On May 26, 2009, China’s Ministry of Finance (MOF) and the China Banking Regulatory Commission (CBRC) jointly issued the Opinions on Strengthening the Financial and Risk Management of Financial Institutions in the Banking Industry in Response to the Current Financial Crisis. The Opinions can be seen as a continuation of the Several Opinions on Strengthening the Management of Enterprises’ Financial Affairs in Response to the Current Financial Crisis, which was discussed in our last issue of China Update), issued by MOF on April 9, 2009. In conjunction with the Several Opinions, the Opinions were released in response to the State Council’s Opinions on Stimulating Distribution and Promoting Consumption, issued by the General Office of the State Council at the end of 2008, to stimulate domestic consumption in the wake of the global financial crisis.
Whereas the Several Opinions target enterprises that are struggling to cope with the financial crisis, the Opinions focus specifically on financial institutions that are operating in the banking industry. The Opinions urge these financial institutions to further improve their quality of service to facilitate economic growth. To this end, MOF and CBRC provide guidance for financial institutions based on their lines of business.
In the Opinions, MOF and CBRC require financial institutions in the banking sector to pay close attention to the target borrower’s financial management conditions by referring to the provisions in Several Opinions. All aspects of the financial management of the target borrower are key considerations for pre-loan screening, loan document review and post-loan inspection. Financial institutions should carefully review cross and cycling guarantees made between affiliated enterprises, and adjust their credit line and management strategies to prevent the accumulation of credit risk. Further, the Opinions provide that the Guidelines on Managing Risks from M&A Loans for Commercial Banks should be followed when offering loans for M&As.
MOF and CBRC also advise financial institutions to keep sufficient resources to cover bad debts. Specifically, financial institutions are expected to categorize their non-performing loans (NPLs), accurately report them in their financial statements, and allocate resources set aside for bad debts on a timely basis, if necessary. While doing so, the financial institutions may refer to the Measures for the Administration of Bad Debt Provisions for Financial Companies. In addition, financial institutions should improve the quality of their assets and divest their NPLs promptly.
Under the Opinions, financial institutions are recommended to conduct overseas M&As carefully and take precautions for the risks related to overseas investments. With respect to M&A, the prescriptions for financial institutions in the Opinions are very similar to those for enterprises in the Several Opinions, except that financial institutions are also encouraged to segregate the multifarious risks arising from M&As in order to more effectively manage them.
Like the Several Opinions, the Opinions also stress the importance of cost control. Financial institutions in the banking sector, for example, are required to reasonably tighten their daily expenses. In particular, the Opinions provide that the compensation of management should be based on the economic environment, development of the industry, and the particular situation of the institutions within the industry. Luxurious rewards and treatments are prohibited.
The Opinions also address the issue of corporate governance to safeguard shareholder interests. The Opinions prescribe that financial institutions, especially those state-owned banks that have gone public, follow the provisions of the Company Law by clarifying the duties of the board of directors, board of supervisors, and executives, and by establishing a mechanism that prevents the accumulation of too much power in any one of these parties. The board of directors and executives should fulfill their fiduciary and supervisory duties; and the role of the board of supervisors should be strengthened so that supervisors have the power to impede acts by directors and executives that do not serve the best interests of the shareholders.
Additionally, MOF and CBRC advise financial institutions to establish an internal risk control system, reduce their off-balance sheet risk exposure, and intensify scrutiny of their financial statements. Overall, the Opinions reflect the expectation of MOF and CBRC that the banking sector will contribute to economic revitalization by improving their strategic decision making, better serving their clients and shareholders, and carefully managing the risks that have arisen in the economic slowdown.