China is on the brink of implementing its first comprehensive financial stability law, a significant legislative move aimed at fortifying the financial system of the world’s second-largest economy. This landmark bill underscores Beijing’s commitment to preventing and mitigating systemic financial risks through enhanced regulation and a robust financial stability fund.

Key Provisions of the Financial Stability Bill

A Holistic Approach to Risk Management

The bill marks China’s first legislative effort to address financial risk across the entire sector, encompassing banks, insurers, asset managers, and securities firms. Previous regulations targeted specific industries, but this new law provides a unified framework for systemic risk prevention and resolution. It aims to ensure the continuity of basic functions and services of financial institutions, markets, and infrastructures, thereby enhancing the financial system’s resilience.

Article 1 of the draft states: “??????????????????,????????????,??????,????????,??????????,?????” This highlights the law’s goal to establish clear rights, duties, and responsibilities for risk prevention and management.

Centralised Leadership and Coordination

The bill places the Chinese Communist Party at the helm of financial oversight, ensuring a centralised and unified approach. This is evident in Article 3, which emphasises the Party’s leadership: “???????????????????”?

A central financial work leading body will oversee decision-making and policy implementation for financial stability, as stipulated in the latest revisions. This body will coordinate with financial regulators and local governments to manage and defuse financial risks, aimed at ensuring a cohesive and responsive regulatory environment.

Financial Stability Fund

A cornerstone of the new law is the establishment of a financial stability guarantee fund. This fund, primarily financed by contributions from financial institutions, will serve as a contingency mechanism to rescue troubled entities and prevent the spread of financial crises. The People’s Bank of China can also provide low-cost loans to the fund, repayable through the disposal of risky institutions.

While the exact size of the fund remains undisclosed, analysts predict it will accumulate between 120 billion and 180 billion yuan annually. This substantial financial buffer is expected to safeguard systemically important institutions deemed “too big to fail” and those with high-risk profiles.

To address concerns of moral hazard, the bill mandates that troubled financial firms and their major shareholders exhaust self-rescue measures before seeking external assistance. This self-accountability aims to maintain market discipline and prevent reckless financial behaviour.

Article 29 outlines the fund’s structure and utilisation: “???????????????????????????????????????”

Risk Prevention and Early Intervention

The bill emphasises proactive risk management and early intervention. Financial institutions are required to conduct regular risk assessments and maintain robust internal control mechanisms. Local governments must also take an active role in monitoring and addressing regional financial risks.

Article 17 mandates the establishment of a macro-prudential policy framework by the People’s Bank of China, incorporating stress tests and risk evaluations to monitor and mitigate systemic risks: “???????????????????????????????????????????????????”?

Enhanced Supervision and Transparency

The law calls for increased transparency and public disclosure of financial risk information. Financial regulators and local governments are obligated to publish relevant data and promptly address misinformation. This transparency is crucial for maintaining public trust and ensuring informed decision-making by market participants.

Article 9 emphasies the importance of accurate information dissemination: “?????????????????????????????????????????????????? ??????”

Comparisons with the US Financial Stability Oversight Council

The introduction of China’s financial stability law can be compared to the establishment of the Financial Stability Oversight Council (FSOC) in the United States, which was created in 2010 under the Dodd-Frank Wall Street Reform and Consumer Protection Act following the 2008 financial crisis. The FSOC is tasked with monitoring the stability of the U.S. financial system, identifying risks, promoting market discipline, and responding to emerging threats (U.S. Department of the Treasury, 2024).

Objectives and Structure

The FSOC brings together federal financial regulators, state regulators, and an independent insurance expert to assess, monitor, and mitigate risks to U.S. financial stability. It improves communication regarding these risks and facilitates cooperation among member agencies. Key areas of focus for the FSOC include risks related to nonbank financial intermediation, climate-related financial risks, Treasury market resilience, and digital assets (U.S. Department of the Treasury, 2024).

Similarly, China’s financial stability bill aims to create a coordinated approach to financial risk management, but it emphasises centralised control through the Communist Party and integrates local governments more directly into the oversight process. The Chinese approach also includes establishing a substantial financial stability fund to act as a buffer against crises, akin to the role of the U.S. Treasury in backstopping critical financial institutions during emergencies.

Historical Context and Evolution

China’s approach to financial stability also reflects its unique political and economic context. The financial system in China operates under a socialist market economy model, where market mechanisms are tools for the state rather than independent entities (Tsang, 2016). In contrast, the U.S. financial system is market-driven and operates with significant independence from direct political control, although the FSOC’s creation was a direct response to perceived regulatory failures during the 2008 crisis.

Despite these structural differences, both the Chinese and U.S. systems face similar challenges in managing financial risks. For instance, both countries have seen the rapid growth of shadow banking sectors in response to financial repression and interest rate controls, which has created new vulnerabilities (Tsang, 2016).

Implications of the Financial Stability Bill

By creating a comprehensive framework for risk management and a substantial financial stability fund, China aims to bolster the resilience of its financial system. This proactive approach is expected to mitigate the impact of financial crises and protect the broader economy from systemic shocks.

The introduction of this law aligns China with international practices observed in major economies like the United States and the European Union. These regions have long-established mechanisms to support systemically important institutions during crises. China’s move signals its commitment to adopting global best practices in financial regulation.

China’s financial system faces significant challenges, including a protracted real estate crisis, vulnerabilities in smaller banks, and the substantial debt burden of local government financing vehicles. Time will tell whether the new law is capable of providing the necessary tools and regulatory framework to address these issues comprehensively and prevent their escalation into larger crises.

Conclusion

China’s first financial stability law represents a pivotal step in strengthening the country’s financial regulatory framework. By addressing systemic risks comprehensively and establishing a robust financial stability fund, the law aims to safeguard the stability of China’s financial system and ensure its continued contribution to the nation’s economic prosperity. As the bill moves closer to enactment, its successful implementation will be crucial in navigating the complex financial landscape and maintaining confidence in China’s economic future.

If you want to look further at the legislative history and other records of this bill, see here: NPC Observer

References

Dr. Cheng-Yun Tsang, “The Chinese financial system vs. the western financial system: Differences and similarities,” China International Business and Economic Law (CIBEL) Centre, UNSW, August 31, 2016.

U.S. Department of the Treasury, Financial Stability Oversight Council. 2024.

Explainer: What is China’s planned financial stability law and how will it work?, Reuters, July 2, 2024, https://www.reuters.com/markets/asia/what-is-chinas-planned-financial-stability-law-how-will-it-work-2024-07-02/