, agriculture and rural areas, small and micro enterprises, and other key sectors and weak links of the economy.

2. Improving the agricultural insurance system and establishing an insurance asset trading mechanism.

To push forward market-oriented reform of the insurance sector, China should expand the coverage of agricultural insurance by increasing the types, depth and density of agricultural insurance. It should also step up efforts in setting up a catastrophe insurance system by promoting catastrophe insurance legislation processes, defining the scope of catastrophe insurance, and establishing a multi-tier catastrophe insurance system that is promoted by the government, operated by the market and with a risk-sharing mechanism. Through claims, equity, real estate and other investment channels, China should promote the value and long-term investment of insurance funds.

3. Improving the fundraising mechanism to establish a more equitable and sustainable social security system.

China should expand the investment channels for social security funds, improve risk management and increase the return on investment. It should also set up a stable and sustainable fundraising mechanism for medical insurance by encouraging private insurance companies to take part in the operation of medical insurance.

Financial modenising

Modernising the financial governance system and capabilities should be based on ‘bottom-line' thinking:

As China's economy is shifting from high speed growth towards medium to high-speed growth, some structural and institutional problems previously covered by high growth have emerged gradually. Therefore, to ward off and resolve potential financial risks is a daunting task faced by China in the coming five years. There are three ways to do this:

1. Enhancing macroprudential financial management, strengthening coordination, reforming and improving the financial regulation framework that adapts to the development of modern financial market.

China should draw experiences from international financial regulation reforms in the wake of the global financial crisis. Efforts should be made to put in place a financial management system where macroprudential and microprudential measures are mutually complementary, and the monetary policy and prudential management are well coordinated. China is also required to explore ways to entail asset expansion activities of systematic significance into macroprudential management. Furthermore, financial institutions of systematic importance, financial infrastructure and foreign debts should operate under enhanced macroprudential management.

Controllable measures should be adopted in a proper manner to release risks so as to better cope with fiscal and financial risks as well as crisis
Zhou Xiaochuan, People’s Bank of China

2. Setting up regulatory rules consistent with international standards and establishing sound and efficient financial infrastructures.

China should enhance regulation of integrated financial services and make sure all new financial business formats are covered by financial regulation. Supervision of financial holding companies should be intensified. Moreover, financial regulation should cover the full range of cross-sector and cross-market financial businesses represented by wealth management products, private equity funds and OTC margin trading. A unified system with functions of currency payment and clearing as well as the registration, custody, clearing and settlement of financial products should be established. An information-sharing system for financial statistics and a big data platform for central financial regulation are to be established, to facilitate adequate and timely information exchanges among relevant regulators. And the transformation of financial regulation should be accelerated to put in place a macroprudential system with capital constraints at its core.

3. Building up a national financial security system to prevent systematic financial risks.

Financial security is an essential part of national security. The result of financial reform hinges on financial security, and full public confidence in the financial system lies at the core of financial security. China should establish a national financial security review mechanism, improve the financial security network, improve the deposit insurance system and establish the mechanism of risk identification and early warning.

Controllable measures should be adopted in a proper manner to release risks so as to better cope with fiscal and financial risks as well as crisis. Regulation measures against money laundering and terrorist financing should be improved and a financial penalty system should be set up to effectively deal with overseas financial attacks and sanctions under extreme circumstances. Furthermore, financial risk management instruments will be effectively utilised and developed to lower the leverage ratio and ward off systemic financial risks.

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