More Reforms Could Bolster China’s Financial Sector, Finds the World Bank

November 15, 2011

WASHINGTON, November 14, 2011 −The World Bank today published the Financial Sector Assessment for China. This report summarizes the findings of the Financial Sector Assessment Program (FSAP) exercise for China undertaken by a joint IMF/World Bank team. 

The FSAP was launched by the International Monetary Fund and World Bank in 1999. The program helps countries identify vulnerabilities and development opportunities in their financial systems and determine needed reforms.

“China has made considerable progress in developing a financial system that is more commercially-based and financially sound,” said Tunc Tahsin Uyanik, Director of East Asia and the Pacific in the Financial and Private Sector Development Vice Presidency at the World Bank.

“Reforms have accelerated since 2003, with the Chinese government adopting a series of policies to enhance the resilience of the financial sector and, on the structural side, strengthening a large number of domestic financial institutions and improving market confidence,” he said.

“However, China is confronted with some near term risks, reform challenges and development opportunities as it continues to modernize its financial sector that will require a strategic and holistic approach to reforms.” 

The report indicates that near term domestic risks are four-fold: (i) the impact of the recent sharp credit expansion on banks’ asset quality; (ii) the rise of off-balance sheet exposures and lending outside the formal banking sector; (iii) the relatively high level of real estate and commodity prices; and (iv) the increase of imbalances due to the current economic growth pattern.

The report finds that macroeconomic and financial policies need to be better aligned to create incentives for a durable transformation to a more commercially-oriented and effective financial system. In particular, the government is advised to reorient its role in the financial system, in order to improve credit allocation processes, promote financial markets and services that reduce the need for high levels of precautionary savings, and strengthen institutional structures.

According to the report, China should continue its efforts to strengthen the financial sector’s regulatory and supervisory regime. The report recommends that the People’s Bank of China (PBC) and the primary supervisory commissions be empowered with focused mandates, operational autonomy and flexibility, increased resources and skilled personnel. Efforts are also needed to implement consolidated supervision and ensure effective regulatory coordination and information sharing among all relevant agencies. According to the report, supervision should be more forward-looking.

The report also finds that progress has been made to upgrade financial infrastructure and relevant legal systems, but more reforms are needed to (i) enhance the legal framework and oversight function of the payments and securities settlement system; (ii) improve the coverage and quality of the Credit Reference Center; (iii) improve the oversight and quality of credit rating agencies; (iv) upgrade and strengthen consumer protection; (v) enhance the insolvency regime and creditors rights; (vi) define a clear process for dealing with troubled financial institutions and depositors; and (vii) establish a framework and tools for effective macro prudential and financial stability.

According to the report, broader and more diversified financial products and services would deepen and strengthen China’s financial system. The report finds that fixed income markets need to be further developed, in conjunction with continued interest rate reforms. It is recommended that this include a more proactive government debt issuance strategy to support the risk-free yield curve, improve access for new non-government issuers, and the development of different types of instruments to address the diverse needs of issuers and investors. The report advises that the continued development of the insurance sector, which has grown rapidly but has scope for further deepening, be supported by more effective regulation and supervision. According to the report, while China is gradually consolidating its multi-pillar pension system, more efforts are needed to meet the sizable challenges.

Finally, the report recommends that financial inclusion be improved through reforms that provide the right incentives for the provision of financial services to under-served sectors, foster market competition, improve legal and regulatory frameworks and financial infrastructure for financial inclusion, and remove policies not properly aligned with the overall objective of improving access to finance.

About the FSAP 

The Financial Sector Assessment Program, established in 1999, is an in-depth analysis of a country’s financial sector. The IMF conducts mandatory FSAPs for the 25 jurisdictions with systemically important financial sectors, and any member countries that request it. Assessments in developing and emerging market countries are conducted jointly through the Fund and the World Bank. FSAPs include two components: a financial stability assessment, which is the responsibility of the Fund; and, in developing and emerging market countries, a financial development assessment, conducted by the World Bank.

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