Speech by the CBRC Vice Chairman WANG Huaqing at 2010 Lujiazui Forum

Speech by the CBRC Vice Chairman WANG Huaqing at 2010 Lujiazui Forum

(June 26, 2010)

Mr. Chairman, distinguished guests,

I am very delighted to attend this forum. There has been a common understanding after the international financial crisis that the lack of financial supervision is one of the major causes of the crisis. Now, I would like to share with you the following observations in relation to the theme of this forum Global Financial Cooperation and Supervisory Reform.

1. There has never been a stop to the reform of financial supervision. Whenever crisis broke out, some people would call for efforts to strengthen supervision. In western culture, there is a proverb saying that one of the keys to happiness is a bad memory . When the market became stable and confidence restored, the lessons from the crisis would be forgotten and people would attribute the increased investment cost to strengthened supervision, thus calling for deregulation. Just like the economic crisis, the supervisory reform has its own cycle. Therefore, excellent supervisors should be able to put forward suggestions on supervisory reform after the end of each crisis, but more importantly they should be able to remain restrained and calm so as to adopt prudential, counter-cyclical supervisory measures at proper times when the market becomes irrational. Of course, this requires that supervisors possess wisdom and considerable political courage throughout the economic cycle, so that they can tell the market with their sense and effective measures that sustainable growth and return comes from human virtues, such as diligence, frugality and saving, other than excessive lending, leverage and speculation. Effective supervision will drive financial industry to return its original nature of simplicity, transparency and effectiveness and its original function of channeling savings and investment. Therefore, finance can and should never forget the essential tenet of obeying and serving the real economy.

The CBRC is responsible for prudential supervision of China s banking sector. Since its establishment in 2003, the CBRC has, given the complicated macro economic situation, introduced a series of counter-cyclical prudential supervision measures. For example, it requires commercial banks to increase counter-cyclical capital buffer and small and medium-sized banks to have a capital adequacy of higher than 10%. As for large commercial banks with systemic importance, it requires the capital adequacy higher than 11%. In addition, it places stringent requirements on capital quality and structure, specifying the tier 1 capital exceeding 80%, restricting the size of banking sub prime debts, and making clear that banks cross-holding sub prime debts can not be counted as capital. It is safe to say that the capital quality of China s banking sector is at its best level in history. Furthermore, the CBRC has introduced the practice of dynamic provision, leverage ratio, as well as more stringent liquidity ratio and scientific compensation mechanism. It has adopted ratios such as LTV and DTI on home mortgage lending, so as to reduce the risk exposure in property market. These counter-cyclical prudential supervision measures have effectively restrained commercial banks from credit expansion and other short-term acts, thereby enhanced the ability of China s banking sector to withstand risks. Counter-cyclical supervision policy has become an important part of China s macro control and it has, together with the industrial policy for boosting economic restructuring, the discretionary monetary policy and the fiscal policy as an automatic stabilizer, formed the fundamental framework for China s macro economic control policies.

2. Upon mentioning the reform of financial supervision system, the adjustment of supervisory framework will automatically come to our mind. Facts have proved that there is no necessary relationship between financial stability and supervisory framework. The complicated, overlaying supervisory architecture of the US has failed to effectively guard against the global financial crisis. Similarly, the unified supervisory architecture in the UK has performed no better. Just like there is no unified corporate governance model in the world, there is no one-fits-all supervisory architecture either. An IMF report shows that it is the independence of the supervisors and their sense of responsibility, other than the supervisory architecture, that play the most crucial part in maintaining a nation s financial stability. So long as the supervisors of a nation can make independent and responsible supervisory decisions, the confidence of the financial intermediaries and investors will be increased and the risk premium will be lowered, thus enabling the financial sector to boost the real economy. We have also noticed that although the supervisory architecture has no necessary relation to supervisory independence, all countries are trying to enhance the independence of supervisors through the reform of supervisory architecture.

China has, in light of its own development stage and financial market deepness, established the system of segregation of financial business, the system of segregation in the supervision of financial institutions, as well as the system of primary supervisory bodies under the supervisory collaboration framework. The practices have proved that this supervisory architecture is in line with the current development stage of China s financial market. For example, this global financial crisis has indicated that appropriate segregation between credit market and capital market is conducive to the prevention of crisis, particularly at the early stage of financial market development. The CBRC has always been building a firewall between the credit market and capital market, e.g. banning the practice of banks to offer guarantee for bond issuance, checking illegal flow of credit funds into the stock market, and strengthening the control of risks in banks bond underwriting business. For another instance, excessive mixed operation has increased the complexity of financial institutions, raised the leverage ratio, and reduced the restraint of capital supervision, which is also a major cause of the global financial crisis. The CBRC has been prudentially facilitating commercial banks to pilot integrated operation, making very clear an exit principle, according to which the non-bank subsidiaries held by banks shall make specific exit plan if they fail to reach industry level within a given period of time, or fail to generate economic added value for the bank s main businesses. Taking another example, excessive assets securitization has helped to link the credit market and capital market, thus decreasing the incentive of banks to review loan applications and blurring the boundary between own operations and commissioned operations, and as a consequence, the banks fail to stick to the concept of customer orientation . Such problems have been fully exposed in this global financial crisis. The CBRC has been prudentially implementing assets securitization, clearly prohibited over-complicated securitization and re-securitization, and strictly controlled the securitization of non-performing assets and assets having no stable cash flow. We always believe that, as a supervisor, our independent, responsible, risk-based prudential supervisory policies will help establishing a sustainable, robust banking system in China.

3. To reform the financial supervisory system under the context of globalization needs more global cooperation. In the 1970s, with the increase of overseas bank operations, people had a heated debate on who should supervise the liquidity of these operations and the potential solvency risks. The Basel Agreement in 1975 laid down the principle of consolidated supervision, and the Basel Accord in 1988 resolved the issue of unfair competition caused by difference in capital requirements of different countries. The Basel Agreement was further improved in 1996 and 2004 respectively. It is safe to say the Basel Agreement is an excellent example of global financial supervisory cooperation. At present, the globalization of financial market has entered a new stage. On the whole, however, global financial cooperation is mainly about the coordination and cooperation between parent and host countries and about the framework for capital supervision, which is not sufficient to facilitate the establishment of a unified, effective global financial supervisory system. The liquidation of Lehman Brothers fully revealed the legal barriers and political resistance in cross-border liquidation. Even in the euro zone where a single monetary system and a single central bank are established, financial supervision is local, although the sovereign of monetary policy has been transferred and the financial market has been unified.

Financial globalization is inevitable. Localization of financial services and aggregation of financial transactions are two trends of the financial globalization. Large-size cross-border financial institutions and international financial centers are important force driving these trends forward. Mutual entry of large financial institutions and localization of financial services will promote the interaction between the supervisory authorities of the countries concerned and the unification of supervisory rules, and the emergence of international financial centers will push the global community to accept unified transaction and supervisory rules. In this sense, in order to build Shanghai into an international financial center, we need to strengthen the international supervisory cooperation and participate in the development of and abide by globally shared transaction and supervisory rules.

The Chinese Government is active in international supervisory cooperation. In 2009, the CBRC became an official member of FSB and BCBS, and since then it has fully participated in the dialogues on financial supervision policies under the framework of FSB and BCBS. In addition, we have participated in the multilateral dialogue and consultation on financial supervision policies under the G20, actively joined the FSAP organized by IMF and World Bank, and carried out effectiveness self-assessment as per the Core Principles for Effective Banking Supervision. We are also actively promoting the implementation of the Basel II Capital Accord in Chinese commercial banks.

That s all for my three observations on counter-cyclical supervision, risk-based supervision, and supervision under the context of globalization.

Thank you.