China’s Central Bank Faces Policy Redirection By Investigation

THE ANTI-CORRUPTION INVESTIGATION of Fan Yifei, one of the six deputy governors of the People’s Bank of China, may suggest that all does not bode well for the central bank as Xi Jinping starts his second decade of leadership.

Xi has been investigating more than two dozen financial regulators, state banks, insurers and investment funds since last year to assert Party authority over a financial sector that Xi far from trusts. Fan is the most senior of several financial officials detained over the past year.

Fan spent most of his career as a banker with the Construction Bank of China, so there may be skeletons not as deeply buried in his cupboard as he may have thought. Over-closeness of party cadre to private sector business is now deeply out of favour.

Yet there a clues that there may be policy motivations behind his investigation. Earlier this year, the Central Commission for Discipline Inspection, the country’s top graft-buster, criticised the central bank for failing to meet Party objectives.

The central bank’s top leadership has been a stronghold of economic reformers and advocates of internationalisation of the Chinese financial system, a policy direction for which Xi has little instinctive enthusiasm.

The PBOC’s internationally respected governor, Yi Gang, and its party secretary, Guo Shuqing, were removed from the Party’s central committee during the 20th Party Congress last month. That is seen as a prelude to them leaving their positions early next year when senior government jobs get reallocated.

Their replacements are likely to be men who will ensure that the central bank — and the financial sector it regulates — fall into line with Party goals, just as the technology sector has been ‘rectified‘. This Bystander expects to be hearing more about financial inclusion for common prosperity.

Fan’s case is the more interesting because he was the vice-governor responsible for payments and financial technology, which involved overseeing the development of the central banks’ digital currency, the e-CNY or digital yuan. It is an area in which the PBOC has built a substantial lead over other central banks. Fan’s last public appearance, in September, was to announce a further expansion of its trial.

Rate Cut Only Highlights Slowing Economic Growth In China

THE 10 BASIS points cut by the People’s Bank of China to its one-year lending rate for the first time since January to 2.75% was unexpected. 

It was a direct response to July’s economic data showing the economy slowing further.

Retail sales growth in July slowed to 2.7% year-on-year, down from 3.1% in June. Industrial output growth was little changed from June at 3.9% year-on-year. Fixed asset investment growth, at 5.7% year-on-year in January-July, was nearly half the pace of last year, and private sector investment grew by just 2.7% year-on-year in the same seven-month period.

The downturn in the beleaguered housing market is accelerating. Property investment fell by 12.3% year-on-year in July, the fastest pace this year. New home sales fell by 28.3% year-on-year. 

Most concerning for the leadership is that, while urban unemployment overall was steady in July at 5.4%, unemployment among 16-24-year-olds set another monthly record at 19.9%. 

The early indications from August are that the economy is not turning round. If anything, the downside risks are growing with the latest lockdowns to control new Covid-19 outbreaks and weaker export prospects as global markets slow.

Further monetary and fiscal stimulus to rev up domestic demand, including state money to revive property development projects, are likely as today’s cut in rates is too modest to have more than a marginal impact. 

China Props Up Housing To Reinforce The Economy

FRIDAY’S CUT IN mortgage rates, the second this year, had been signalled, but its size was a surprise.

The People’s Bank of China lowered the five-year loan prime rate by 15 basis points to 4.45%, the deepest cut since the 2019 revision of its interest rate mechanism, and at least half as much again as private economists expected.

However, the central bank left its one-year reference rate unchanged at 3.70%. This hints that caution over policy easing persists even as authorities seek to boost the beleaguered housing sector to prop up an economy sagging under the weight of the zero-Covid strategy to contain outbreaks of infection.

Housing starts, sales and prices all fell in April. Construction activity fell by 44% year-on-year, following a 20% year-on-year drop in January-March. For the first four months of the year, residential property sales were down by 32.2% year-on-year and commercial property sales by 29.5%.

More than 100 cities have introduced measures in recent months to support first-time buyers while keeping speculative investors at bay. In the short term, the latter group’s return would most rapidly ginger up housing market activity, even if the long-term costs are undesirable.

For now, authorities can hope to do little more than stabilise the property downturn, especially while cities remain in lockdown. Reinflating prices would require broader stimulative measures, undoing several years of stop-go deleveraging of the debt risks in the economy.

Meanwhile, the scope for broader interest cuts is also limited by fears of accelerating the pace of capital outflows as the US Federal Reserve raises its rates.

Soft GDP Number Will Pressage More China Stimulus

THE PEOPLE’S BANK OF CHINA (PBOC)’s announcement that it was cutting banks’ reserve requirement ratio by a quarter of a percentage point from April 25 was well signalled.

It is likely the first in a series of small stimulus measures as authorities seek to counter the slowing of the economy in the face of the country’s worst wave of Covid outbreaks and soaring food, energy and metals commodity prices due to the war in Ukraine.

Premier Li Keqiang has stressed the need to ensure that economic growth picks up in the second quarter. Economic stability is the new watchword.

Monday’s first-quarter preliminary GDP figures are unlikely to make pretty reading. Year on year growth is expected to slow from 4.0% to around 3.5%, and quarter-on-quarter growth from 1.6% to barely 1.0%. The accompanying industrial production and retail sales numbers will also likely be soft.

Beijing will find it difficult to reach its 5.5% growth target this year, but there is no sign yet that it will be jettisoned.

PBoC Indicates Careful and Selective Easing in 2022

THE PEOPLE’S BANK OF CHINA (PBoC) on December 24 provided support for those who think that the central bank’s monetary policy will be more expansive early next year so that the slowing economy does not get ahead of its intended orderly decline.

The statement issued after its quarterly monetary policy committee meeting echoed the view of the Central Economic Work Conference earlier this month that:

The external environment is becoming more complex and severe and uncertain, and the domestic economic development is facing the triple pressure of demand contraction, supply shock and weak expectations.

In response, the PBoC foreshadowed its greater and pro-active support for the real economy through a more forward-looking and targeted monetary policy.

Small and micro businesses are one set highlighted for support. However, this came with the rider that the central bank will ‘strive to ensure that financial support for private enterprises is compatible with the contribution of private enterprises to economic and social development’ — a reminder that private enterprises must remember they are expected to contribute to common prosperity.

Two other stated objectives are to use monetary policy to realise the national goals of carbon peaking and carbon neutrality through developing green finance and safeguarding what the PBoC describes as ‘the legitimate rights and interests of housing consumers’. For those who track such things, the phrase ‘healthy development’ of the real-estate market preceded ‘virtuous circle’ in the statement.

GDP growth is likely to have slowed to 4-5% in the fourth quarter, although it will still come in above the 6% target for the entire year. Sub-6% growth is likely planned for in 2022, even if monetary (and fiscal) policy is carefully and selectively loosened, as the central bank indicates. Economic stability is the watchword for the coming year.

China Doubles Down On Its Crypto Crackdown Again

CHINA IS INTENSIFYING its elimination of cryptocurrencies, banning all trading and mining and promising a crackdown on any illegal activity, according to a joint announcement by the central bank and nine other regulatory agencies.

While the campaign against crypto dates back to at least 2017, the latest announcement reaffirms May’s ban on financial institutions, payment companies and internet firms from facilitating cryptocurrency trading.

The People’s Bank of China also now says that overseas cryptocurrency exchanges providing services in mainland China will be illegal. This closes a loophole being used to evade May’s domestic trading restrictions. Any Chinese citizen aiding or abetting a foreign exchange is now explicitly at risk of investigation.

The central bank added that it had improved its systems for monitoring crypto-related transactions and speculative investing.

As for reasons, the preamble to the announcement says:

Recently, virtual currency trading hype activities have risen, disrupting economic and financial order, breeding illegal and criminal activities such as gambling, illegal fund-raising, fraud, pyramid schemes, and money laundering, and seriously endangering the safety of people’s property.

The announcement sent the prices of cryptocurrencies, notably Bitcoin tumbling, along with the share prices of crypto and blockchain-related companies.

Before the clampdown, Chinese miners accounted for more than half of the world’s crypto supply. The National Development and Reform Commission (NDRC) says ‘such activities contribute little to China’s economic growth, spawn risks, consume a huge amount of energy and hamper carbon neutrality goals’. It has told local governments that it is ‘imperative’ to wipe out crypto mining.

Crypto miners use powerful, energy-hungry computers designed to verify bitcoin transactions in a process that produces new bitcoins. That is a bad look internationally for a country touting its net zero carbon ambitions, and especially amid domestic power shortages for industry.

Following May’s crackdown, most Chinese mining relocated to Central Asia and North America, with cheap energy and policy support. However, the latest announcement suggests that not all of it has moved. The hunt is clearly on for any that remained.

None of the latest measures applies to the state digital currency, the digital yuan or e-yuan, now being trialled in several regions.

Peoples’ Bank Of China Lays Out 2021 Policy Priorities

THE PEOPLES’ BANK OF CHINA has set out its ten priorities for the year. The three it has added to last year’s list of seven are what caught this Bystander’s eye as they indicate what is at the forefront of official thinking: developing green finance, playing a greater role in global financial regulation and containing risks in the bond market.

The priorities are set out in a statement following the central bank’s recent work conference, part of the cascade of work conferences across officialdom from the Politburo’s meeting in December on the 2021 economic goals and subsequent Central Economic Work Conference the same month.

Some high-profile defaults have made bond-market reform as high a priority for the central bank as reining in fintech companies. We expect to see regulatory reform to strengthen market governance, especially in the area of default resolution, and exemplary supervisory punishment of misconduct such as fraudulent issuance. The two bond markets are likely to be unified, with the introduction of common standards used as an opportunity to tighten regulation overall.

The central bank is signalling that it will closely monitor the carbon trading market that is due to start on February 1. It also seems set to get more deeply involved with central banks’ international effort to improve financial systems’ ability to manage climate-change risk and require more transparency from financial institutions about climate-related impacts of their lending and investment.

On the domestic front, the bank will steer the financial system to provide more finance for green development as a prop for an important pillar of national policy. This will be mirrored for other national priorities, including the tech and agricultural sectors and small businesses, which are being weaned off the shadow banking system.

There is also a nod in the direction of not stifling financial innovation but a more vigorous waving of the finger in the direction of fintech companies, which can expect continuing tighter oversight both of the financial risks they may pose and their alleged abuses of market power.

Regulators Will Bend Not Break Ant Group

JACK MA’S ANT GROUP, the fintech affiliate of e-commerce giant Alibaba, is to be restructured following the regulatory squashing of its would-be blockbuster initial public offering in November. The company says it is working on a timetable to meet the requirement of China’s regulators that it returns to being a payment-services provider at core (ie, go back to being just Alipay).

This will involve overhauling its lending, insurance and wealth management businesses to strip down their complexity, and then putting them under a single financial holding company. People’s Bank of China officials have told the company to do that to ensure both capital adequacy and compliance regarding related transactions while protecting personal data privacy in its credit-scoring services — the velvet glove of prudential regulation over the iron fist of supervision.

By corralling its financial businesses in a separate subsidiary, Ant will be better placed to comply with the new regulations on financial holding companies that took effect in November and mitigate the risk of a forced full-scale break up of the group, if not of having to bend to the regulators’ will.

November’s regulations require non-financial companies that control businesses in at least two different financial sectors to have a central bank-approved financial holding company to control them.

There is an element of bringing Ma to heel in the high-profile application of the new regulations to Ant. It also fits with the reining-in of the large tech companies that grew up outside the orbit of state-owned industries.

However, regulators are intent on tightening their grip on non-financial companies moving into financial services, including innovative fintech-enabled services such as online microcredit, as part of their broader desire to rein in systemic financial risk.

The restructuring will likely crimp Ant’s growth. For one, it will face tighter oversight and higher capital adequacy requirements, especially in highly-leveraged business lines such as online microcredit.

The overhaul of Ant’s financial businesses may also result in some regulator-driven divestment. That could eliminate synergies between Ant’s fast-growing fintechs and its existing businesses. It is in exploiting those synergies that the group’s real value lies.

National Launch Of Digital Yuan May Be Only Two Years Away

THE PEOPLE’S BANK OF CHINA has been experimenting with a sovereign digital currency since April. Last week, it conducted a showy trial in Shenzhen to coincide with President Xi Jinping’s visit for the former fishing village’s 40th anniversary of its transformation into the first special economic zone.

The central bank gave away 10 million yuan ($1.5 million) of its digital yuan, formally called Digital Currency Electronic Payment (DCEP), to 50,000 randomly chosen residents to spend in Shenzhen shops. The test, the largest to date of the digital yuan, reportedly went without a hitch.

Central bank digital currencies (CBDCs) are gaining attention globally. China’s progress in implementing one is pushing the US Federal Reserve and the European Central Bank to speed up work on their digital dollar and digital euro, respectively.

Cash is already fading in China as a medium of exchange, with mobile and cashless payment commonplace, notably via Alipay and WeChat. Four out of five payment transactions already happen via mobile devices.

Beijing has other reasons for favouring the development of a CBDC.

First, it will improve authorities’ ability to manage the money supply. Second, it will help track financial transactions. That will help with everything from combatting corruption and money laundering to monitoring the distribution of international aid. It also potentially expands the toolbox for domestic social control once the use of digital yuan is widespread, as it is likely that only digital wallets authorised by the central bank and issued by one of the big four state-owned banks will be allowed.

Third, it opens the possibility of an international payments system independent of the dollar, and thus immune to US financial sanctions. In that regard, a digital yuan would provide some of the transactional advantages of an internationalised yuan without all the disadvantages of losing capital controls. Internationalisation of the currency remains a long-term goal for Beijing but is not a short-term priority.

For most countries, the main challenges to issuing a CBDC are not technological, but political and regulatory. A second-order regulatory effect will be that CBDCs will advance the digitalisation of all financial assets. Thus there will be a need for more all-embracing regulatory scrutiny of all cryptocurrencies and other digital financial instruments.

China may have an advantage on both points, thanks to the Party’s monopoly on power and the country’s monopolistic internet platforms.

Widespread adoption will also require collaboration between governments and private-sector technology platforms. The PBOC is already exploring with online local shopping platform Meituan and ride-hailing app Didi Chuxing applications for their services.

The next step will be large-scale tests in cities like Hong Kong, Shanghai and Beijing, with the 2022 Winter Olympics in Beijing providing an ideal international showcase for a national launch.

Beijing Bolsters Its Banks

THE STIMULUS APPLIED to restore the economy post-pandemic has done nothing to lessen the fragility of an overleveraged financial system. If anything, Covid-19 has slowed the drive to reduce the debt overhang in the banking system.

Authorities have now issued long-awaited draft rules to ensure the capital adequacy of its global systemically important banks (G-SIBs, or those ‘too big to fail’).

The regulations from The People’s Bank of China and the China Banking and Insurance Regulatory Commission (CBIRC) stipulate that from the start of 2025, G-SIBs must be able to absorb losses of at least 16% of their risk-weighted assets, or at least 6% of their total exposures. From 2028, those ratios increase to at least 18% and 6.75%, respectively.

The four biggest state-owned commercial banks are listed as G-SIBS by the Financial Stability Board (FSB), the G20 body set up after the 2008 global financial crisis to monitor the global financial system. They are Bank of China; Industrial and Commercial Bank of China, Agricultural Bank of China and China Construction Bank.

The credit rating agency S&P said last month that the quartet fell short of the capital requirement by 2.25 trillion yuan ($330 billion) as of the end of 2019 and that without raising further capital would be around 6 trillion yuan adrift by 2024. The draft rules will be out for public comment until October 30.

Several regional banks have required bailouts, including Bank of Jinzhou, Hengfeng Bank and most notably Baoshang Bank, which has been allowed to fail, the first Chinese bank to do so in decades.

A national plan was drawn up in May to speed up capital replenishment across the banking system and to put in place the necessary bulwarks against a potential systemic banking collapse by giving central government more coordinating power over provincial-level and below supervision of such actions. Local governments will bear the brunt of the financial burden of recapitalising the banking sector as they own or control either directly or through local SOEs and investment holding companies hundreds of the weakest lenders.

Earlier this year, CBIRC’s vice chairman, Zhou Liang, said that 4,000 of the country’s 4,600 licensed banking institutions were small and midsize banks that together accounted for about a quarter of the sector’s total assets. More than 600 of them are undercapitalised, and more than 500 characterised as of ‘high risk”. That is mainly the result of a combination of lax oversight, poor or policy-driven lending decisions and corruption.

Forced provincial-level mergers of weaker banks are likely, along lines already seen in Shanxi and Sichuan.

Assuming any local political obstacles to restructuring can be removed, there will remain the need to inject better corporate governance, lending standards, risk management and accountability into banks. Whether local authorities have the capacity and expertise, let alone the financial wherewithal to do that is another question. On the last, Beijing is allowing local governments to use 5% of this year’s 3.75 trillion yuan quota of special-purpose bonds for bank recapitalisation.

However, that also raises questions of how far public funds should be used for bank bailouts, as that potentially shuffles where the risk lies rather than reduces it. The same argument can be made about suggestions that the sovereign wealth funds’ investment arm, Central Huijin Investment, should take stakes in financial institutions in need of repair, as it has already done in the recapitalisation of Hengfeng Bank.

The bigger bullet to bite is whether more insolvent banks should be allowed to go bust, although the stalled bankruptcy law for financial institutions needs to become law first.