Information about Asia and the Pacific Asia y el Pacífico
China's Road to Greater Financial Stability
Front Matter

Front Matter

Udaibir Das, Jonathan Fiechter, and Tao Sun
Published Date:
August 2013
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Information about Asia and the Pacific Asia y el Pacífico
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© 2013 International Monetary Fund

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Joint Bank-Fund Library

China’s road to greater financial stability: some policy perspectives / editors Udaibir S. Das, Jonathan Fiechter and Tao Sun.—Washington, D.C.: International Monetary Fund, 2013.

p.: ill. ; cm.

Includes bibliographical references.

1. Finance—China 2. Financial institutions—China. 3. Banks and banking—China. 4. Economic development—China. 5. Macroeconomics. I. Das, Udaibir S. II. Fiechter, Jonathan. III. Sun, Tao, 1970–IV. International Monetary Fund.

HG187.C6C55 2013

ISBN: 978-1-61635-406-0 (paper)

ISBN: 978-1-48431-534-7 (ePub)

ISBN: 978-1-47552-373-7 (Mobi pocket)

ISBN: 978-1-47553-321-7 (Web PDF)

Disclaimer: The views expressed in this book are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its member countries.

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The last four years have been a roller-coaster ride for global financial stability. As China transforms its economic and financial future, a key lesson from the crisis is to put in place financial stability safeguards. This book was born of that realization. It is a culmination of the efforts of many people in China, staff of the International Monetary Fund (IMF), and select policy-focused China watchers. The diversity of contributors ensures that we set out issues across different perspectives. Several of the contributors are senior-level practitioners with knowledge and years of experience on China matters. We thank them for their contributions despite their busy schedules.

We would like to extend our special thanks to Deputy Managing Director Min Zhu, who was instrumental in this book coming together. We discussed the original idea with him at the “High-Level Regional Symposium on Monitoring and Managing Financial Stability: Lessons from and for the FSAP” in Shanghai in December 2011, and greatly benefited from his support and guidance for this book.

We would like to pay a special tribute to the staff of the Financial Stability Bureau and the International Department of the People’s Bank of China, who contributed in several different ways during the course of the 2010–11 China Financial Sector Assessment Program to deepening our understanding of the financial stability challenges confronting China. The underlying logic in putting the book together stems from the partnership we developed during those years. We are also grateful for the encouragement provided by José Viñals, Financial Counsellor and Director of the IMF Monetary and Capital Markets Department, who believed in the need for a book such as this.

We would also like to thank Nirmaleen Jayawardane of the IMF Monetary and Capital Markets Department for formatting support, and Patricia Loo and Joanne Johnson of the IMF External Relations Department for coordinating the production of the book.

Last, but not least, we would like to thank a large number of colleagues at the IMF, including those from the Asia and Pacific Department, for their support.

Udaibir S. Das

Jonathan Fiechter

Tao Sun


“They must often change, who would be constant in happiness or wisdom.”


The vast economic and financial transition currently under way in China surely has no precedent in modern economic times. We are indeed witnessing a fascinating and exciting period of economic history. China’s economic ascendancy, which has generated immense opportunities for wealth creation and redistribution, has also been accompanied by a significant expansion in the financial services sector. Not surprisingly, this scale and pace of change is posing some complex financial stability challenges.

It is thus a very great pleasure for me to introduce this impressive series of papers on China’s rapidly growing financial system. This volume makes a timely and definitive contribution to the world’s understanding of the Chinese financial system and its interaction with and impact on the real economy. As the financial sector matures, some of the inherent risks and stress points embedded in the “old” financial system have started to emerge. Fortunately, policy efforts have continued to focus on what is needed to maintain stability while gradually pursuing structural change and financial sector deepening. It is fitting then that this volume focuses on financial system stability—crucial for continued economic progress in China, and also for the functioning of the global monetary and financial system.

The breadth of issues and proposals raised in this book highlights both the considerable ground covered in China in recent years as well as the challenges that lie ahead. The volume brings together contributions from a broad range of world-class experts, including Chinese policymakers, academic leaders, private market participants, and IMF staff. The book reflects the IMF’s ongoing commitment to promote worldwide financial stability and to work closely with the Chinese authorities in support of their financial reform agenda.

Policymakers today are still in a firefighting mode. A key lesson emerging from this long global crisis is that issues of financial soundness that might arise in a single financial firm or in a segment of a country’s financial market can quickly turn into a full-fledged nationwide crisis of confidence. To quote a Chinese proverb: “A spark can start a fire that burns the entire prairie.” If not addressed promptly and effectively, issues regarding the soundness of the financial system may quickly morph into a macroeconomic crisis, with adverse effects on output, trade, and employment. Given the interconnectedness of financial systems and markets, problems in one country may be rapidly transmitted across borders.

A second key lesson from this crisis has been the persistence of the poisonous adverse feedback loop between macrosovereign risk and financial sector weaknesses. In addition to the primacy of strengthening public balance sheets and lowering public debt in key advanced economies, increased efforts are being marshalled by global leaders to strengthen the robustness of financial systems, including supervisory and regulatory frameworks. Some of these initiatives require bold political decisions related to these frameworks. In this respect, the IMF’s increased focus on financial sector surveillance and the effective integration of financial stability analysis in our Financial Sector Assessment Programs (FSAPs) are timely and will help our members better identify risks to financial stability and address those risks through enhanced policy and structural changes.

Financial reforms in China have been a priority for over a decade and the authorities are fully aware of the challenges ahead. They should be commended for the patience and skill with which they have deftly handled the process thus far, and for their intellectual objectivity and openness to learning from outside experience. The first independent assessment of the Chinese financial system was carried out by the IMF and World Bank during 2010–11 as part of the FSAP. The assessment lauded the progress that had been made over the past decade and also confirmed what senior Chinese officials had already been highlighting: there are important gaps in the regulatory and supervisory system, and China needs to broaden and deepen its financial markets and services in order to create a more diversified sector that operates on commercial principles. While the banking system will continue to play a dominant role, other elements of the financial sector will need to assume a larger share of the intermediation role.

At the same time, reforms in China should seek to modernize the monetary policy framework so that the central bank can respond and adapt to the opening of the financial and capital accounts and help sustain China’s economic growth and development goals. Despite the remarkable improvement in China’s ability to transform savings into productive investments, a consistent macroeconomic policy framework is intrinsic to financial stability.

The increasingly complex global environment will not make life any easier for China’s policymakers. First, Asia remains vulnerable to external shocks through the trade channel and from shifting tides of investor sentiment. As we have seen during the crisis, this has strongly affected international financial flows and the functioning of capital markets. On the corporate side, major international firms are restructuring and choosing to disengage from some business lines and market segments altogether, which is affecting the availability of credit. Second, the agenda for globally agreed-upon regulatory reforms is ambitious and the impact of these reforms on markets and financial intermediation has yet to play out. These factors have implications for financial stability in China and will require careful thought, monitoring, and action.

On the bright side, China stands to benefit from the mistakes and lessons of others that have come to light during this crisis. Of particular significance for China is the importance of gathering and analyzing relevant data and information, complying with internationally agreed-upon regulatory norms, implementing robust disclosure practices that act as a buffer against excessive risk-taking, and strengthening monitoring and supervision of nonbank financial institutions. In addition, China needs to develop a clear and accountable institutional framework for financial stability in which the roles and responsibilities of the relevant government institutions are clearly specified.

As the financial crisis recedes and the global economy mends, the appropriate set of financial stability policies will need ongoing attention. This vigilance is the new normal for all policymakers, regulators, and supervisors around the world given the rapid pace of innovation and technological change in financial markets. Even if one subscribes to Hyman Minsky’s “financial instability hypothesis” that the financial system is inherently prone to swings between robustness and fragility, policymakers have no choice but to do everything within their power to strive for stability in order to reduce the severity of boom-bust cycles and the burden of distress on the general public.

In this spirit, it is reassuring to know that China will continue on its path of reform and sustain its important contribution to global financial stability. The experience of other IMF member countries suggests that the appropriate sequencing, quality, and timely implementation of financial reforms will decisively influence the financial stability outcome. In China’s case, continued coordinated interagency efforts will also be needed to build a comprehensive macroprudential framework for measuring and managing systemic risks. All of this will support China’s efforts to rebalance its economy while building a safe and strong financial system that contributes to sustainable growth and employment.

Finally, I would like to extend my thanks to the contributors to this volume. Their essays will contribute richly to the development of the ideas and policies best suited to supporting China’s unique reform path. China has been steadily building the foundation for the future and is well aware of the journey ahead. There will be bumps and bends in the road that will force China’s policymakers to frequently adapt plans and sometimes change course. But with their commitment to the importance of financial stability, I am confident they will succeed in their quest for durable, broad-based economic growth.

Christine Lagarde

Managing Director

International Monetary Fund


Continued reform of China’s financial sector is essential. As the financial sector becomes more complex and domestic and cross-border interconnections expand, the preservation of financial stability in China, a high policy priority, becomes even more of a challenge. The years 2010–11, therefore, were quite significant because China participated for the first time in an external assessment of its financial system, an in-depth analysis undertaken as part of the joint IMF-World Bank Financial Sector Assessment Program (FSAP). China published the resulting financial stability assessment along with detailed reports on its observations of five international financial sector standards. For China, it was a big step forward to allow an independent set of experts to have access to its data and information, to work with these experts to determine risks and gaps in the system, and then to agree to publish the findings.

The results and conclusions of the financial stability analysis were by no means the end of the process, but rather the start of a deeper engagement on financial stability issues. This book focuses on some of the major financial stability issues that came up during the course of the FSAP. It documents what China is already working on to enhance its financial stability monitoring capabilities, while seeking to highlight areas where ongoing policy efforts might focus. It also provides a perspective on shifts taking place in the manner in which China views its financial sector policies and oversees the stability of the financial system. The topics cover issues such as the financial stability framework, risk and vulnerability analysis, systemic linkages, liquidity management, and sequencing financial reforms. These are examined in a forward-looking manner, consistent with China’s objective of strong, sustained, and balanced growth.

China today has become an important global player in financial markets, and a comprehensive approach to the maintenance of financial stability is essential. As China examines policy options for transitioning from its earlier role as a processor of tradable goods for external markets to becoming a source of final demand growth, the financial system needs to adapt. A balance will need to be maintained between domestic considerations and the international implications of the evolving economy. A roadmap for reform should include strengthening the monetary policy framework, continuing to improve the regulatory, supervisory, and financial stability framework, deepening and developing financial markets, and eventually moving toward the longer-term goal of an open capital account with the renminbi as a fully convertible currency. It is for this reason that I believe the FSAP in 2010–11 was so important. A strengthened Chinese financial system will not only help transform China’s growth model toward a more inclusive economy but it will also facilitate the maintenance of stable financial conditions.

The Chinese authorities responsible for financial stability acknowledge the importance of these issues. The challenge facing China will be the sequence, design, and proper implementation of the reforms. There is little doubt that important progress has been made in moving to a more market-based financial system. But China will need to address the buildup of financial sector vulnerabilities as a consequence of the rapid expansion of credit in recent years. The macrofinancial interconnections are deepening and the structural complexity of the financial system is growing.

There are legal and institutional limitations in terms of data collection, monitoring of systemic issues, and information exchange. Systemic risk monitoring and identification requires access to and continuous monitoring of data on business and financial cycles; credit quantity and quality; systemically important institutions, markets, and instruments; and firms and activities that might be outside the perimeter of regulation. There are well-known near-term risks arising primarily from crisis-related credit expansion, the increase in off-balance-sheet exposures, the rapid increase in real estate prices, and potential external spillovers. Given these pressures, preserving financial stability is a huge task. A systematic and steady approach to strengthening the financial infrastructure will have significant benefits for China’s long-term economic growth and performance.

The ongoing global economic and financial crisis has reshaped the focus of the FSAP product. The China FSAP emphasized the importance of a sound financial stability framework. It aimed to help national authorities identify the source, probability, and potential impact of key risks to macrofinancial stability, assess China’s ability to manage and resolve financial crises, and design longer-term policies and reforms. The IMF has sought to recognize—and learn from—the shortcomings of precrisis FSAPs, which may have underappreciated idiosyncratic and systemic liquidity risks and cross-border or cross-market interconnections. More focus is now being placed on country-specific circumstances. The FSAP has also benefited from an improved analytical toolkit covering a wider range of risks, cross-border spillovers, and interactions between the financial sector and the broader economy. We have also sought to make our assessments more candid and transparent.

In 2010, the FSAP was made a mandatory part of Article IV surveillance for jurisdictions with systemically important financial sectors. For all other jurisdictions, participation in the FSAP is voluntary. Key considerations in making the FSAP mandatory included the important spillovers that can stem from disruptions in financial centers that are highly interconnected with those in the rest of the world, and the need to make financial sector surveillance more risk-based by focusing on jurisdictions with the greatest impact on the global financial system.

This landmark decision has formally brought financial sector issues to the core of the IMF’s bilateral surveillance. For both advanced and emerging economies, FSAPs represent a unique opportunity to obtain an external assessment of their financial sectors, while taking advantage of lessons arising from the current crisis. Although FSAPs cannot prevent future crises, they can help national authorities assess the quality and preparedness of their financial infrastructures to deal with major strains in their financial sectors. The improved FSAP is playing a particularly important role in the Asia Pacific region, where we have seen a significant increase in demand since the onset of the financial crisis. Most Asian members with large financial sectors have now undertaken one or more FSAPs.

The three questions arising out of the FSAPs that have become central to financial stability framework are:

  • How prepared are systemic countries to assess the adequacy of their financial stability policy framework and implement tougher regulatory supervisory standards? The global crisis has underscored the need to evaluate the effectiveness of financial supervision, the quality of financial stability analysis and reports, the role of and coordination between the various institutions involved in financial stability policy, and the effectiveness of monetary policy. Addressing these issues presents challenges for national authorities and the international community.
  • Are countries adequately assessing the source, probability, and potential impact of key risks to macrofinancial stability? The FSAP makes a comprehensive assessment of the financial system and its linkages with the real economy. This involves, in particular, investigating the features of the overall policy framework that may attenuate or amplify financial stability risks (e.g., the exchange rate regime). It also involves quantitative stress testing of banks and the broader financial system, and a qualitative assessment of the authorities’ ability to monitor and identify systemic risks.
  • What systems are in place to manage and resolve financial crises? The adequacy of contingency planning, financial safety nets, and resolution regimes that provide for the orderly restructuring or liquidation of financial institutions has become essential today. Resolutions of cross-border institutions and insolvencies in the nonbank sector make this more complicated. Effective coordination of policies across key agencies is crucial to reduce gaps and ensure consistent communications.

There are still many questions regarding financial stability that have yet to be fully addressed. For instance, how prepared are countries to implement major regulatory changes, including Basel III, and will that be enough to address systemic risks or is more required? How do we ensure that regulatory reforms and higher prudential standards are applied consistently across countries and without undue disruption to the ability of the financial system to support growth? Are we adequately covering the “nonsystemic” institutions and markets in our financial stability monitoring? Can we design a financial safety net that helps mitigate the need for “excess” reserve accumulation? How can we ensure consistency in the quantitative risk analysis to improve cross-country comparability and go beyond bank-centric risks to include sovereign risks, asset price shocks, and spillovers? Hopefully this book on China’s financial stability issues will contribute to a dynamic discussion of these important questions.

José Viñals

Financial Counsellor and Director

International Monetary Fund

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