Does Integrated Supervision Work in Emerging Markets: The Chinese Experience Daochi Tong China Securities Regulatory Commission April 2003/Washington DC

Global Trends in Integration of Financial Services and industries Globalization push forward integration of financial services and creation of financial conglomerates which include banking, securities, and insurance “One corporate body, multiple licenses, and multiple business”; traditional distinctions between banking, securities, and insurance are blurring

Factors Behind Integration of Financial Services and Industries Globalization and competition pushing forward higher efficiency and lower costs, which call for integration of financial industries and services Technological innovation and financial innovation leads to mutual penetration of financial services Clients of financial services demand for “one-stop shopping”

Advantages of Financial Services Integration Full services to one customer, one-stop shopping Sharing of customers, information as well as market network Risk diversification

Integrated Financial Groups Develop Rapidly in Developed Markets US: Mergers of CITI Bank, Travelers Group, and Smith Solomon Barney Sweden: Merger of SE Banken and Trygg- Hansa Dutch: Merger of ING Group and Equitable of Lowa Swiss/US: Merger of Credit Swiss and First Boston Germany: Merger of Anlien Insurance and Deiston Bank

Separate vs. Integrated Financial Services: Supervision Capability Matters Financial services integration: supervision capability and risks control measures needed to prevent spreading of risks between banking, securities, and insurance industries Thus, financial supervision capability determines which financial system will be chosen, separate or integrated management 。 Choice of financial system should be in line with level of supervision and risk management

Evolution of Chinese Financial Industries Integration 1980s-early 1990s: mixed financial services, banks and trust companies heavily engaged in securities business, the three largest securities firms were set up by three state banks; trust companies (such as CITIC and GITIC) were allowed to engage in full range of banking, securities, and investment business Results: substantial flow of banks funds to securities, creating a bubble economy and financial disorder; many of the trust companies went bankrupt (e.p. GITIC)

Evolution of Chinese Financial Industries Integration (II) 1995: China’s Commercial Bank Law stipulate for the first time that commercial banks can not engage in securities business; securities firms were spin-off and separated from banks 1997: The State Council stated clearly the principles of separated financial businesses and industries for the reasons of financial safety and stability

Evolution of Chinese Financial Industries Integration (III) 1998: Securities Law requires that securities business has to be separated from banking and insurance business with separate institutions and supervision institutions 1999 and beyond: cooperation and penetration between different financial business institutions, securities firms and fund management firms are allowed to enter inter-bank market; banks can use their network to sell securities on behalf of securities firms

Moving toward Financial Services Integration China’s enter into WTO requires China to open up its financial services industries for foreign competition China financial services industries have to raise its productivity and efficiency levels and risk control skills to compete with foreign financial conglomerates Financial services and industries integration in China is a must in the long run

Transit from separate to integrated financial services: role of financial holding companies Financial Holding Companies (FHCs) allow each subsidiaries to engage in separate business, under supervision of different regulatory body, while set up “fire-wall” between them to prevent risk spreading between subsidiaries Subsidiaries can share clients-base, information, network, and other resources FHCs thus have advantages of both separate and integrated financial systems.

China’s Financial Holding Companies China ’ s FHCs consists of: FHCs developed from financial institutions and FHCs derived from industrial groups FHCs derived from financial institutions are mainly from nonbank financial institutions, such as CITIC, Everbright Group, and PingAn Insurance. FHCs developed from industrial firms include Shandong Electricity Group, Haier Group, Bao Steel Development of FHCs are gaining speed in the last 2- 3 years

FHCs in China still at early stage FHCs still belongs to loose and superficial integrations FHCs require integrated business and management. As to this nature, China ’ s FHCs are not yet real FHCs with integrated business but FHC structure rudiments. Most FHCs in China cannot make most of such co-ordination advantages as brand resources, strategic plans, usage of capital,market network, information resources, etc.

Is China Ready for Financial Industries Integration:Supervision Capacity With the rapid development of FHCs and penetration of business across financial industries, there is a trend in China toward financial integration. However, the financial supervision capacity will determine how fast and how far can we go toward integration financial industries. Further reform of the banking sector and securities industries and upgrading of supervision capacity are needed to fully embrace the benefits of financial integration while avoid the risks

Financial Regulatory Framework Under the separate business system, banking, securities, and insurance industries are regulated by three separated institutions Banking: People’s Bank of China (before 2003); China Banking Regulatory Commission (2003 newly established) Securities: China Securities Regulatory Commission (set up in 1992) Insurance: China Insurance Regulatory Commission (set up in 1997)

The Banking Sector The banking sector is still largely state-owned, the four state banks accounts for more than 60% total assets Large amount of non-performing loans: 33% of total loan portfolio Low capital-to-asset ratio. After recapitalization in 1997, the average capital-to-asset ratio in the four state banks is around 6%, still below the BIS requirement of minimum 8%

Banking Reform To deal with NPLs, the four state banks set up four asset management companies (AMCs). NPLs were transferred to AMCs AMCs can sell the assets, conduct debt restructuring, debt-equity swaps, and can engage in underwriting and M&A business Going public: five non-state shareholding banks are listed in China’s domestic market; Bank of China is listed in HK, and considering listing in the A-share market

Banking Supervision A separate supervision body, the China Banking Regulatory Commission (CBRC) was established by the new government in March 2003; banking supervision function was separated from the central bank, the People’s Bank of China New corporate governance rules were promulgated last years for shareholding banks; At least two independent directors are required on the board of directors

The Securities Sector Two stock exchanges, Shanghai and Shenzhen, established in 1990; three commodities and futures exchanges 1250 listed companies, total market cap around US$580 billion, 50% of GDP 110 securities firms, dozens of fund management firms manages open-end and close-end funds 60 million investors accounts, accounting for 5% of China’s population

Securities Regulatory Reform Corporate governance reform Information disclosure Enforcement Legal and accounting reform Market for corporate control Institutional investors and open for foreign investors Training of directors and investors education

Corporate Governance Reform Independent directors. Regulation issued in Aug 2001, requiring 1/3 of the board to be independent directors by June By June 2002, 2,414 independent directors already on board, at least 2 for each firm. Code of Corporate Governance mandatory for all listed companies, promulgated in Jan. 2002, stipulates the rights of shareholders, the responsibilities of controlling shareholders, fiduciary duty and duty of care for directors, rights of stakeholders, disclosure requirements and compensation schemes

Conclusions Globalization push for integrated financial services, which require integrated financial supervision Financial supervision capacity will have to catch up with integration of financial services; choice of financial system should be in line with level of supervision and risk management Financial holding companies might be a good choice for emerging markets when moving from separate financial services system toward an integrated system