China debates a financial stability guarantee fund

China debates a financial stability guarantee fund

A Chinese government proposal for a financial stability guarantee fund to safeguard against systemic risks has attracted attention from many parties. Some have differing opinions on how to best resolve the current financial risks related to defaults and debt reduction, especially among property developers.

At the direction of the State Council, the People's Bank of China (PBoC) will take the lead in developing the framework for the fund. Also taking part are the National Development and Reform Commission, the ministries of Justice and Finance, the China Banking and Insurance Regulatory Commission (CBIRC), the China Securities Regulatory Commission and the State Administration of Foreign Exchange. Preliminary work is expected to be completed by the end of September.

The purpose of the fund is to improve risk prevention and deal with systemic-hidden dangers, a spokesperson for the CBIRC has said. Participants are studying the relevant regulations for the establishment of the fund and exploring ways to accumulate funds for risk prevention. Along with deposit insurance and industry guarantee funds for risk prevention, the fund will be indispensable in strengthening the financial safety net in China.

The fund is to be differentiated across industries and entities with corresponding charges for balancing risks, benefits and responsibilities. At the same time, there will be an emphasis on preventing any possible losses to the government and taxpayers.

The fund's objectives, rationale, purposes and principles, as well as a specific timeline, have now been established. An overall plan for institutional settings, funding sources and funding uses is still being worked on.

Researchers from Anbound, a Beijing-based think tank specialising in public policy, view that while the policy framework has been clarified, the fund is still not properly planned. Frequent deliberation and changes could lead to uncertainty about the fund, its purposes and performance.

First, the goals of the fund must be clearly understood. From the perspective of institutional settings, the leadership of the PBoC with the participation of multiple bodies has been made clear.

It appears that the risk prevention objectives of the fund will be associated not only with the banking and insurance industries but also with non-bank financial institutions, such as trust companies, leasing entities, payment institutions and capital markets institutions like fund management and securities companies. This is consistent with the fund's goal of preventing risk in the financial system.

At the moment, financial institutions such as banks, insurance companies, trust companies, and securities firms are covered by risk-mitigation mechanisms such as deposit insurance. Local credit risk funds have also been established by some local governments. Some bodies may wonder if setting up a financial stability guarantee fund will conflict with some existing financial risk prevention mechanisms.

Another issue is whether the fund should act as a last-resort risk shield or take a more proactive role in intervention to bolster risk management.

In terms of operation, some research institutions believe that the European Financial Stability Facility (EFSF) can be used as a model for market-oriented risk prevention. Among the considerations for operating such funds are appropriate market intervention during times of financial risk, preventive action plans, and provision of funds for the recapitalisation of financial institutions. Some of these responsibilities overlap with those currently held by the Chinese central bank.

When systemic risks emerge and spread in the financial market, the central bank will always act as the "lender of last resort". As a result, more research should be conducted to determine the practicality of Europe's financial stability policy model.

Finally, the establishment of the financial stability guarantee fund primarily serves to position it as an investor in capital reorganisation in the post-event risk prevention stage. This is not entirely consistent with the market-oriented risk prevention principle. If the only goal is to raise funds to prevent systemic risks, which cannot be separated from the strong intervention of the financial supervision department, then the financial stability guarantee fund cannot fully reflect market principles.

The responsible bodies might also wonder about the funding sources of for the fund and the means of allocation. Current information shows that it might be funded by financial institutions in the market in accordance with the deposit insurance fund model.

The market is highly concerned about whether the financial stability guarantee fund will participate in market activity, while wondering whether local financial players would inject capital. Regarding current market concerns about property companies' defaults and the resolution of debts at the local level, the market has high expectations for the fund.

For the researchers at Anbound, the financial stability guarantee fund is not comparable to a comprehensive market-oriented risk response institution. The guarantee fund has a policy role that government finance should serve as a high-probability choice to avert any embarrassing conditions.

However, there is still no conclusion as to whether local financial institutions or governments should make capital contributions to the fund. How the funding will be applied for risk protection also remains vague. It will be important to rationalise the fiscal system between the central and local governments to avoid more new local debts.

Under the current risk prevention scenario, local corporate defaults basically involve financial institutions and local governments. The financial stability guarantee fund is likely to present itself as a local and regional risk protection mechanism, which means that local and regional financial risks must be prevented rather indirectly. Local governments would continue to deal with regional risks and territorial responsibilities.

The market is most concerned about the types of risks that could be considered systemic and the types of institutions that will be targeted by the fund. Another concern is whether it should be directly targeting national financial institutions to manage market entities, or conduct market interventions based on the scale of risk exposure.

These issues remain to be clarified by regulators. As well, in the process of creating a financial stability guarantee fund, it will be hard to avoid talk about the "too big to fail" interests of commercial-financial institutions.

Bailouts, interventions, avoidance of risk contagion and avoidance of moral hazard in financial institutions are among the challenges the fund might come across in the future. All these will require constant fine-tuning and adjustment of financial-regulatory policies.

Wei Hongxu, a researcher at Anbound, a Beijing-based think tank specialising in public policy, graduated from the School of Mathematics at Peking University and has a PhD in economics from the University of Birmingham.

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