What does China’s planned financial stability law entail and how will it work?
(China has previously passed sector-specific laws for commercial banking, securities and insurance, but this new law fills a crucial gap in the regulatory framework. (Image: Shutterstock)
China is moving closer to unveiling its financial stability law, which includes the creation of a fund to bail out troubled financial institutions. The law is part of Beijing’s broader efforts to prevent systemic financial risks in the world’s second-largest economy.
A revised draft version of the bill was reviewed for a second time last week by the country’s top legislative body, the Standing Committee of the National People’s Congress (NPC). China’s legislative body typically passes a bill after a third review.
Here’s what we know about the new law and the Financial Stability Fund:
What is the Financial Stability Act?
The bill is China’s first comprehensive legislation specifically aimed at preventing, resolving and handling risks in the country’s $66 trillion financial sector, which includes banks, insurers, asset managers and securities firms.
China has previously passed sector-specific laws for commercial banking, securities and insurance, but this new law fills a crucial gap in the regulatory framework, according to a note from Chinese law firm JunHe.
The law provides “a high-level design for systemic financial risk prevention and inter-agency supervision” and addresses the need for better coordination among various financial regulators and market participants to prevent systemic financial risks, analysts at Huatai Securities said in a report on Monday.
The bill was first revised in December 2022. New revisions were published on Monday, stating that a central financial body would be responsible for decision-making and oversight of financial stability and development policies.
Under the revisions, financial regulators and local governments must also take responsibility for preventing and mitigating financial risks.
What is the Financial Stability Fund and how is it financed?
A key priority of the bill is the creation of a Financial Stability Guarantee Fund. The fund is designed as a backup source of funding to bail out troubled financial institutions to prevent contagion risks. The fund would primarily raise money from financial institutions, the bill said.
The Chinese central bank can also provide cheap loans through the refinancing facility, the company said. The loans would be repaid with proceeds from the sale of risky institutions.
The exact size of the fund has not been officially disclosed. However, in 2022, China’s banking regulator said the fund had initially raised 64.6 billion yuan ($8.89 billion) from financial institutions.
Analysts at China Securities expect the fund to eventually raise between 120 billion and 180 billion yuan annually, making it large enough to weather a major financial crisis.
The fund would cover systemically important financial firms that are “too big to fail”, such as large banks and insurers, as well as institutions considered highly risky, the analysts said.
To limit moral hazard, the bill requires financial institutions in trouble and their major shareholders to first save themselves and take all necessary steps to repay debts and recover losses before seeking external help.
Why does China need the fund now?
The creation of the fund brings China into line with international practices. Major developed economies, including the US and the European Union, have similar funds to provide capital support to troubled systemically important institutions.
China has already set up a deposit guarantee scheme, an insurance guarantee fund and a trust guarantee fund, but the size of these funds is not sufficient to address systemic financial risks.
The 2019 rescue of troubled small regional lender Baoshang Bank tapped more than half of its deposit guarantee fund, which had a balance of 121.6 billion yuan at the end of 2019.
China’s financial system is currently facing multiple challenges stemming from an ongoing real estate crisis and slow economic recovery. Small and medium-sized banks have become a vulnerable part of the financial sector.
China’s financial stability is also threatened by the $9 trillion in debt accumulated by local government financing vehicles (LGFVs), platforms set up to finance local government projects.
This debt burden poses potential contagion risks as a wide range of financial institutions, including regional banks and trust companies, have significant exposure to LGFVs.
(Only the headline and image of this report may have been edited by Business Standard staff; the rest of the content is auto-generated from a syndicated feed.)
First print: 02 Jul 2024 | 10:51 am IST