New Laws Boost Banking Industry Supervision and Management

The PRC Banking Regulation Law (中华人民共和国银行业监督管理法)establishes a new ¡§State Council Banking Supervision Management Institution¡¨ that is, the CBRC, to undertake regulatory supervision responsibilities for all banking institutions and activities within China. Financial asset management companies (AMCs) managing system bad debts, trust and investment companies, finance companies and financial leasing companies are also subject to the CBRC¡¦s authority under this law. However, it should be noted that foreign banking institutions in China may be subject to other laws and regulations, in which case those would prevail.

The functions and responsibilities of the CBRC include:

(1) drafting and promulgating regulations and rules for banks and banking activities in conformity with laws and administrative edicts;

(2) examining and approving establishment and changes of business scope of banking institutions;

(3) vetting banks¡¦ capital increases as well as identities and sources of funds of investors;

(4) approving all banking products;

(5) vetting directors and senior managers;

(6) enacting prudent operating procedures and standards, relating to, inter alia, risk management, internal controls, capital adequacy, asset quality, loss provisions, risk concentration, related party transactions, and asset liquidity (it is noted that separate laws and administrative rules may also apply to these matters);

(7) setting up a database to systematically monitor the activities and risks of the banking institutions;

(8) undertaking on-site inspections of the banking institutions to determine their activities and risk situations;

(9) supervising preparation of unified financial statements;

(10) establishing a risk rating system and risk monitoring system for individual banking institutions, and setting inspection schedules and scope accordingly;

(11) establishing and designating a position with responsibility for perceiving and reporting ¡§sudden incidents¡¨ in the banking industry (if such incidents threaten to increase banking system risk or imperil social stability, it is the responsibility of the head of the CBRC to immediately report to the State Council);

(12) together with the PBOC and the Ministry of Finance, establishing a sudden incident resolution system, designating persons and agencies and related operating procedures; and

(13) compiling and publishing national statistics relating to banking institutions.

Specific deadlines are provided within which the CBRC is to render decisions on matters such as approving new banks (six months), changes in business scope and new products (three months), and eligibility of directors and senior managers (30 days).

The law provides the CBRC with powers to order banks to reform, alter or cease specific operations, and it can also revoke banking licences. The CBRC can forbid, restrict, or order transfers of assets and equity ownership. It can dismiss or restrict the authority of directors and senior managers. The CBRC is also empowered, when it deems that a bank faces a credit crisis or otherwise threatens the interests of depositors or the banking system, to take over administration of the bank.

The law gives the CBRC unambiguous enforcement powers and specifies a long list of infractions and non-compliance for which penalties, administrative punishments, and referral to criminal justice authorities shall be meted out.

Amendments to the PRC Commercial Banking Law

Looking at the revisions of the Commercial Banking Law, it is clear that the NPC Standing Committee has in mind a quid pro quo for additional state funding of the banking system. This is surely an attempt to usher in a new era of probity and honesty in the operations of the banks. While the previous act issued in 1995 empowered the China Securities Regulatory Commission to punish wrongdoing, the revisions in the banking law lay out in greatly expanded and detailed provisions the wrongdoing that is being targeted and the punishments for violators.

Enlargement of the scope of business ¡V actually codifying activities already approved provisionally and under way ¡V is limited to acceptance and discounting of commercial bills, trading government and financial institution bonds, and engaging in credit card business. With PBOC approval, banks can deal in foreign currency.

Minimum registered capital for setting up a nationally licensed bank is set at Rmb1 billion, while the requirement for a city commercial bank is Rmb100 million. Recognizing that many banks are being recapitalized, and thereby acquiring new shareholders, a new provision requires that information must be provided regarding the credit standing of all equity holders of 5% or more.

The revisions take aim at senior managers, and especially the directors, of banks. The new regulations require vetting to ensure competence and pre-approval by the CBRC of acquisition of ownership stakes of 5% or more. Provisions have been carried over from the original law that prohibit persons acting as directors or senior bank managers who have records of corruption, criminal conduct, responsibility for corporate bankruptcy and the like.

Several new provisions in the Commercial Banking Law tighten up lending and remedial management practices. Banks are newly required to immediately call on guarantors for repayment when guaranteed loans are defaulted. Collateral assets acquired must be disposed of within two years.

Other new provisions highlight previous abuses. For example, banks are specifically prohibited from using funds raised in the interbank funds market to make fixed asset loans or for investments. Banks are specifically ordered to issue financial reports that truly and completely reflect their operations to the CBRC, PBOC and the Ministry of Finance. They must keep only one set of financial statements.

The most extensive revisions are seen in Chapter Eight on Legal Responsibilities. Essentially, the revisions lay out in detail the monetary penalties for negligence or malfeasance by banks. In particular, where a bank has profited from improper or negligent handling of customer transactions, the provisions stipulate fines of one to five times the amount of the profit gained, in addition to compensation to the customer. The revisions lay down specific monetary penalties and more severe punishments for a broad array of specific infractions and violations ¡V e.g., buying or selling foreign exchange without approval or acting as a securities broker. The penalties include revocation of licences and assignment of criminal responsibility, as determined by the CBRC. Further, the new law makes it clear that passive resistance to supervision, stalling actions or deception by banks will no longer be tolerated. Such actions are now subject to specific sanctions and punishments. Moreover, the revisions hold directors and senior bank officers directly responsible for compliance with the provisions of the law and mete out specific penalties, including dismissal and lifetime prohibition of service as directors or senior banking officers.

A supplementary article provides that foreign banking institutions may be subject to different regulations.

Amendments to the People¡¦s Bank of China Law

The amendments to the Central Banking Law are essentially those that were needed to refocus and redefine the central bank¡¦s role after the transfer of principal authority and responsibility for banking supervision to the CBRC. The role and responsibility of the PBOC is thus narrowed to ¡§under the leadership of the State Council, setting and implementing monetary policy, preventing and resolving financial risk and maintaining financial stability¡¨. The objective of monetary policy, which remains unchanged, is to maintain a stable value for the currency and to promote economic growth.

An amended article requires the PBOC to report on monetary policy and financial system operations to the Standing Committee of the NPC. It is stipulated that the Monetary Policy Committee of the PBOC should play an ¡§important role¡¨ in setting and adjusting macroeconomic and monetary policy.

In other amended provisions, the PBOC retains authority (clearly co-extensive with that of the CBRC) to launch inspections and exercise supervision in respect of issues and transactions for which the PBOC remains responsible, e.g., activities in the interbank funds market (which is managed by the PBOC); actions relating to foreign exchange handling regulations; actions relating to currency management regulations; actions relating to reserve deposit account regulations; money laundering; etc. A separate revision specifies that criminal charges will be filed against persons engaged in or supporting currency counterfeiting. As in the banking law, amendment provisions set out clear and specific penalties and punishments, including criminal prosecution, for the infraction of regulations set by the PBOC in the areas of its responsibility. A rewritten provision warns PBOC staff of severe punishment for corruption, abuse of power and negligence.

In conclusion, it can be said that the creation of the CBRC and the revisions of the commercial banking and central bank laws constitute a significant step forward not only for effective bank regulation in China, but also for reform of the system. Anyone familiar with China¡¦s state-owned banks knows that, more than simple prudential regulation, what is needed to ensure the safety and soundness of the financial system is progress in resolving the inherent conflicts and mismanagement resulting from state ownership exercised as a monopoly. Because during the next few years virtually all Chinese banks will adopt corporate systems and offer equity ownership to the public, including foreign strategic investors, the role of the regulatory authority will be to ensure that banks offer greater transparency and accountability, in the interests of investors as well as of the state.

Stephen M. Harner is president of S.M. HARNER AND COMPANY, a Shanghai-based financial industry consultancy. He can be reached at [email protected].