China makes strong start on economic transition

Last year was a complicated and volatile one for the global economy. In China, economic headwinds helped forge consensus on the need to promote structural reforms, which are rebalancing the relationship between the government and the market. There is a need to deepen financial reforms and improve financial stability while boosting financial sector competitiveness. Some important progress was made in the past year.

Deposit insurance

On May 1, 2015, the State Council launched its Deposit Insurance Regulation, which guarantees deposits of up to 500,000 yuan, thus fully covering 99.63% of depositors, including enterprises. The deposit insurance scheme is an essential reinforcement of China's existing financial safety nets that will further stabilise the country's banking sector. It will boost the incentives for long-term saving and strengthen small- and medium-sized banks. The deposit insurance scheme lays the foundation for a competitive and sustainable financial system.

Renminbi reform

In August 2015, the People's Bank of China (PBoC) changed the way it determines the exchange rate of the renminbi, giving market forces greater influence over where it sets the daily midpoint rate – the rate it gives to the China Foreign Exchange Trade System before the opening of the interbank foreign exchange market on each working day. This marked a milestone in renminbi exchange rate reform during the past decade. However, in response to the market reaction that followed, the government adjusted the exchange rate, so that it can return to a reasonable and balanced level. This will allow it to serve as a reliable benchmark in future. The renminbi exchange rate formation mechanism (the midpoint rate determination mechanism) was overhauled and the International Monetary Fund's (IMF) Special Data Dissemination Standard was adopted.

In addition, several measures designed to further liberalise the renminbi have been announced. The foreign exchange and interbank bond markets are now open to foreign financial institutions, including central banks. The Ministry of Finance has been issuing three-month Treasury bills on a weekly basis since October, thereby strengthening the yield curve. And the first phase of the Cross-border Interbank Payments System (CIPS) was launched in October 2015. CIPS allows processing of cross-border renminbi transactions and supports the settlement of cross-border trades of commodities and services, cross-border direct investment, cross-border financing and cross-border remittance business for individuals. It simplifies settlement and safeguards renminbi internationalisation.

Relaxing interest rate regulation helps optimise resource allocation, directing financial resources towards those sectors and enterprises truly in need of capital
Zhang Hongli, IFF Academic Committee

The measures mentioned paved the way for the renminbi's successful inclusion in the IMF's Special Drawing Rights (SDR) basket announced on November 30, 2015. The RMB is weighted 10.92% and the new basket will be launched on October 1. SDR inclusion is not only an important step towards renminbi internationalisation, but a testament to China's role at the centre of global economic and financial governance. There had been four currencies that made up the SDR basket for the past few decades, which represented the four most powerful economies in the world. The fact the renminbi joins as the fifth reserve currency represents the IMF's recognition of China's economic and financial system, and acknowledgement of the free use and internationalisation of the renminbi.

Interest rate liberalisation

To allow the market to play a decisive role in allocating financial resources, the PBoC, with the approval of the State Council, decided to remove the upper limit on deposit rates charged by commercial banks and rural cooperative financial institutions on October 24, 2015. Thus, a key step was made towards interest rate liberalisation, manifesting China's determination to implement its reform agenda.

First, relaxing interest rate regulation helps optimise resource allocation, directing financial resources towards those sectors and enterprises truly in need of capital. It allows the market to play a vital role and should help to ensure healthy and sustainable economic development.

Zhang Hongli

Second, relaxing control on interest rates instills fresh momentum in promoting the transformative development of financial institutions. With the upper limit on deposit rates removed, the traditional business model of financial institutions following the concept of ‘scale is profit' is no longer sustainable. This helps financial institutions to adopt a business concept that is profit-centered, accelerate the transformation of their business models, improve the interest rate determination mechanism, enhance the capacity of independent pricing, implement differential pricing, satisfy increasingly diversified financial needs and truly enhance the quality of financial services.

Third, relaxing control on interest rates creates favourable conditions for the transformation of the monetary policy framework, allowing authorities to gradually switch from quantity-based to price-based monetary policy regulation. Strengthening price control is inevitable to improve the efficiency of macro control, and easing control on interest rates is an important prerequisite to achieving such a transformation.

The PBoC has also released a paper on the roadmap for developing an interest rate corridor. According to the paper, the central bank could stabilise market interest rates through range management and expectations guidance. With the formation of market-based benchmark interest rates and improvement of the transmission mechanism, the PBoC's role in determining benchmark lending and deposit rates may be gradually reduced or even removed.

Policy-based finance

China has stepped up structural reform efforts and accelerated the implementation of innovation-driven strategies. Other major strategies, such as achieving the Belt and Road initiative and the Beijing-Tianjin-Hebei regional development, need substantial investment. Development-oriented and policy-backed finance is crucial.

In April 2015, the State Council approved a reform plan laid out by China Development Bank, the Export-Import Bank of China and the Agricultural Development Bank of China. The plan specifies the core functions and roles of these three policy banks and requires them to establish and strengthen a capital restraint mechanism.

Specifically, the China Development Bank should adhere to its role as a development-oriented financial institution; the Export-Import Bank of China should strengthen its role as a policy-backed financial institution; and the Agricultural Development Bank of China should focus on policy-based mandates and transform itself into a sustainable agricultural policy bank. As $48 billion and $45 billion of foreign exchange reserves were injected into the China Development Bank and the Export-Import Bank of China respectively in July 2015, the work of capital replenishment required by the reform plans was successfully completed.

Meanwhile, reform plans on the scope of business, the improvement of governance structures and statute amendment of the three banks are in progress. Such reforms will improve the capital strengths and risk resistance capacity of the banks; strengthen their functions and the roles of policy-backed and development-oriented finance in supporting underdeveloped and key sectors; and help to ensure steady growth, make structural adjustments, bring benefits to people and promote a healthy and sustainable economic and social development.

Regulated internet finance sector

As China's development model is changing and technological advances are making themselves felt in finance, China's financial sector is undergoing a transformation. Regulators and supervisors must adapt. In July 2015, the PBoC – together with 10 ministries, departments and agencies of the Chinese government – jointly published the Guiding Opinions on Promoting the Healthy Development of Internet Finance (the ‘guiding opinions'), an important step that led the internet finance sector into a new stage of law-based regulated development.

China made important progress in 2015, with reform measures being implemented at different levels of government and dividends constantly manifested
Zhang Hongli, IFF Academic Committee

Centering on five principles – "legal-based regulation, proportional regulation, classified regulation, coordinated regulation and innovative regulation" – the guiding opinions specify the regulatory responsibilities of different authorities in major types of internet finance businesses, including internet payment, online lending, equity crowdfunding, online sales of investment funds, internet insurance, internet trust funds and internet consumer finance. The guiding opinions represent a new starting point for developing internet finance in China, securing regulated development of this sector.

Regional financial reforms

In December, the State Council decided to pilot several financial reform and innovation projects in selected regions. The purpose is to allow for further accumulation of experience, with the aim to deepen financial reforms and improve the capacity to serve the real economy.

For instance, a rural finance pilot zone in the Jilin Province focuses on defusing risks associated with the scale operation in modern agriculture and exploring new ways of making good use of rural property rights. Meanwhile, the Guangdong free-trade zone facilitates investments and cooperation between the Guangdong Province and Hong Kong and Macau, and the Fujian free-trade zone focuses on the financial cooperation across the Taiwan Strait. The Tianjin free-trade zone, moreover, focuses on development of the financial leasing industry, providing support for the ‘going out' strategy of the large equipment industry.

The PBoC is also piloting the expansion of cross-border use of the renminbi, as well as investment and financing activities.

Deposit reserves assessment

To further improve the deposit reserves system, provide more flexibility to financial institutions in managing their liquidity and smooth money market volatility, the PBoC implemented a new method of calculating bank deposit reserve ratios in September 2015. Under the new average assessment method, financial institutions calculate the average value of their daily final balance of the deposit reserve over a reporting period and its ratio to the reserve assessment base, to ensure such ratio is not lower than the statutory deposit reserve ratio. To promote the stable operation of financial institutions, a daily lower bound is set in the deposit reserves assessment. At the end of each working day during the reporting period, financial institutions should calculate the quotient of the daily balance of the deposit reserves and the PBoC's assessment benchmark coefficient. The quotient should remain no more than 1% below the required reserve ratio.

Switching the method (from the ‘time-point method' to the ‘average method') of calculating bank deposit reserve ratios can lower the amount of required reserves financial institutions must hold to deal with emergency situations and can serve as an important buffer mechanism for financial institutions. During the assessment period, the deposit reserves of financial institutions can be lower than the statutorily required amount at some point of the time, providing the average amount during the period meets the statutory requirement. In this way, financial institutions will have more flexibility in managing liquidity, which mitigates money market volatility, improving the monetary policy transmission mechanism and creating favourable conditions for transforming the monetary policy framework.

The year 2015 was the last of the Twelfth Five-Year Plan and was a key reform year for financial deepening. At the eighth meeting of the central leading group for deepening overall reform, President Xi Jinping, emphasised that improving the quality, rather than the pace, of reforms should be prioritised. President Xi also pointed out that the authorities should strengthen the momentum and synergy of reforms, reinforce the responsibilities of different departments and raise awareness of the general situation and urgency, so that the reforms of many key sectors can be driven by the reform of government itself.

With such guidance, China made important progress in 2015, with reform measures being implemented at different levels of government and dividends constantly manifested, helping to ensure the successful structural transition of the Chinese economy.