Precise regulation over liquidity of commercial banks in China

By Wu Jiejiang, Jingtian & Gongcheng
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After experiencing a series of high-profile events in 2015 and 2016, including the stock market crash, the battle between Baoneng and Vanke, and Ezubao’s P2P lending fraud, the Chinese financial market entered a year of strengthened regulations in 2017, which was marked by the People’s Bank of China’s (PBOC) macro-prudential supervision, China Banking Regulatory Commission’s (CBRC) special corrective actions, and the formal establishment of the Financial Stability and Development Committee under the State Council in the second half of 2017.

吴杰江 WU JIEJIANG 竞天公诚律师事务所 合伙人 Partner Jingtian & Gongcheng
Jingtian & Gongcheng

Since the beginning of 2018, CBRC upgrades regulatory by promulgation of a series of new regulations, including the Interim Measures for the Administration of Equities in Commercial Banks, the Measures for the Administration of Entrusted Loans of Commercial Banks, and the Circular on Further Deepening the Rectification against Market Chaos in the Banking Industry. Targeting especially at interbank business, wealth management and off-balance-sheet transactions as well as shadow banking, the 2018 corrective actions of CBRC will continue to highlight deleveraging, delinking and elimination of passageway business in the financial system.

Strengthening financial regulation is just a means to an end. The ultimate purpose is to prevent financial risks and improve the ability of financial institutions to serve the real economy. Objectively, ongoing rigorous regulation does have a significant impact on commercial banks’ access to fund resources of credit, thereby restricting their debt expansion.

In the government work report made on 5 March 2018, Premier Li Keqiang proposed a prudent monetary policy for 2018. Featuring moderate tightening and relaxation, the policy will be aimed at maintaining reasonably steady liquidity and raising the percentage of direct financing, especially equity financing.

In connection with the Premier’s call to maintain reasonably steady liquidity of commercial banks, both regulators and the market are already in movements.

In order to provide commercial banks with further supports in expanding channels of supplementing their capital, enhancing the soundness of their banking systems, and strengthening banks’ capabilities to support the real economy, the CBRC, PBOC, China Securities Regulatory Commission (CSRC), China Insurance Regulatory Commission (CIRC) and State Administration of Foreign Exchange (SAFE) jointly issued the Opinions on Providing Further Supports for Capital Instrument Innovations of Commercial Banks (No. 5 Document) in January 2018.

Below is a summary of the highlights of the No. 5 Document.

Firstly, channels for issuance of capital instruments shall be broadened. The regulators will support commercial banks to issue capital instruments through a diverse range of channels so that the scale of offered capital instruments may grow steadily by taking maximum respective advantages of domestic and foreign financial markets and making effective use of domestic and foreign market resources.

Secondly, research activities shall be carried out actively to add new categories of capital instruments. Summing up experiences and causing improvements in amending relevant laws and regulations, the regulators will create favourable conditions for banks to issue capital instruments, such as non-fixed-term capital bonds, secondary capital bonds that are convertible into shares, capital bonds with regular conversion clauses in a fixed-term, and TLAC (total loss-absorbing capacity) instruments.

Thirdly, investor base shall be expanded. On the precondition of risk prevention, the regulators will develop policies for institutions, such as social security funds, insurance companies, securities institutions, fund companies to invest in capital instruments of commercial banks, thereby expanding the base of eligible investors in these instruments.

Fourthly, the process for approval of issuing capital instruments shall be optimized and the shelf registration system be improved. It is worth noting that on the evening of 12 March, the Agricultural Bank of China announced a plan to raise not more than RMB100 billion through private placement of A-shares. Setting a record in the history of private placements in China’s A-share market, the amount of fundraising delivers a positive signal from regulators to the market.

On 6 March 2018, the CBRC issued the Circular on Adjusting the Regulatory Requirements for Loan Loss Provision of Commercial Banks (No. 7 Document). Key contents of the No. 7 Document include adjusting the provision coverage ratio from 150% to 120%-150% and the loan provision ratio from 2.5% to 1.5%-2.5%. Wang Zhaoxing, Vice Chairman of CBRC, says that benefiting from good performance in the past couple of years, banks have set aside abundant loan loss provisions, pushing provision coverage ratio of the whole industry to 180%, a figure much higher than the international level. That is why the CBRC adjusts the provision coverage ratio to lower requirements moderately. The move is expected to help accelerate disposal of existing non-performing loans so that banks will have more capital for supporting the development of the real economy.

As a result of lowering the provision coverage ratio and the loan provision ratio (the two ratios), banks will be better able to serve the real economy by releasing more liquidity to support the supply-side structural reforms effectively. Generally speaking, lowering the two ratios will help commercial banks activate the existing capital and make good use of the incremental portion of capital. As commercial banks will see their amount of capital rising more or less after the downward adjustment of the two ratios, they will feel less capital pressure.

Meanwhile, the downward adjustment will also be helpful for commercial banks to liquidize their capital. Using the incremental liquidity to support new industries, economic drivers and technologies, commercial banks will be better positioned to serve the real economy. Actually, the fact that regulators dare to announce this policy at this moment reveals their belief that the bad debts of the banking industry in China have been fully disclosed and the problems are controllable. Now the top challenge for the banking industry is to properly dispose of or write off the bad debts that have been revealed.

As emphasized at the Central Economic Work Conference, adopting a general work style that continues to make progress while maintaining stability will be crucial for governance and administration of the country. Benefiting from supporting policies provided by regulators, each commercial bank may take measures appropriate to its own circumstances to improve its capital strength and ability to serve the real economy.

Wu Jiejiang is a partner at Jingtian & Gongcheng

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