Prudential regulationi 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 would conduct off-site and on-site supervision of business operations and 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.
The CBIRC or its local counterparts would 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 Corporate Governance Guidance for Commercial Banks, the board of directors is ultimately responsible for the operation and management of a bank, including liquidity risk management. 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 liquidityCapital 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. 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.Unconsolidated and consolidated capital adequacy ratio
The CBIRC imposes capital requirements on commercials 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.Composition of capitals
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 excess and a portion of the minority shareholders' capital.
The principal deductible items in calculating the capital adequacy ratio include:
- business goodwill;
- other intangible assets;
- 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; 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.
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. 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 shall 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 shall 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. 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. The CBIRC should decide upon and arrange the implementation of such takeover. 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. The maximum period of time for a takeover shall be two years. 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 expiration of takeover period.
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.
To date, two banks (Hainan Development Bank and the credit cooperatives of Shang Village in Hebei Province) 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. 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. This means there will be no more unlimited guarantee from the government for larger debts. The bankruptcy of banks will be likely implemented following the Western market practice.