The Banking Regulation Review: China
The banking system in the People's Republic of China (PRC)2 was historically monopolised by the People's Bank of China (PBOC), first as the only bank, then later as the central bank of the PRC. After China started its economic reform and began opening up in 1978, and since the early 1980s, China has gradually opened its banking industry to embrace diversified ownership and sophisticated businesses. The Chinese banking system is still evolving under various reforms.3 In the early 1980s, the government allowed four state-owned specialised banks to accept deposits and conduct banking business, namely:
- the Industrial and Commercial Bank of China (ICBC);
- the China Construction Bank (CCB);
- the Bank of China (BOC); and
- the Agricultural Bank of China (ABC).
In 1986, the Bank of Communications (BCM) opened for business after being restructured into the first state-owned joint-stock commercial bank. Since then, ICBC, CCB, BOC, ABC and BCM have secured their positions as the five largest commercial banks in the PRC measured by gross assets. In addition, the Postal Savings Bank of China is now regarded as the sixth state-owned large commercial bank according to the latest official list of banking institutions in 2021.4 These six banks have all conducted initial public offerings (IPOs) and have diversified their state ownership to the public. Despite these IPOs, they are all still majority-owned by the central government. Apart from the six big banks, since the mid-1990s there have been 12 nationwide joint-stock banks, including CITIC Bank, Hua Xia Bank and Minsheng Bank, which have diverse equity structures comprising state ownership and private or foreign shareholding, as well as 130 city commercial banks.5 Since 2014, the government has also promoted the participation of private capital in the financial sector. To date, 18 privately owned banks have been approved,6 including internet banks, such as Zhejiang E-Commerce Bank and Shenzhen WeBank. These two banks were founded by the internet giants Alibaba and Tencent to provide internet financial services.
To encourage constructional, industrial and agricultural development, in 1994 China established three policy banks to fulfil special lending services for construction projects, import and export companies and the agricultural sector.7 There are also banks in China dedicated to rural areas of the country.8 In addition, foreign banks are allowed to establish subsidiaries and branches in China, and to make strategic investments in Chinese-funded commercial banks.9 As at the end of December 2021, the total assets of the Chinese banking system were 3376.579 trillion yuan.10 This volume marked an increase of 8 per cent year-on-year, with the five largest commercial banks controlling 1325.831 trillion yuan, or approximately 39.3 per cent of the total assets.11
Banking business in the PRC is primarily supervised and regulated by the China Banking and Insurance Regulatory Commission (CBIRC) (formerly known as the China Banking Regulatory Commission (CBRC)), together with the central bank, the PBOC, which is responsible, among other things, for formulating and implementing monetary policy. In addition, non-banking financial institutions, such as trust companies, financial leasing companies, foreign exchange companies, consumer financial companies and automobile financial companies, are also under the administration of the CBIRC.
The regulatory regime applicable to banks
Companies planning to conduct banking business or the business of taking deposits in the PRC are required under the PRC Law on Regulation and Supervision over Banking Industry (Banking Regulation Law) to be approved by the CBIRC.
i Main regulatory body
The CBIRC was formed via the merger of the CBRC and the China Insurance Regulatory Commission as part of the efforts of the central government to improve the efficiency of financial regulation and eliminate regulatory arbitrage. The CBIRC is responsible for drafting and promulgating the rules and regulations governing the banking and insurance sectors in China. It also examines and oversees banks and insurance companies, collects and publishes statistics on the banking system, approves the establishment or expansion of banks, and resolves potential liquidity, solvency or other problems that might occur to individual banks.
The CBRC was founded in 2003 to play the role of supervisor and regulator in the banking sector, which was previously performed by the PBOC. Nonetheless, the PBOC still has considerable influence over the PRC banking system. Aside from the typical central bank responsibility of monetary policy and representing the PRC in international forums, the PBOC is also in charge of reducing overall financial risk and promoting the stability of the financial system. Its supervision over interbank markets, foreign exchange markets, the payment and settlement system and the credit information system interim is crucial to the operation of banks in the PRC. Moreover, according to the Statement on the State Council's Institutional Reform Plan (2018),12 some of the authority for drafting key regulations and prudential oversight of banking and insurance companies has been transferred from the CBRC (now the CBIRC) to the PBOC.
ii Banking regulation structure
The PRC banking regulation structure is three-tiered.
At the top level sits legislation enacted by the National People's Congress, including the Banking Regulation Law (2006), the People's Bank of China Law (2003)13 and the Law of the PRC on Commercial Banks (2015) (Commercial Banks Law).14 Further important regulations concerning foreign banks were formulated by the State Council, namely, the Administrative Regulations of the People's Republic of China on Foreign-Invested Banks (revised in 2019).15 The CBRC (now the CBIRC) subsequently issued interpretive rules in December 2019 to implement these Regulations.
The second tier consists of regulatory policies issued by the CBIRC and the PBOC, which reiterate the legislative principles set out in the legislation enacted by the National People's Congress and the State Council. A range of policy matters were addressed by the CBIRC and the PBOC. The medium-term goal of the CBIRC focuses on a prudential framework, whereas the long-term goal is to establish a fair and competitive market. The PBOC, as the central bank, is responsible for making and implementing currency policy as well as supervision and management of the financial sector.
The third tier consists of the guidance, notices and rules issued by the CBIRC and the PBOC. Most of the regulatory rules issued by the CBIRC and the PBOC fall into this category. As China finds specific measures more helpful than a principles-based approach, the guidance, notices and rules are prescriptive in content and abundant in number. In general, the third tier of regulatory rules serves as the bottom rung of China's banking regulations, and deals with contemporary regulatory issues.
iii Licensing of banks
In terms of licensing, banks in the PRC are divided into two general categories: Chinese-funded banks and foreign-funded banks. The division is based on the status that the individual bank gained at its establishment. In other words, if foreign investors buy into an established Chinese-funded bank as promoters or strategic investors, that bank would keep its original status as a Chinese-funded bank in respect of its supervision and regulation by the CBIRC.16
Licensing for Chinese-funded banks
Commercial banks in the PRC are primarily governed by the Commercial Banks Law, and are licensed to undertake banking activities by the CBIRC or its local counterparts. To implement licensed bank activities, the CBIRC has promulgated the Implementing Measures for Administrative Licensing Matters Related to Chinese-funded Commercial Banks,17 which apply to, inter alia, the six aforementioned biggest commercial banks, joint-stock commercial banks and urban commercial banks, and the Implementing Measures for Administrative Licensing Matters Related to Rural Small and Medium-sized Financial Institutions,18 which apply to, inter alia, rural commercial banks, rural cooperative banks, rural credit cooperatives and county banks. According to these two sets of measures, the establishment, transformation or termination, and the business scope, of a commercial bank, as well as of its domestic and overseas branches, are subject to the approval of the CBIRC or its local counterparts. If a commercial bank intends to raise or issue debts and capital supplement instruments, or operate foreign exchange business, derivative products transaction business, credit card business, offshore banking business or other business, it shall seek approval from the CBIRC or its local counterparts separately. The PBOC's approval is required if commercial banks intend to conduct the business of settlement and sale of foreign exchange.
Licensing for foreign-funded banks
The State Council amended the Administrative Regulations of the People's Republic of China on Foreign-Invested Banks, and the CBIRC subsequently issued the implementing measures of the State Council Regulations19 (together, the Foreign-Funded Banks Regulations). Foreign financial institutions are allowed to establish wholly foreign-owned banks or Sino-foreign joint venture banks in the PRC, provided that the foreign investor meets the prudential requirements as specified in the Foreign-Funded Banks Regulations. The sole or major foreign investor should be a commercial bank and fulfil the capital adequacy requirements of the regulatory authority where it is located and the CBIRC. Foreign commercial banks are also allowed to establish branches and representative offices in the PRC in accordance with the prudential requirements as specified by the Foreign-Funded Banks Regulations.
Similar to Chinese-funded banks, a foreign-funded bank must obtain the CBIRC's approval for its establishment, any changes to its registered capital, articles of association, shareholders and business scope, and its termination. Foreign-funded banks, including wholly owned foreign banks, Sino-foreign joint venture banks and foreign banks' branches, shall seek separate approval from the CBIRC to engage in foreign currency and yuan business, such as:
- taking deposits;
- issuing loans;
- issuing and underwriting government debt securities;
- purchasing or selling government and financial debt securities;
- providing letters of credit or guarantees;
- providing international and domestic settlements;
- processing collections and payments (and insurance) in an agency capacity;
- interbank lending;
- banking card business; and
- other business approved by the CBIRC.
The above-mentioned banks must seek separate approval from the PBOC for the business of settlement and sale of foreign exchange. However, foreign banks' branches are excluded from conducting credit card business and yuan business towards Chinese citizens, except absorbing fixed-time deposits from Chinese citizens in an amount of no less than 500,000 yuan.20 The representative offices are only allowed to engage in non-business operations related to foreign banks represented by such offices, such as liaison, market survey and consultation activities.21
iv Securities activities
The Chinese bond market is now one of the largest in the world (only second to the US), with an estimated US$742.626 billion as at 31 December 2021.22 The China Interbank Bond Market (CIBM) was established on 6 June 1997. It is the market for securities trading and repurchasing for institutional investors (including commercial banks, rural credit unions, insurance companies and securities companies). The CIBM comprises the China Foreign Exchange Trading Center, the National Interbank Funding Center and the Central National Debt Registration and Settlement Company. The PBOC is the supervisory body of the CIBM.
Six major kinds of bonds are available in the CIBM:
- treasury bonds issued by China's Ministry of Finance;
- bonds issued by the PBOC;
- policy bank bonds issued by policy banks;
- financial bonds, including commercial bank bonds and non-bank financial institution bonds;
- corporate bonds issued by non-financial enterprises, commercial paper and medium-term notes; and
- other types of bonds, such as local government bonds issued by provincial or city governments, asset-backed securities and foreign bonds issued by foreign entities.23
Financial institution issuers, such as policy banks, commercial banks, finance companies and financial institutions with legal person status within the territory of China, need to obtain approval from the PBOC to issue financial bonds. Foreign-funded banks are also qualified to engage in debt trading in the CIBM according to the Foreign-Funded Banks Regulations.24
Foreign institutions incorporated outside of China are also permitted to issue bonds, also called Panda bonds, subject to the fulfilment of certain conditions and requirements. The government has further loosened the thresholds for foreign issuers by issuing new Panda bond measures in 2018.25 Currently, all types of issuers (except for financial institutions) are only required to apply for registration with the National Association of Financial Market Institutional Investors (NAFMII), a self-regulation body.26 On the other hand, overseas financial institutions are subject to stricter requirements when issuing Panda bonds, and have to meet demands set out in the new Panda bond measures and other related regulations.
i Relationship with the prudential regulator
All banks in the PRC shall strictly observe the rules of prudent operation, including risk management, internal control, capital adequacy, asset quality, loan loss provisioning, risk concentration, connected transactions and liquidity management of assets. The CBIRC conducts off-site and on-site supervision of business operations and assesses the risk profile of banks.
The CBIRC has established a rating system and an early warning mechanism for the continuous supervision of banks. The CBIRC has the power to require banks to submit their balance sheets, profit statements, other financial accounting statements, statistical reports, and information concerning business operations and management, as well as audit reports prepared by certified public accountants. The CBIRC may also enter the premises of banks, interview staff, check and make copies of or seal up banks' documents and materials, and examine computer systems, as required for prudent supervision.
ii Management of banks
The CBIRC closely controls the appointment and removal of the directors and senior executives of banks. All directors and senior executives shall meet the requirements specified by the CBIRC and be approved by the CBIRC or its local counterparts before taking office. The chair of a board of directors and senior executives of a wholly foreign-owned bank shall not concurrently serve as senior executives in a foreign bank's branch that engages in the foreign exchange wholesale business.27
The CBIRC, or its local counterparts, examine candidates' qualifications with regard to:
- their experience, knowledge and skills;
- their reputation, character, competence, soundness of judgement and diligence;
- whether they have a record of non-compliance with non-statutory codes or have disciplinary records;
- their involvement as a director in any companies wound up by the court; and
- their business record and financial soundness and strength.
In addition, the CBIRC may interview a person to be appointed before making its decision.
According to the Circular of the China Banking and Insurance Regulatory Commission on Issuing the Guidelines for the Corporate Governance of Banks and Insurance Institutions,28 the board of directors is ultimately responsible for the operation and management of a bank, including liquidity risk management.29 The CBIRC may, if necessary for performing its duties, hold supervisory consultations with the directors and senior executives of a bank, and ask them to explain important matters concerning its business operations and risk management. Directors and senior executives are responsible for the misconduct of banks, and in the event of the misconduct of a bank may receive a lifetime ban on working in the banking sector.
iii Regulatory capital and liquidity
Capital adequacy ratio
In implementing the Basel III capital regulations, the CBIRC has set up a uniform regulation system of the capital adequacy ratio of commercial banks.30 The requirements also apply to the branches of foreign banks in the PRC.
The minimum requirements for the capital adequacy ratio of a commercial bank include the following: the core Tier 1 capital adequacy ratio shall not be lower than 5 per cent; the Tier 1 capital adequacy ratio shall not be lower than 6 per cent; and the capital adequacy ratio shall not be lower than 8 per cent. Based on the minimum capital requirements, a commercial bank shall accrue reserve capital at 2.5 per cent of its risk-weighted assets fulfilled by the core Tier 1 capital. Under specific circumstances, a commercial bank shall also accrue countercyclical capital based on the minimum capital requirements and the reserve capital requirement. The countercyclical capital shall be zero to 2.5 per cent of its risk-weighted assets, and would be fulfilled by the core Tier 1 capital. A systemically important bank is required to accrue supplementary capital at 1 per cent of its risk-weighted assets fulfilled by the core Tier 1 capital. In addition, the CBIRC is entitled to specify more prudent capital requirements under the second pillar framework to ensure that the capital fully covers the risks.31
Unconsolidated and consolidated capital adequacy ratio
The CBIRC imposes capital requirements on commercial banks on both an unconsolidated and a consolidated basis. The calculation on an unconsolidated basis covers all domestic and overseas branches of a PRC-incorporated commercial bank, while the calculation on a consolidated basis covers a commercial bank itself as well as the financial institutions in which it directly or indirectly invests. Commercial banks and investee financial institutions shall jointly constitute a banking group.
A commercial bank shall report both its unconsolidated and consolidated capital adequacy ratios to the CBIRC. The consolidated capital adequacy ratio must be submitted once every six months, while the unconsolidated capital adequacy ratio shall be submitted on a quarterly basis.32
Composition of capital
The core Tier 1 capital is the sum of paid-up capital or common shares, capital reserve, surplus reserve, general risk reserve, undistributed profits and a portion of the minority shareholders' capital. Additional Tier 1 capital of a commercial bank includes other Tier 1 capital instruments and their premiums as well as a portion of the minority shareholders' capital. The Tier 2 capital of a commercial bank is the sum of Tier 2 capital instruments and their premiums, reserve for loan loss in excess33 and a portion of the minority shareholders' capital.
The principal deductible items in calculating the capital adequacy ratio include:
- business goodwill;
- other intangible assets;34
- net deferred tax assets caused due to operating losses;
- shortfall in the loan loss reserve;
- proceeds from sales of asset securitisations;
- the net amount of pension assets with confirmed beneficiaries;
- shares held directly or indirectly in the commercial bank itself;
- cash flow reserves formed by hedging against items that are not measured at fair value in the balance sheet;35 and
- unrealised gains and losses caused by changes to the fair value of the liabilities of the commercial bank due to changes in its own credit risks.36
On 23 May 2018, the CBIRC issued the Measures for the Liquidity Risk Management of Commercial Banks (Liquidity Risk Management Measures) to replace its prior trial version.37 The Liquidity Risk Management Measures introduce three new indicators for liquidity risk supervision in response to Basel III reforms, namely, the net stable funding ratio (NSFR), the liquidity matching ratio and the adequacy ratio of high-quality liquid assets (HQLA), to join the original two indicators: liquidity coverage ratio (LCR) and liquidity ratio.
According to the Liquidity Risk Management Measures, a commercial bank with an asset size of 200 billion yuan and above must continuously meet the minimum supervisory standards for LCR (at 100 per cent), NSFR (at 100 per cent), liquidity ratio (at 25 per cent) and liquidity matching ratio (at 100 per cent). A commercial bank with an asset size of less than 200 billion yuan must continuously meet the minimum supervisory standards for adequacy ratio of HQLA (at 100 per cent), liquidity ratio (at 25 per cent) and liquidity matching ratio (at 100 per cent).
iv Recovery and resolution
When a commercial bank has suffered or will possibly suffer a credit crisis, thereby seriously affecting the legitimate rights and interests of the depositors and other clients, the CBIRC may take over the bank or procure its restructuring.38 The purpose of a takeover is to protect the interests of depositors and to enable the bank to resume normal business through taking such measures as are necessary. The debtor–creditor relationship with regard to the taken-over bank would not change as a result of the takeover.39 The CBIRC should decide upon and arrange the implementation of such takeover.40 From the date of the takeover, the administrator executing the takeover shall exercise the powers of operation and management of the taken-over commercial bank.41 The maximum period of time for a takeover shall be two years.42 A takeover would terminate when the takeover period expires, or when the bank regains its capacity for normal business or is merged or declared bankrupt prior to the expiry of takeover period.43
If a bank violates the law or is not properly operated and managed, thereby seriously threatening the financial order and undermining the public interest unless it is closed, the CBIRC has the power to close and liquidate it. If a commercial bank is unable to pay its debts as they fall due, a PRC court may, after obtaining the consent of the CBIRC, declare it bankrupt and arrange for liquidation with the involvement of the CBIRC. When liquidation is carried out for a bankrupt commercial bank, payment of the principal and interests of the savings deposits of individuals shall be given priority after the liquidation expenses, wages owed to employees and labour insurance premiums have been paid.44
To date, four banks45 have been approved to be declared bankrupt when they were definitively unable to pay their debts. However, in the end the government took over the debts to avoid losses of non-professional depositors.46 In May 2015, the State Council issued the Deposit Insurance Regulation, which prescribes that deposit insurance is subject to a coverage limit of up to 500,000 yuan.47 This means there will be no more unlimited guarantees from the government for larger debts. The bankruptcy of banks will likely be implemented following the Western market practice.
Conduct of business
i Conduct of business rules
One key element of PRC banking regulation is that all banking products or services fall within the regulatory framework. Prudential regulation is not only applied to banking institutions, but also to their banking business products and services. Apart from deposit and loan services, which are generally regulated under the Banking Regulation Law (2006) and the Commercial Banks Law (2015), wealth management, structured deposits and national debts are also ruled by special regulations. The Wealth Management Measures outline a clear structure for a bank to avoid shadow banking and to control a concentration risk of capital.48 According to these Measures, commercial banks issuing structured deposits must have the required derivative product trading business qualifications, and must comply with the CBIRC's regulation of derivatives.49
Overall, the CBIRC takes a broad and rigorous approach to the regulation of banking products and services. Approval of core banking products must be sought from the CBIRC on a case-by-case basis.
ii Potential sources of liability
The potential sources of liability for banks include but are not limited to the Banking Regulation Law and the Commercial Banks Law. The Criminal Law (2018) and the Measures for Banning Illegal Financial Activities (1999) regulate the crime of undermining the orderliness of financial management and the crime of financial fraud.50
The Anti-Money Laundering Law (2007) and the Provisions on Anti-Money Laundering of Financial Institutions (2007) require financial institutions to establish and continually improve a system identifying clients' identities and information, and a reporting system for large-sum transactions and doubtful transactions. Organs and functionaries of banks are also obliged to submit a report on large-sum transactions or doubtful transactions.51 The Administrative Measures on Anti-Money Laundering and Anti-Terrorist Financing of Banking Financial Institutions (2019) also require banking financial institutions to establish anti-terrorist financing management mechanisms to identify and report any clients or transactions in relation to terrorism.52
The administrative punishments in the Administrative Punishment Measures of the CBRC (2015) will be triggered when there are violations of the banking supervision provisions. Banks may face warnings, fines, the confiscation of illegal gains and other punishments when they violate the Foreign Exchange Administrative Regulations on Crimes of Defrauding through, inter alia, illegal arbitrage, evasion, or illegal purchases or sales of foreign exchange.
As the Chinese banking regulator, the CBIRC has tightened its reins on maintaining the order of the banking and insurance sectors by issuing the Administrative Punishment Measures in 2020.53
iii Banking confidentiality
As banks hold large online databases of personal information, data protection has been a major issue in the banking sector. Under the basic principle of customer information confidentiality, commercial banks should keep the secrecy of depositors when handling individual saving deposits. Commercial banks have the right to refuse any individual's or entity's inquiries about private data, and not to freeze, deduct or transfer an individual's savings deposits, unless this is otherwise prescribed by law.54
All transactions and information recordings of any bank cards shall be checked only with a password, and a card-issuing bank shall explain the importance of passwords and the responsibility for their loss to the cardholders in the relevant articles of association on bank cards or the directions for use.55
According to the Cybersecurity Law (2017), banks should require clients to provide their true identity, and should check that information by sending a code via a message before conducting the relevant services. Portable platforms such as telephone banking and online banking apps are under even stricter checks regarding fingerprints and facial identifiers.
The Cybersecurity Law also provides that making disaster recovery backups of important systems and databases, establishing emergency response plans for cybersecurity incidents and organising drills on a periodical basis could be helpful to protect confidential information.56
In 2021, the Personal Information Protection Law of the People's Republic of China was enacted (PIPL).57 According to the PIPL, no organisation (including banks) or individual may illegally collect, use, process or transmit any personal information of another person, or illegally deal in, provide or disclose any personal information of another person.58
Financial institutions, including banks, may raise funds through equity injections, loans, deposit taking, bond issuance, financial leases and obtaining refinancing from the PBOC.59 A branch may raise funds through an allocation of operational capital by its parent bank, loans and deposit taking (if allowed under its business scope). The capital instruments (including Tier 1 and Tier 2 capital instruments) issued by a commercial bank shall meet the eligibility criteria specified in Appendix 1 of the Administration Measures for the Capital of Commercial Banks issued by the CBIRC.60
Customer deposits are the most important source of funding for retail banks in the PRC. Chinese people's propensity to save has been the main cause for keeping customer deposit rates at a high level. Banks taking deposits are required to set aside a yuan deposit reserve61 or a foreign currency deposit reserve,62 or both, and in each case, deposit the same with the PBOC. Under the Deposit Insurance Regulation,63 all deposit-taking financial institutions incorporated in the PRC are required to participate in the deposit insurance scheme. The deposit insurance scheme protects depositors from the loss of their funds, and eliminates the possibility of a run on a bank if rumours spread about that particular bank. However, the Deposit Insurance Regulation excludes its application to branches of foreign banks, and is silent as to whether a branch is able to participate in this deposit insurance system on a voluntary basis. In practice, this is not feasible at the moment.
In terms of loans, a bank may borrow loans through the PRC interbank lending market in accordance with the terms of the Administrative Rules on Interbank Lending.64 A bank may also borrow foreign debts (including foreign loans, foreign interbank lending, foreign interbank deposits, dealings between overseas affiliated banks or affiliates, deposits by non-residents and other forms of foreign debts). Proceeds received under foreign debts cannot be used for the settlement of exchange (i.e., conversion into yuan), to pay debts or interest, or to purchase other foreign exchange.65 Banks can also raise funds through issuing bonds in the CIBM under the supervision of the PBOC.66 In October 2018, the PBOC introduced third-party repos into the CIBM, which is a common type of bond transaction in developed markets but was previously unknown in the Chinese market.
Control of banks and transfers of banking business
i Control regime
In January 2018, the CBIRC issued the Interim Measures for the Equity Management of Commercial Banks, which is aimed at persons who hold more than 5 per cent of the total capital of a bank, or less than 5 per cent of the total capital but with a significant impact on the business management of a bank.67 One focal point is the transparency between shareholders and their holding companies or other concerned persons, and another the origins of the purchasing funds. With regard to the procedure, an investor intending to initially or accumulatively hold more than 5 per cent of the shares of a bank shall file an application with the CBIRC in advance, while an investor holding from 1 per cent to 5 per cent shall, within 10 working days of the date of obtaining the corresponding equities, report to the CBIRC. The shareholding ratio of a shareholder and its affiliates and the persons acting in concert will be calculated on a consolidated basis.68
The same investor and its affiliates and persons acting in concert shall not purchase shares of more than two commercial banks as a major shareholder or control more than one commercial bank, unless their purchase is authorised by the State Council. A major shareholder of a commercial bank shall not transfer any equity it holds within five years of the date of obtaining the equity. In addition, there are some general principles about preventing conflicts of interest.
A detailed business plan is neither required in connection with an application for regulatory approval of an acquisition of a significant stake in a commercial bank, nor where the proposed acquisition is of a significant stake in a holding company of a commercial bank.
The Interim Measures apply to all of the types of commercial banks in China, including state-owned, postal savings, joint-stock and city commercial banks, and, in principle, also to foreign-funded banks. For the latter, there are some further special demands on the capital amounts of foreign investors.
ii Transfers of banking business
Commercial banks cannot transfer their deposits without the assent of their clients, for they are the creditors. On the other side, and in line with the general regulations of the Civil Code of the People's Republic of China, a bank as creditor should be able to transfer its loan arrangements to another bank without the agreement of its clients as debtors.69 However, according to a notice of the CBRC on the transferring of credit assets, the consent of clients is essential for this kind of business, unless it is agreed in advance in the loan contracts. If there is a guarantor for the loan, the guarantor must be consulted about the transfer. When the guarantor does not agree to it, the transfer and the debtor (client) need to look for a new guarantor or a new mortgage.70
In addition, when the transferee is a non-financial institution, the transferring of loan arrangements also needs the approval of the administrative authorities.71 All transferring business must be reported to the regulatory authorities within 30 days of the end of each quarter.72
The year in review
i Further strengthening of the banking regulatory regime
With the imminent revisions to the People's Bank of China Law and the Commercial Banks Law, commercial banks' business scope and corporate governance will be adjusted and strengthened, particularly for small and medium-sized commercial banks. Rules and regulations for internet banking, digital currencies and shadow banking will also be established in the near future.
ii Strengthening data protection in the banking industry
2021 was a milestone year of data protection in China. Personal information protection and compliance are becoming increasingly important in China. Following the Cyber Security Law of China enacted in November 2016, t several important regulations and laws were enacted in 2021.
The Notice on Continuing to Carry Out the Relevant Work of 'Construction Year of Internal Control and Compliance Management' for Banking Institutions,73 issued by the CBIRC on 23 November 2021, emphasises the prevention of personal information security risk events.
The Data Security Law of China was enacted on 1 September 2021. The Data Security Law of China will regulate data processing activities, ensure data security, promote data development and use, protect the legitimate rights and interests of individuals and organisations, and safeguard national sovereignty, security and development interests. Banks' data activities outside China that may 'harm the national security or public interests of China, or the legitimate rights of Chinese citizens or entities' shall undergo national security review.
On 1 November 2021, the Personal Information Protection Law of China (PIPL) came into effect. The PIPL will protect personal information rights and interests, regulate activities of processing of personal information and promote a reasonable use of personal information.
These laws will have far-reaching impacts on banks' IT systems, especially foreign banks' IT systems, as some of the servers are located outside of the territory of China. Banks that are in serious breach of these laws may even lose their business licences.
iii Strengthening green finance and promoting carbon neutrality
On 5 March 2021, Premier of the State Council Li Keqiang delivered the Report on the Work of the Government (Government Report).74 In the Government Report, China sets the targets for its contributions in response to climate change by 2030 and vowed to reduce carbon dioxide emissions per unit of GDP by 18 per cent. The PBOC then issued green finance self-assessment implementation rules to regional banks requiring all banks to strengthen their green finance and to promote carbon neutrality.
iv Further promotion of China's digital currency
China plans to launch its digital currency, or e-CNY, in 2022. It is a cash-like digital currency that is expected to be primarily used for domestic and cross-border retail payments in China. Unlike the decentralised cryptocurrency, which is not backed by any central banks or a single administrator, the e-CNY is controlled and issued by the central bank, the PBOC. The PBOC and e-CNY operating institutions have conducted large scale e-CNY pilot programmes in multiple cities in 2021. The introduction of the e-CNY serves two goals:
- the long-term goal is to compete with other cryptocurrencies or other central banks digital currencies while ensuring the renminbi remains as the dominant currency in China;
- the more immediate goal is to introduce a cash-like digital payment method into China's current payment system that is accessible to all, has low costs and allows greater anonymity.75
The PBOC has adopted a two-tiered structure for the e-CNY. The PBOC issues the e-CNY. Users will need to open an e-CNY account at one of the tier 2 institutions, which currently include the six largest stated-owned banks and two internet banks (WeBank and MYBank). According to statistics, the e-CNY app has been used by approximately 261 million users in transactions totalling US$13.8 billion by the end of December 2021.76 China has also opened the e-CNY to foreigners gradually. The e-CNY is an important step for China to further develop its digital payments and technological innovations.
v Expanding CIBM underwriting business scope for foreign-funded banks
On 20 July 2019, the Financial Stability Committee of the State Council announced measures on the further opening up of the financial industry pursuant to which foreign-funded banks are allowed to obtain a Category A lead underwriting licence in the CIBM.77 Under the CIBM rules, bond underwriters are divided into two categories: lead underwriters and underwriters. Previously, foreign-funded banks were rarely allowed to become underwriters. In 2013, NAFMII further subdivided lead underwriters into two categories: Category A and Category B, of which only the latter was open to foreign-funded banks.78 The difference between the two categories mainly lies in the fact that Category A lead underwriters may conduct lead underwriting businesses nationwide for debt financing instruments of non-financial enterprises, while Category B lead underwriters may only conduct lead underwriting business within a specified scope, and need to conduct lead underwriting business jointly with Category A lead underwriters (which must be banks) for one year. After the one-year period has expired, Category B lead underwriters can conduct lead underwriting business on their own.
Currently, only eight foreign-funded banks have obtained interbank bond market underwriting licences in relation to non-financial enterprises debt financing instruments, with only two of these qualified as Category A leader underwriters,79 two qualified as Category B lead underwriters80 and four qualified as underwriters.81 The PBOC further limited Category B lead underwriters' business scope to debt financing instruments issued by offshore non-financial enterprises only. In practice, this meant that foreign-funded banks could only underwrite Panda bonds, which is a rather small market compared with the domestic interbank bond market.
The measures issued by the Financial Stability Committee allow foreign-funded banks to obtain Category A lead underwriter qualifications and expand their business into underwriting issuance of all types of debt financing instruments nationwide. This means that foreign-funded banks will be able to tap into the trillion-dollar interbank bond market, and compete with their domestic counterparts on a more level playing field.
vi Implementation of the revisions of Basel III 2017 in China
China has not yet taken steps in direct response to the revisions of Basel III 2017 (Revisions), as the newly revised standards will not come into force until 2022. However, some regulations issued by the Chinese regulator in the past few years, such as those regarding the leverage ratios,82 liquidity risks83 and large exposure,84 concentrate on some of the shared focuses under the Revisions.
Commercial banks in China still need to accept the standardised measurement approach under Basel III, which is not yet generally used in practice in China. According to the renewed framework, many banks in China should increase their capital. It is expected that more detailed regulations concerning implementing the Revisions into China's whole banking regulatory system will be released in the near future.
vii Reform on wealth management business of commercial banks
In late 2018, commercial banks were requested to separate their wealth management businesses from banking operations by the end of 2020.85 Specific regulations over wealth management subsidiaries of commercial banks have been released accordingly in the past year.86 Following new regulatory requirements, Chinese banks have been racing to set up wealth management firms. The regulators are also encouraging foreign financial institutions to buy into wealth management subsidiaries of commercial banks,87 and the CBIRC has gone on record to state that it will guide qualified banks towards bringing in foreign investment to their wealth management operations,88 a sector in which foreign investors are likely to have a longer track record in what is still a relatively young industry in China.
viii Cross-border NAFMII Master Agreement
On 27 January 2022, NAFMII issued the cross-border NAFMII Master Agreement and the related interest rate derivative definitions and credit derivative definitions.89
There are five major changes compared with the 2009 version of the NAFMII Master Agreement:
- added tax-related provisions;
- added applicable cross-border netting arrangements;
- added multiple branch provisions;
- added applicable dispute resolution provisions; and
- added non-legal entities' products provisions.
Regarding interest rate derivative definitions, there are three major changes compared with the 2012 version of the interest rate definitions:
- added option definitions;
- added loan prime rate and fixing depository-institutions repo rate definitions; and
- added fallback provisions.
Regarding credit derivative definitions, there are five major changes compared with the 2016 version of the credit derivative definitions:
- revised debt restructuring definitions;
- added debt inheritance provisions;
- added single debt special arrangements;
- added credit deterioration option; and
- revised public information expression.
These three documents show the government's endeavours to further open up the financial markets.
ix Derivatives close-out netting development
Close-out netting, a well-known mechanism in international derivative transactions, is not a legal concept expressly recognised under PRC law and this leads to uncertainty in its enforceability. This is despite the fact that the concept has been introduced into master derivative agreements prevalent in the Chinese market, including the NAFMII Master Agreement (2009 version) (NAFMII Master Agreement), which is applicable to financial derivative transactions. Under the Chinese bankruptcy law,90 the administrator is entitled to rescind or continue the performance of contracts that were concluded prior to the acceptance of the bankruptcy application.91 This cherry-picking presents challenges to the enforceability of close-out netting under the Chinese legal framework and increases the market risk of derivative transactions. Moreover, the administrator has the right to request the courts to revoke any settlement made between the debtor and individual creditors within six months before the courts accept the bankruptcy application.92 This further affects the enforceability of close-out netting. Particularly since memoranda published by international industry associations classify China as a 'non-netting jurisdiction', Chinese and foreign banks generally calculate their counterparty risk exposures and related regulatory capital charges on a gross basis when dealing with Chinese bank derivatives counterparties.
In 2018, the CBIRC (then the CBRC) issued the Measurement Rules for the Default Risk Assets of Derivatives Counterparties (No. 1  of the General Office of the CBRC), pursuant to which the CBIRC recognised the credit risk mitigation benefits of close-out netting in its regulatory capital rules. Furthermore, on 26 November 2021, the CBIRC issued the Notice on Issues Concerning the Measurement Rules for the Default Risk Assets of Derivatives Counterparties [CBIRC, 26 November 2021]) allowing Chinese banks to apply the netting approach on financial institution derivative exposures calculations for the purpose of daily large exposure monitoring and regulatory reporting of large exposure. Following various regulatory changes, China has made a breakthrough in its netting legislation. The relevant provisions of the draft Futures and Derivatives Law and the draft amendments to the Commercial Banks Law all reflect the recognition and protection of close-out netting at the legislative level.93
The National People's Congress, China's top legislature, published the Futures and Derivative Law (draft) on 29 April 2021 for a first round public consultation and on 23 October 2021 for the second round public consultation (Futures and Derivative Law (Draft)). The Futures and Derivative Law (Draft) recognises that a master agreement, all supplementary agreements under the master agreement and any agreement agreed by both parties in each specific transaction shall together constitute a single integrated agreement between both parties and be legally binding (single agreement).94 The transaction may be terminated as agreed upon in the agreement and netting of all trading profits and losses under the agreement shall be conducted accordingly, which shall not be suspended, invalidated or revoked in the event that either party to the transaction enters bankruptcy proceedings (close-out netting).95 This prevents the bankruptcy administrator from cherry-picking by continuing a favourable contract and terminating an unfavourable one. If the Futures and Derivative Law (Draft) is adopted in its current form, the single agreement and the close-out netting clauses will prevail over the Enterprise Bankruptcy Law of the People's Republic of China, as special laws are superior to general laws in the hierarchy of Chinese legal authorities.
Outlook and conclusions
Even with the coronavirus pandemic, the outlook for the PRC banking system remains positive as the industry continues to grow robustly and the country opens up further to international investment. We anticipate a more level playing field for domestic and foreign banks, and more opportunities for foreign banks to develop in the PRC. We also anticipate that the banking regulation will be loose in general but tight in key areas. The Chinese financial regulatory environment is constantly evolving, and foreign investors need to combine the regulatory strategy with business plans for the purpose of sustainable development in China.
1 Shengzhe Wang is legal counsel at Credit Agricole Corporate & Investment Bank (China) Limited and Fugui Tan is a senior associate at Hogan Lovells International LLP.
2 For the purposes of this chapter, the PRC excludes Taiwan and the special administrative regions of Hong Kong and Macao.
3 For a good overview of the history of banking reform in China, see Chapter 2 of C Jiang and S Yao, 'The Evolution of the Banking Sector in China', Chinese Banking Reform, 2017, the Nottingham China Policy Institute Series, DOI 10.1007/978-3-319-63925-3_2.
4 Issued by the China Banking and Insurance Regulatory Commission (CBIRC) on 19 August 2021; see http://www.cbirc.gov.cn/cn/view/pages/govermentDetail.html?docId=1002746&itemId=863&generaltype=1.
5 List of banking financial institutions (as at 30 June 2021) issued by the CBIRC on 19 August 2021; see id.
7 The policy banks are the Agricultural Development Bank of China and the Export-Import Bank of China, which are individually dedicated to a specific lending purpose, and the China Development Bank, which is the financial institution for development, and is not only committed to financial policy programmes but also to commercial financial services.
8 As at 30 June 2021, there were 1,478 rural commercial banks, four lending companies and 178 rural cooperative banks in China (statistics from the official list of banking financial institutions, issued by the CBIRC on 19 August 2021).
9 As at 30 June 2021, there were 40 foreign-funded banks in China (statistics from the official list of banking financial institutions, issued by the CBIRC on 19 August 2021).
10 Issued by the CBIRC on 27 December 2021; see http://www.cbirc.gov.cn/cn/view/pages/ItemDetail.html?docId=1026346&itemId=954&generaltype=0.
12 www.gov.cn/guowuyuan/2018-03/17/content_5275116.htm, accessed on 24 January 2022.
13 The People's Bank of China (PBOC) published the People's Bank of China Law (Consultation Draft) on 23 October 2020, in which, inter alia, digital currencies, monetary policy tools and monetary penalties were added or amended.
14 The PBOC published the Law of the PRC on Commercial Banks (Consultation Draft) on 16 October 2020, in which, inter alia, commercial banks' business scope, restrictions on interest rates, reorganisation, takeover procedures and close-out netting, were amended. Once the revised Law of the PRC on Commercial Banks is enacted, it will have some impact on commercial banks in China.
15 Promulgated and enforced on 30 September 2019.
16 Article 11 of the revised Implementing Measures for Administrative Licensing Matters Related to Chinese-funded Commercial Banks, promulgated and enforced on 17 August 2018.
17 First promulgated by the CBRC on 5 June 2015 and last revised by the CBIRC and enforced on 17 August 2018.
18 First promulgated by the CBRC on 5 June 2015 and revised by the CBIRC and enforced on 17 August 2018, last revised by the CBIRC and enforced on 26 December 2019.
19 Implementing Measures of the China Banking and Insurance Regulatory Commission on Administrative Licensing for Foreign-funded Banks, promulgated and enforced on 26 December 2019.
20 Article 31 of the Administrative Regulations of the People's Republic of China on Foreign-invested Banks (Revised in 2019), first promulgated by the State Council on 11 November 2006 and last revised by the State Council and enforced on 30 September 2019.
21 Article 33 of the Administrative Regulations of the People's Republic of China on Foreign-invested Banks (Revised in 2019), first promulgated by the State Council on 11 November 2006 and last revised by the State Council and enforced on 30 September 2019.
24 PBOC Measures for the Administration of Bond Transactions in the National Interbank Bond Market, promulgated and enforced on 30 April 2000.
25 The Administration of Issuance of Overseas Institutional Bonds in the National Interbank Bond Market Interim Measures, promulgated and enforced on 8 September 2018.
26 The National Association of Financial Market Institutional Investors (NAFMII) is a self-regulation organisation under the approval of the State Council of China. Members include policy banks, commercial banks, credit cooperative banks, insurance companies, securities houses, fund management companies, trust and investment companies, finance companies affiliated with corporations, credit rating agencies, accounting firms and companies in non-financial sectors. NAFMII aims to propel the development of the Chinese over-the-counter financial market, which is composed of the interbank bond market, interbank lending market, foreign exchange market, commercial paper market and gold market.
27 CBRC Measures for the Administration of the Office-holding Qualifications of the Directors (Council Members) and Senior Managers of Banking Financial Institutions, promulgated on 18 November 2013 and enforced on 18 December 2013.
28 Article 44 of the CBIRC's Circular of the China Banking and Insurance Regulatory Commission on Issuing the Guidelines for the Corporate Governance of Banks and Insurance Institutions, promulgated and enforced on 2 June 2021.
29 Article 8 of the CBIRC's Measures for the Liquidity Risk Management of Commercial Banks, promulgated on 23 May 2018 and enforced on 1 July 2018.
30 CBRC Administration Measures for the Capitals of Commercial Banks (for Trial Implementation), promulgated on 7 June 2012 and enforced on 1 January 2013.
31 id., at Article 26.
32 id., at Article 148.
33 Up to 1.25 per cent of the risk-weighted assets for credit risks if adopting the weighting approach; and up to 0.6 per cent if adopting the internal ratings-based approach, Article 31 of the Administration Measures for the Capitals of Commercial Banks (for Trial Implementation).
34 Land use rights are not included, Article 32 of the Administration Measures for the Capitals of Commercial Banks (for Trial Implementation).
35 Positive cash flow reserve shall be deducted, while a negative one shall be reversed, , Article 32 of the Administration Measures for the Capitals of Commercial Banks (for Trial Implementation).
36 Article 32 of the Administration Measures for the Capitals of Commercial Banks (for Trial Implementation).
37 CBIRC Liquidity Risk Management Measures, promulgated on 23 May 2018 and enforced on 1 July 2018.
38 Articles 38 and 64 of the Commercial Banks Law, promulgated on 29 August 2015 and enforced on 1 October 2015.
39 id., at Article 64.
40 id., at Article 65.
41 id., at Article 66.
42 id., at Article 67.
43 id., at Article 68.
44 id., at Article 71.
45 Hainan Development Bank (1995–1998), Shantou Commercial Bank (1997–2001), the credit cooperatives of Shang Village in Hebei Province (1956–2017) and Baoshang Bank Co, Ltd (1998–2020).
46 The debts of the Hainan Development Bank were taken over by the Industrial and Commercial Bank of China under the instruction of the PBOC (PBOC announcement on 21 June 1998): www.huagu.com/hgjj/20180603237567.html; Shantou Commercial Bank was restructured into Guangzhou Huaxing Bank in 2013 with the support of Guangdong provincial government and Shantou city: www.ghbank.com.cn/tzzgx/gsgg/201603/t20160303_7195.html; the debts of the credit cooperatives of Shang Village were paid through the funding of the Union of Credit Cooperatives of Suning County of Hebei Province: www.chinanews.com/cj/2012/08-19/4117014.shtml; and the debts of the Baoshang Bank Co, Ltd were taken over by the Mengshang Bank and Huishang Bank (CBIRC announcement on 30 April 2020): www.cbirc.gov.cn/cn/view/pages/ItemDetail.html?docId=901933&itemId=925&generaltype=0.
47 Article 5 of the Deposit Insurance Rule (State Council), promulgated on 17 February 2015 and enforced on 1 May 2015.
48 CBIRC Measures for the Supervision and Administration of the Wealth Management Business of Commercial Banks, promulgated and enforced on 26 September 2018.
49 Article 75 of the Wealth Management Measures.
50 Part 2, Chapter 3, Sections 4 and 5 of the Criminal Law 2020; and the Measures for Banning Illegal Financial Activities (State Council) enforced on 13 July 1998 and revised on 8 January 2011.
51 Chapter 1 of the Anti-Money Laundering Law, promulgated on 31 October 2006 and enforced on 1 January 2007.
52 Article 19 of the Administrative Measures on Anti-Money Laundering and Anti-Terrorist Financing of Banking Financial Institutions, promulgated and enforced on 29 January 2019.
53 Administrative Punishment Measures of the China Banking and Insurance Regulatory Commission, promulgated on 15 June 2020 and enforced on 1 August 2020.
54 Articles 29 and 30 of the Commercial Banks Law.
55 PBOC Notice on Issuing the Measures for the Administration of Bank Card Business, promulgated and enforced on 5 January 1999.
56 Article 34 of the Cybersecurity Law, promulgated on 7 November 2016 and enforced on 1 June 2017.
57 Personal Information Protection Law of the People's Republic of China, promulgated on 20 August 2021 and enforced on 1 November 2021.
58 Article 10 of the PIPL.
59 The Financial Rules for Financial Enterprises were promulgated by the Ministry of Finance on 7 December 2006 and enforced on 1 January 2007, and the Circular of the Ministry of Finance Regarding the Release of Financial Rules for Finance Enterprises – Guidelines for Implementation was released by the Ministry of Finance on 30 March 2007 and enforced on the same date.
60 Article 28 of the Administration Measures for the Capital of Commercial Banks (for Trial Implementation) issued by the CBIRC.
61 Article 32 of the Commercial Banks Law and Article 39 of the Foreign-Funded Banks Regulations.
62 Article 3 of the PBOC Regulations on Foreign Currency Reserve of Financial Institutions, promulgated on 29 October 2004 and enforced on 1 January 2005.
63 Regulations on Deposit Insurance (State Council), promulgated on 17 February 2015 and enforced on 1 May 2015.
64 The Administrative Rules on Interbank Lending, promulgated on 3 July 2007 and enforced on 6 August 2007.
65 The Administrative Measures on the Foreign Debts of Foreign-funded Banks were promulgated by the National Development and Reform Committee, PBOC and CBRC on 27 May 2004 and enforced on 27 June 2004.
66 Administrative Measures for the Issuance of Financial Bonds in the National Inter-bank Bond Market, promulgated on 27 April 2005 and enforced on 1 June 2005; Administrative Procedures for the Issuance of Financial Bonds in the National Inter-bank Bond Market, promulgated on 25 March 2009 and enforced on 15 May 2009.
67 Article 4 of the Interim Measures for the Equity Management of Commercial Banks, promulgated and enforced on 5 January 2018.
69 Article 545 of the Civil Code of the People's Republic of China, promulgated on 28 May 2020 and enforced on 1 January 2021.
70 CBRC Circular on Further Regulating the Credit Asset Transfer Business of Banking Financial Institutions, promulgated and enforced on 3 December 2010.
71 PBOC Reply on the Problems of Transferring Loan Arrangements, promulgated and enforced on 30 July 2001.
72 CBRC Circular on Further Regulating the Credit Asset Transfer Business of Banking Financial Institutions, promulgated and enforced on 3 December 2010.
73 Notice on Continuing to Carry Out the Relevant Work of 'Construction Year of Internal Control and Compliance Management' for Banking Institutions, promulgated and enforced on 23 November 2021.
74 https://language.chinadaily.com.cn/a/202103/15/WS604ed1cfa31024ad0baaf337.html, accessed on 29 January 2021.
76 '<a href="https://www.scmp.com/tech/tech-trends/article/3163953/chinas-digital-currency-e-cny-wallet-nearly-doubles-user-base-two">China's digital currency: e-CNY wallet nearly doubles user base in two months to 261 million ahead of Winter Olympics', South China Morning Post (scmp.com).
77 www.pbc.gov.cn/goutongjiaoliu/113456/113469/3863019/index.html, accessed on 29 January 2022.
79 ibid., Deutsche Bank and BNP Paribas.
80 ibid., HSBC and Standard Chartered.
81 ibid., JPMorgan Chase, Citi, MUFG and Mizuho.
82 CBRC Measures for the Administration of the Leverage Ratio of Commercial Banks, promulgated on 30 January 2015 and enforced on 1 April 2015.
83 CBIRC Measures for the Liquidity Risk Management of Commercial Banks, promulgated on 23 May 2018 and enforced on 1 July 2018.
84 CBIRC Measures for the Administration of the Large Exposures of Commercial Banks, promulgated on 24 April 2018 and enforced on 1 July 2018.
85 Article 82 of the Wealth Management Measures.
86 For instance, the CBIRC Administrative Measures on Wealth Management Subsidiaries of Commercial Banks, promulgated and enforced on 2 December 2018; and the CBIRC Administrative Measures on Net Capital of Wealth Management Subsidiaries of Commercial Banks (for Trial Implementation), promulgated on 29 November 2019 and enforced on 1 March 2020.
87 www.pbc.gov.cn/goutongjiaoliu/113456/113469/3863019/index.html, accessed on 23 February 2021.
88 www.cbirc.gov.cn/cn/view/pages/ItemDetail.html?docId=227841&itemId=915&generaltype=0, accessed on 23 February 2021.
89 Proposal to review the 'Master Agreement on Financial Derivatives Transactions in the China's Interbank Market (Cross-Border Text - 2022 Edition)', Interest Rate and the Terms of Credit Derivatives, the second meeting of the fourth council of NAFMII, accessed on 8 February 2022.
90 Enterprise Bankruptcy Law of the People's Republic of China, promulgated on 27 August 2006 and enforced on 1 June 2007.
91 ibid., Article 31.
92 ibid., Article 32.
93 http://www.cbirc.gov.cn/cn/view/pages/ItemDetail.html?docId=1020671&itemId=915&generaltype=0, accessed on 8 February 2022.
94 Futures and Derivative Law (Draft), Article 33.
95 ibid., Article 35.