The financial sector is a pivotal component of China’s national security, in President Xi Jinping's view.  With a comprehensive regulatory overhaul approved at the NPC in March, the supreme leader aims to assume full control of China’s sprawling financial industry.

The Party is taking charge of major financial sector issues previously handled by the State Council or central government.

Our view is that Xi’s Leninist discipline and control will not benefit China’s financial market in the long run. In the short-term, it is likely to prove effective in getting the sector to toe the Party line.

But as always, nothing is black and white in China.

Some of the leadership’s objectives are likely to boost productivity and lower systemic risk. The worry is that, over time, stamping out incentives to experiment will undermine the development of a vibrant and effective financial market.

The worst case scenario is that financial sector development is subjugated completely to Xi’s overarching goal of re-unification with Taiwan and the likely need to use military means to achieve it. In this scenario, most, if not all, bets are off.

More prosaically, we expect that the restructuring underway will address the worst problems of the past decade but fail to spark efficiency or dynamism.

The anti-corruption crackdown

Xi Jinping has been effective in destroying any political opposition, asserting control over the military and internal security service apparatus and subjugating the powerful technology sector, so there is little doubt he will succeed in getting the financial sector under his full control.

His administration has started a new round in the anti-graft campaign, aimed at the country’s financial institutions.

The Central Commission for Discipline Inspection (CCDI), which is the highest-level anti-corruption watchdog of the Party, said in March that it would “cut off the link between power and capital”. It plans to conduct inspections of more than 30 giant state-owned enterprises. It also indicated that it would re-examine five financial companies that were targeted in previous anti-graft exercises in 2021.

In the past month, the CCDI has investigated more than a dozen senior executives at state-owned financial institutions for alleged bribery or concealment of overseas assets. 

Executives under probe include Liu Liange, chairman and party secretary of Bank of China, and Wang Bin, chairman and party chief of China Life Insurance. Luo Xi, the party secretary and president of People’s Insurance Company of China or PICC, was removed without any official explanation.

Li Xiaopeng, former chairman of China Everbright Group, one of the country’s oldest and well-established state-owned financial conglomerates, was also nabbed on suspicion of “serious violations of law and discipline.”

The list also includes municipal-level financiers. Wang Jianhong, former head of Bank of China's Beijing branch, Zhao Zhiran, an executive of China Construction Bank’s Shenzhen branch, and other high-level state employees have been targeted.

These actions were a continuation – and large-scale amplification – of a series of anti-graft measures after the 20th Party Congress last October.

They began late last year with the disgrace of former Bank of China vice-governor Fan Yifei, but the first major case this year took place in February. That's when Bao Fan, CEO of China Renaissance, an investment bank specializing in mergers and acquisitions in the tech sector, was detained. His fate and whereabouts remain unknown.

The disciplining of bankers and CEOs is expected to intensify after the formation of the Central Financial Commission (CFC) and Central Financial Work Commission (CFWC).

Their creation is part of the regulatory overhaul of the financial sector announced at the NPC.

Financial regulatory overhaul: what we know so far

The infographic below summarises recent regulatory changes,  although few details are known as yet. More information should emerge during the National Finance Work Conference this summer.

The CFC and the CFWC report directly to the Party Central Committee’s Central Finance and Economics Commission, which is chaired by Xi himself. The CFC has assumed all the functions of the Financial Stability and Development Committee, which was under the State Council.

Meanwhile, the authorities set up the National Financial Regulatory Administration under the State Council to supervise all financial institutions apart from the securities sector. It has absorbed the functions of the CBRIC and some functions from the PBoC and the CSRC.

The CSRC will retain its oversight of the securities sector. However, it will become a government agency directly under the State Council rather than a public institution. It will also expand its role by assuming responsibility for approval of corporate bond issuance from the NDRC.

The PBoC, China's central bank, will see a reorganization of its local branches. It will continue to be responsible for macro-prudential regulation.

Importantly, all personnel of the related financial regulatory organizations will become civil servants, which means lower pay and less independence.

The restructuring of central authorities at both party and government levels will be completed this year, and local-level adjustments will be done by the end of 2024.

Financial regulatory overhaul: reasons and consequences

There are many reasons why Xi is targeting the banking and financial sectors, after securing the status of “leader for life” at the 20th Party Congress last year.

Several state- and privately-owned conglomerates found to be guilty of bribery and illegal practices – including Anbang, HNA Group, Huarong Assets Management Corp – were able to grow from tiny start-ups to multi-billion-yuan giants in ten years or less, thanks to the generous supports of banks.

The loans were often made on the recommendation of powerful CCP factions or clans, many of whose members are political foes of Xi’s.

One of the key new economic initiatives of both Xi and new premier Li Qiang is to tackle improper lending and investments by large financial institutions. The Xi leadership’s efforts to rein in the dubious business activities of companies in the IT, e-commerce and related sectors can only be effective if the CCP leadership has tight control over the banks and other financial institutions.

In our February report “New Appointments and High-Profile Detentions Herald Finance Sector Shake-up” we also noted that the coming financial sector shake-up is motivated by Xi's "common prosperity" policies.

Poorly regulated financial institutions, including fintech and platform vehicles, have allowed a few finance whizzes to amass huge fortunes, at the expense of the welfare of the Party-state and ordinary citizens.

Additionally, tighter financial discipline is essential to tackle overleverage, which is serious at both the central and provincial levels, as well as to monitor and address financial risks systemically. Enodo’s estimates suggest that China’s credit losses amounted to between 26% and 31% of GDP in 2021.

The CCP leadership also believes that only well-targeted and strictly calibrated loans made by central- and local-level banks could save the tottering real-estate sector, which accounts for more than 30% of GDP. For example, after the 20th Party Congress, Beijing allowed banks to extend Rmb3.2trn in lines of credit to real-estate companies.

The Xi leadership wants to ensure that huge loans to the real estate industry are wisely spent, and fend off any systemic risks to the financial system before they materialise.

We expect the comprehensive reform of China’s financial regulatory framework to decrease regulatory arbitrage, ensure comprehensive regulatory coverage and boost the development of capital markets.

In the past, China’s fragmented financial regulatory landscape created arbitrage opportunities for different market entities and contributed to the emergence of undetected financial risks. Shifting from institutional regulation to functional regulation should eliminate the arbitrage opportunities created by industry-specific regulation. Additionally, new forms of financial activity are unlikely to remain outside of regulation, under the functional approach.

The overhaul, by placing the CSRC directly under the State Council and making it responsible for the review of corporate bonds as well, should also help develop China’s capital markets. It should enable more effective capital markets regulation, which together with the IPO registration system reform now fully implemented across the board, should promote a greater role for capital markets.

The authorities want to diminish the economy’s dependence on bank finance and ensure that both the banking sector and capital markets intermediate domestic savings more productively.

Moreover, the increase of top-down Party oversight is expected to diminish corruption. A senior PBoC official has argued that the blame for the string of bank runs and failings among China’s smaller reginal lenders in the first half if 2019 lies with poor corporate governance and lack of effective oversight by the Party committee.

But a heightened role for the Party committees in enforcing the decisions of the top leadership could also increase inertia and diminish initiative.

In “On the Road Again – A Taste of China’s Hopes and Fears After COVID” we noted the words of one banking veteran we interviewed, “If we offer less financial support to the targeted sector, regulators would ask you why, but if we lend to enterprises which lack the capacity to repay, shareholders would also question you,” he said. “Truly hard choices.”

Conclusion

There are good reasons for all the restructuring of the financial sector underway in China. Many problems have cropped up as the economy matures, that are in need of a solution. 

But in the long run, the consolidation of financial control in Xi’s hands does not bode well for the development of China’s financial sector. 

Xi has increasingly surrounded himself with sycophants, creating a counter-productive echo chamber. Fear of bringing problems to the top as well as unwillingness to share different views is likely to make course correction difficult to achieve, even when needed.

Moreover, the solutions proposed are either punitive (the anti-corruption crackdown) or bureaucratic (the re-jiggering of the regulatory structure).  

They lack the sort of checks and balances that might rein in corruption or steer bankers towards a healthier loan portfolio. Instead, many of the factors that caused the most prominent problems of the past decade -- the tendency of the state to dictate unproductive loans, the unwillingness to allow state companies to fail or to provide capital to private firms -- remain unchanged. 

Xi's regulatory changes will shake the financial sector to its core. But once the dust settles, we expect the problems of the past will reappear.