An assessment of China's recent financial stability law

Recently, the People's Bank of China (PBoC), together with the National Development and Reform Commission （NDRC）, the Ministry of Justice, the Ministry of Finance, the China Banking and Insurance Regulatory Commission (CBIRC), the China Securities Regulatory Commission (CSRC), the State Administration of Foreign Exchange (SAFE) and other relevant departments have drafted the "Financial Stability Law of the People's Republic of China (Draft for Comment)" (hereinafter referred to as the "Financial Stability Law"), which has attracted the attention of the society and the market. The PBoC pointed out that the enactment of the law is an institutional consideration, aiming at establishing institutional arrangements for preventing, resolving, and dealing with risks, improving the long-term mechanism for maintaining financial stability, enhancing China's financial legal system, further fine-tuning the financial safety net, and firmly guarding against systemic risks.

In the view of researchers at ANBOUND, the introduction of the Financial Stability Law is of outstanding significance in terms of institution establishment, and it also builds the institutional foundation and general operational framework for preventing systemic financial risks.

It can be seen that the legislation of the Financial Stability Law summarizes the relevant experience in dealing with a series of regional financial risk problems. In particular, as China's economic growth is slowing down, problems accumulated in the past are constantly emerging and exposed in the context of "deleveraging". Institutions and enterprises that used to operate in a "highly leveraged" mode, such as Anbang Insurance, Baoshang Bank, Hengfeng Bank, Founder Group, HNA Group, as well as a number of large and debt-ridden real estate enterprises, are no longer sustainable. The debt problems and operational problems of these institutions and enterprises are often extensional and continuous, which will affect the stability of the financial system. In the absence of a systematic system and mechanism, the relevant risks can only be dealt with by financial regulators or local governments on a "case by case" basis. This approach often fails to maintain the confidence of the financial market and establish stable expectations due to the non-transparent handling process, which often results in "excessive contraction" of the financial system and the phenomenon of "asset shortage" often mentioned in the market. If the relevant laws are established in an institutionalized and legalized manner, it will be the result of the further maturity of the financial market and the continuous improvement of the market system, which can make the financial market more rational.

The draft of the Financial Stability Law has clear provisions on the authority, responsibility, and funding for the prevention and resolution of financial risks. In addition to clarifying the Financial Stability and Development Committee as the main body responsible for preventing and defusing financial risks, the responsibilities of local governments, financial authorities, and regulators are also distinctly clarified. For the source of funding, on the one hand, the establishment of funds to prevent financial risks is required; on the other hand, the responsibilities and uses of industrial risk funds, deposit insurance funds, and local risk funds are clarified. The funding and use of relevant funds will also be based on the experience and mechanism of international financial risk prevention and control. In this way, the draft essentially constructs the implementation mechanism for preventing and dealing with financial risks.

Different from the previous general government bailouts of troubled financial institutions and enterprises, the most important element of the financial stability law is to distinguish the main responsibility of financial institutions themselves for risks, and to clarify the responsibilities of industry supervisors and local governments. It requires that the main responsibilities of financial institutions themselves, their major shareholders, and actual controllers be clarified, the prudent operation obligations of financial institutions be strengthened, and the access and supervision requirements for major shareholders and actual controllers to be strengthened. It clarifies local governments' responsibility for maintaining stability, and promptly and proactively defusing regional financial risks. The draft also stated that the supervisory responsibility of financial regulators should effectively perform their duties of financial risk prevention and control, and to prevent and dispose of risks in a timely manner. The PBoC will play the role of lender of last resort to guard against systemic financial risks.

As for the principle of maintaining financial stability, Article 4 of the Financial Stability Law stipulates, "To maintain financial stability, the control of the source of financial risks shall be strengthened, financial activities shall be fully under supervision, financial risks shall be handled in accordance with the market-oriented and law-based management, the legitimate rights and interests of market players shall be fairly protected, and moral hazard shall be prevented." This statement, in fact, is to clarify the source of risk and its own responsibility, while adhering to a market-oriented and law-based restructuring mechanism. First, financial institutions must be licensed to operate and abide by the law. Second, deposit insurance funds and various risk protection funds can act as liquidation and escrow institutions to take over troubled institutions. Third, the loss should be written down in the risk handling of the troubled financial institution. If necessary, the original shareholders or actual controllers will be completely eliminated, rather than a debt-equity swap in the general sense. Fourth, the reorganization needs to guarantee the creditor's rights and interests not less than bankruptcy liquidation, and to safeguard the creditor's interests. A number of financial instruments can be used to provide necessary liquidity support during liquidation and restructuring. Researchers at ANBOUND have noted that the current handling of some financial risk problems is basically proceeding along these lines, and the financial stability law affirms some of the more mature practices in the current handling of financial risk problems, forming institutional rules.

At present, there is a more urgent need to address the problem of debt risk of some large and medium-sized real estate enterprises in China. Most of the troubled real estate enterprises are still in the process of debt restructuring. The new regulations not only provide legal basis for these practical problems, but also provide institutional support and guidance for financial supervision and government departments to play a leading role. Although most of the enterprises with risk problems are private enterprises, it is not impossible for some state-owned enterprises such as “urban investment enterprises” to have risk problems in the future. Considering the impact of Yongmei Group's default on the bond market and financial system in the past, the related risk spillover and the chain shock will be greater. Therefore, the construction of the relevant regulatory system needs to be carried out in a timely manner.

The promulgation of the Financial Stability Law can systematically solve institutional problems of risk prevention, control, and handling. From the perspective of financial market development and financial stability, it is a sign of further maturity and soundness of relevant laws and regulations. In the absence of relevant mechanisms, both investors and financial institutions have no idea how to deal with the debt problem and how to resolve risks, which will more easily trigger market panic and cause the spread of risk. This has been reflected in the shocks to the financial markets caused by the problems of Baoshang Bank. It should be pointed out that the establishment of relevant risk mechanism is of great significance to the marketization of financial market, so as to facilitate financial market participants to truly assess market risks and establish stable expectations. From the perspective of market development, the introduction of the Financial Stability Law is of great significance to the financial system's continuous maturity and market-oriented development.