Intent Declared Summary

In regards to the country's adoption of the Basel Core Principles (BCPs), a 2006 Working Paper prepared by Richard Podpiera for the International Monetary Fund (IMF) indicates that considerable progress has been achieved by the China Banking Regulatory Commission (CBRC) in improving banking supervision, notably in the area of asset classification and provisioning and capital adequacy. According to information provided on the CBRC's website, starting in 2003, the CBRC began conducting self-assessments every two years on China's implementation of the BCPs in order to "benchmark" banking supervision in China to international standards so as to identify gaps in Chinese practices and make necessary improvements. These assessments, however, are not publicly available. The CBRC's third self-assessment, which establishes the grounds for China's further participation in the joint IMF/World Bank Financial Sector Assessment Program, was carried out in 2007 against the revised Basel Core Principles, released by the Basel Committee on Banking Supervision in October 2006. Results of the third self-assessment reflect the CBRC's notable progress in improving the legal and regulatory framework as well as strengthening enforcement, according to the regulator's annual report published in 2008. Shortcomings remain with regards to the supervisory framework, governance of the supervisory authority, effectiveness of cooperation and coordination among supervisory departments, risk supervision and consolidated supervision, and corrective measures. Information on its website indicates that the CBRC is seeking public comments on seven Basel II related guidance drafts as part of its efforts to adopt Basel II. Finally, several reports have commented on China's relative insulation from the recent global financial crisis. The CBRC, in a 2009 report, narrates all the measures that it undertook pre and post crisis to safeguard the Chinese banking system. The IMF, in a 2009 report, observes that the financial crisis has left the Chinese financial sector relatively unscathed and the authorities have, notwithstanding, taken rapid steps to avert a meltdown.

General Overview

The opening up of the banking sector in China as part of a far-reaching and comprehensive reform of the financial sector started in 1978, as detailed in the 2008 annual report of the China Banking Regulatory Commission (CBRC), and continued for the next thirty years in three distinct phases. From 1979 to 1993, the mono-bank system was transformed into a multi-bank system with “robust competition” (p. 40); between 1994 to 2002, commercialization reforms were strengthened by the formulation of fundamental banking rules and regulations, mitigation of risks, and bolstering the financial markets. Starting in 2003, the next phase of reforms focused on bank restructuring, corporate governance, joint-stock reform, and further opening up of the sector. The International Monetary Fund's (IMF)'s 2006 Article IV Consultation report also notes that until 1984, the banking sector in China was comprised of only one financial institution, the central bank of the People's Republic of China, also known as the People's Bank of China (PBC). China then became a dual banking system with the PBC on the one hand, and state-owned commercial banks on the other hand, including the Agricultural Bank of China (ABC), Bank of China (BOC), China Construction Bank (CCB), and Industrial and Commercial Bank of China (ICBC). The financial restructuring of the commercial banks, with the exception of the ABC, was completed in 2005 by means of capital injections and sale of non-performing loans (NPLs), according to the IMF. The IMF report encouraged Chinese authorities to consider restructuring and recapitalizing the ABC. In this regard, the 2008 CBRC annual report mentions that the financial restructuring of the ABC has been completed. Its NPL ratio is 4.2 percent and its capital adequacy ratio stands at 9.4 percent. The ABC website adds that in January 2009, the ABC became a joint stock company.

The 2009 Article IV Public Information Notice (PIN) by the IMF reveals that although the real Chinese economy has been hit hard by the global economic crisis, the financial sector has proven more resilient. Banks have not only maintained their minimum capital adequacy requirements, but also increased capital. They also boast of high profits and low NPLs, coupled with increases in loan loss reserves. The IMF attests that “progress has also been made in recapitalizing and restructuring Agricultural Bank of China.” Notwithstanding the satisfactory performance of the Chinese financial sector in the face of the turmoil, the authorities have taken “rapid and vigorous policy response,” per the IMF, and the latter encourages them to continue “vigilant monitoring” of credit quality. China, per the 2009 IMF PIN, has declared its willingness to participate in the IMF’s Financial Sector Assessment Program (FSAP) to “help identify priorities for further financial sector reform.” Elaborating on the measures taken by China to deal with the financial crisis, the 2009 Global Survey by the Institute of International Bankers (IIB) mentions that the PBC has waived the mandatory restriction on the commercial banks’ loan plan, and the CBRC has, in agreement with the insurance regulator, allowed the state-owned banks to launch their own insurance company for the first time beginning 2009. In addition, the authorities have decided to extend the lock-up period for foreign strategic ownership in commercial banks from three years to five years. The CBRC’s 2008 annual report asserts that the regulator has taken countercyclical regulatory measures since 2006 in response to the “overheating economy at home and adverse development in the overseas market” (p. 30) and has also been proactive in warning banks of the conditions and requiring them to take preventive measures. Noting its efforts to control the impact of the global financial crisis, the CBRC states in its annual report that it has sought to ring-fence the banking sector from the volatilities of the capital market and has also “further strengthened the consolidated supervision of large commercial banks for tightened cross-border and cross-sector risk control” (p. 30). Going forward, the CBRC intends to apply “scientific regulation” under the guidance of the central government, with differentiated credit policies, tightened internal control measures, and reinforced risk management guidelines, the annual report states. In September 2008, the CBRC issued the first batch of regulations to prepare the banks for the implementation of the Basel II capital regulatory framework.

The legal framework for banking supervision consists of the 1995 Law on Commercial Banks, the 1995 Law on the People's Bank of China, and the 2003 Law on Banking Regulation and Supervision (hereafter referred to as "Banking Law"). Pursuant to the Banking Law, responsibilities for banking supervision were transferred to the China Banking Regulatory Commission (CBRC) when it was created in April 2003. The supervisory objective of the CBRC, as stated on its website, was "to put in place all the essential elements for banking supervision in 2006 and achieve broad compliance of the Basel Core Principles (BCPs) in 2012." The CBRC’s approach to supervision, per its 2008 annual report, is to provide risk-based and consolidated supervision so as to enhance internal controls and transparency in the supervised institutions, and ensure stable and sustainable capitalization, credit policies, and provisioning. The Regulation Governing Capital Adequacy of Commercial Banks (hereafter referred to as "New Capital Rules") was enacted in 2004, requiring banks to maintain adequate provisioning for NPLs, in addition to minimum capital adequacy ratios of 8 percent, as noted in a 2006 Working Paper prepared by Richard Podpiera for the IMF. The Regulation was expected to become fully binding as of 2007. As indicated in the IIB 2007 Global Survey, China enacted new regulations in December 2006 to fully open the country's banking sector to foreign competitors.

At the time of the 2004 study by Stefan Brehm and Christian Macht of the University of Tübingen, the Chinese regulatory framework showed "a high degree of compliance with the BCPs" (p. 327). In addition, the legal system was approaching conformity with international prudential requirements. The 2006 IMF Working Paper by Podpiera further indicated that Chinese authorities had placed banking reform as a priority to improving intermediation of China's large private savings. Podpiera noted that considerable progress had been achieved by the CBRC in improving banking supervision, notably in the area of asset classification and provisioning and capital adequacy. During 2004, Chinese authorities strengthened on-site examination and monitoring of large exposures and connected lending, and introduced a risk-based supervisory system for city commercial banks. Efforts were still required in reforming the framework for banking supervision and regulation in China. In addition, rules on prudential regulations and requirements did not provide for detailed criteria, clear quality standards and an explicit timeframe for their implementation, as reported by Brehm & Macht. A 2009 report by the U.S. Department of Commerce states that overall, “though improving, China’s legal and regulatory system remains complex, contradictory, and lacking in consistent enforcement” (p. 111) and that arbitrary and non-transparent regulatory enforcement is a constant concern for foreign investors in the Chinese market.

Starting in 2003, the CBRC began conducting self-assessments every two years regarding the implementation of the BCPs. However, these reports are publicly available. The Basel Committee on Banking Supervision revised its BCPs and Methodology in October 2006. As a representative of non-member states in the Basel Committee, the CBRC has been involved in the revision of the BCPs, as stated in its 2007 Annual Report, and has played an active role in drafting the international standards. The CBRC's third self-assessment was carried out in 2007 against the new Core Principles, and establishes the grounds for China's further participation in the joint IMF/World Bank Financial Sector Assessment Program. Results of the third self-assessment reflect the CBRC's notable progress in improving the legal and regulatory framework as well as strengthening enforcement, as reported in the regulator's 2007 Annual Report. In particular, a preliminary legislative framework for prudential banking supervision has been put in place. This new regulatory framework uses off-site surveillance as the main tool coupled with the on-site examination approach. The administration and procedures of licensing activities have also become more standardized and transparent. Finally, the CBRC has strengthened cross-border supervisory cooperation and information exchange. Shortcomings remain with regards to the supervisory framework, governance of the supervisory authority, effectiveness of cooperation and coordination among supervisory departments, risk supervision and consolidated supervision, and corrective measures. The KPMG website indicates that the CBRC is strongly advocating the adoption of Basel II by the major financial institutions in China. In February 2007, according to the CBRC's 2007 Annual Report, the CBRC issued the Guidance on the Implementation of the New Capital Accord by the China Banking Industry, specifying the objectives, principles, scope, methods, timetable and major measures of the implementation of Basel II. In 2008, the imitative was taken a step further with the issuance of the first five supervisory guidance on the implementation of Basel II: Guidance on Risk Exposures Classification of Commercial Banks, the Guidance on Supervision of Internal Rating System of Commercial Banks, the Guidance on Capital Charge for Specialized Lending of Commercial Banks, the Guidance on Implementing Risk Mitigation in Basel II by Commercial Banks, and the Guidance on Capital Charge for Operational Risk of Commercial Banks. According to the 2008 CBRC annual report, the second batch of guidance was expected to be issued soon. Several large internationally-active commercial banks are expected to implement the Basel II framework on a pilot basis from the end of year 2010, per the 2007 annual report.

An article written by Liu Shiyu et al in a 2006 Paper by the Bank for International Settlements (BIS) indicates that "credit risk arising from NPLs and loan concentration is the major risk to the banking sector" (p. 184). The size of NPLs was another important threat to the banking system in China. Further challenges were identified by the IMF's 2006 Article IV Consultation report with regards to banks' commercial orientation, risk management, internal controls, and governance. In 2008, according to the CBRC's 2008 annual report, there were 5,634 banking institutions in China, including the five large commercial banks, 12 joint-stock commercial banks, 136 city commercial banks, 22 rural commercial banks, 163 rural cooperative banks, 22 urban credit cooperatives, 4,965 rural credit cooperatives, 10 rural mutual credit cooperatives, 91 village or township banks, one postal savings bank, three policy banks, and 32 locally-incorporated foreign bank subsidiaries. Total assets of the banking sector amounted to Chinese currency (RMB) 62.4 trillion at the end of 2008, an 18.6 percent increase from the previous year. The five largest banks accounted for almost half of the total banking sector assets, with combined assets amounting to RMB 31.8 trillion. Liabilities also grew 18.2 percent over the previous year to reach RMB 58.6 trillion. The ratio of NPLs dropped to about 2.5 percent in December 2008 from 8 percent in 2006, as reported in the U.S. DoC's 2009 Country Commercial Guide. In addition, NPLs on new loans have been under 2 percent since 2003. Also, provisioning has improved, per the CBRC’s annual report, granting the commercial banks greater resilience to risk. The provisioning coverage ratio reached 116.4 percent or RMB 773.5 billion in 2008, an increase of 75.2 percent over 2007. Banks also maintained their capital adequacy ratio (CAR) above the international minimum requirement of 8 percent, with the average CAR for the commercial sector reaching 12 percent, a 3.7 percent increase over 2007.

The Principles

II1. (1) Clear responsibilities and objectives for each supervisory agency.

The supervisory objective of the CBRC, as stated on its website, was "to put in place all the essential elements for banking supervision in 2006 and achieve broad compliance of the BCPs in 2012." According to the 2004 study by Brehm & Macht, the Banking Law meets most of the requirements of BCP 1. However, the authors do not explicitly address China's compliance with this sub-principle of BCP 1. Pursuant to the Banking Law, the CBRC is the main supervisory body for banking institutions in China. The PBC also has supervisory and investigative powers over banking institutions.

II1.(2) Operational independence and adequate resources.

While the Banking Law meets most other BCP 1 requirements, as stated in the 2004 study by Brehm & Macht, the CBRC's operational independence and resources are restricted. The State Council of the People's Republic of China (i.e. Chinese government) and the Chinese Communist Party exert control over the CBRC through various channels. The State Council namely has the authority to issue regulations overruling those of the CBRC. It can also use the Audit and Supervisory Institution to influence the CBRC. Nevertheless, the 2004 Brehm & Macht report does not explicitly address China's compliance with this principle.

II1.(3) A suitable legal framework for authorization and ongoing supervision.

The legal framework for banking supervision consists of the 1995 Law on Commercial Banks, the 1995 Law on the People's Bank of China, and the 2003 Banking Law. In December 2006, China enacted new regulations to fully open the country's banking sector to foreign competitors, as indicated in the IIB's 2007 Global Survey. The 2004 study by Brehm & Macht indicates that the Banking Law meets most of the BCP 1 requirements. However, the authors do not explicitly address China's compliance with this sub-principle of BCP 1.

II1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.

See Principle 1.(3).

II1.(5) Legal protection for supervisors.

According to the 2004 study by Brehm & Macht, the Banking Law meets most of the BCP 1 requirements. However, the authors do not explicitly address China's compliance with this sub-principle of BCP 1.

II1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.

Results of the CBRC's third self-assessment indicate that the CBRC has strengthened cross-border supervisory cooperation and information exchange. While the CBRC has been working closely with the Ministry of Finance (MoF), the PBC, the China Securities Regulatory Commission (CSRC), the China Insurance Regulatory Commission (CIRC), and the State Administration of Foreign Exchange, weaknesses remain regarding the effectiveness of cooperation and coordination among supervisory departments, Brehm and Macht note. In this regard, the 2008 CBRC annual report mentions that the CBRC has signed an MoU on Deepening Bank-Insurance Cooperation and Cross-sector Supervisory Cooperation with the CIRC. It has also set up a special IT network connection with the PBC, and this has “enhanced timeliness, integrity and availability of data sharing” (p. 82). Further, it also enhanced supervisory cooperation with the CSRC by jointly releasing the Guidance of CBRC and CSRC on Contingency Plans for the Information Systems across Banking and Securities Industries in 2008, and by conducting joint inspections of commercial banks carrying out mutual fund business. Enhanced supervisory information exchange was also achieved between the CBRC, CIRC, and CSRC, per the annual report. Despite the above description, the available sources do not explicitly address China's compliance with this principle.

EN2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.

The 2004 study by Brehm & Macht states that, overall, the regulatory framework in China fully complies with this principle. Pursuant to the Banking Law, the term "banking institutions" refers to financial institutions established in China that take deposits from the general public, including commercial banks, credit cooperatives, and policy banks. While the Banking Law does not empower the CBRC to set criteria for the establishment of a banking institution, as indicated by Brehm & Macht, the Law on Commercial Banks mentions explicit rules for the establishment of a commercial bank and of a bank branch.

EN3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.

Overall, according to the 2004 study by Brehm & Macht, the regulatory framework in China fully complies with this principle. The CBRC is the licensing authority in China, and has the authority to "approve or reject applications for the establishment, restructuring and termination of banking institutions" (p. 319), Brehm & Macht note. However, the Banking Law does not provide explicit licensing criteria. Results of the CBRC's third self-assessment reflect progress in improving the administration and procedures of licensing activities, by notably making them more standardized and transparent. With regards to corporate governance, the Asian Development Bank's 2008 Country Partnership Strategy report recommends strengthening the corporate governance framework for commercial banks in China. While state-owned commercial banks are required by law to have independent, outside directors, the latter only have a minority representation on the boards. Moreover, the boards are controlled by the Chinese government.

EN4. Authority to review and reject transfer of ownership.

The 2004 study by Brehm & Macht states that, overall, the regulatory framework in China fully complies with this principle. Pursuant to the Banking Law, and in line with the BCP on licensing and structure, the CBRC approves "changes in the shareholders that hold a certain percentage or more of the total capital" (p. 319).

EN5. Authority to review major acquisitions and investments.

The 2004 study by Brehm & Macht states that, overall, the regulatory framework in China fully complies with this principle. While the Banking Law does not require the CBRC's approval for major acquisitions or investments by a bank, the authors note, this requirements is provided under the Law on Commercial Banks.

II6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).

The 2004 study by Brehm & Macht states that rules on prudential regulations and requirements do not provide for detailed criteria, clear quality standards, and an explicit timeframe for their implementation. The study expressed concerns regarding the low capital adequacy ratio of banks in China, and the misallocation of capital due to weak lending practices. However, the New Capital Rules entered into force in 2004, requiring banks to maintain adequate provisioning for NPLs, in addition to minimum capital adequacy ratio (CAR) of 8 percent, as noted in the 2006 study by Podpiera. The Regulation became fully binding as of 2007. The IMF's 2006 Article IV Consultation report indicated that, banks accounting for 75 percent of total banking assets were compliant with the 8 percent minimum at end-2005. The most recent annual report (2008) of the CBRC, also attests that the weighted average CAR of all banking institutions in China reached 12 percent in 2008, which is “well above the international regulatory level of 8 percent” (p. 35). Further, 204 banks accounting for 99.9 percent of the total bank assets met the CAR requirement, and only one bank failed to meet this level in 2008. In terms of regulatory activities, the CBRC cooperated with other government agencies to enhance capital adequacy at commercial banks, urged and educated commercial banks to improve their capital base, meet their capital requirements, and replenish their tier-2 capital through innovative capital vehicles. It also adopted its CAR requirement as a precondition of granting new bank licenses. Capital requirements for banks with foreign and cross-sectoral exposures were subject to especially high capital requirements, and capital adequacy calculation guidelines have become more stringent, the annual report notes. Nevertheless, the available sources do not directly address China's compliance with this principle.

II7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.

According to Brehm & Macht's 2004 study, rules on prudential regulations and requirements do not provide for detailed criteria, clear quality standards and an explicit timeframe for their implementation. The 2006 article by Liu Shiyu et al indicates that "credit risk arising from NPLs and loan concentration is the major risk to the banking sector" (p. 184). The size of NPLs is another important threat to the banking system in China. In this regard, procedures were introduced in China, including the classification of loans in five categories, the CAMELS rating system, and other prudential regulations. CAMELS is an international bank-rating system where bank supervisory authorities rate institutions according to the following six factors: capital adequacy; asset quality; management quality; earnings; liquidity, and sensitivity to market risk. In July 2007, according to the CBRC's 2007 Annual Report, the CBRC revised the 2001 Guidance on Risk-based Loan Classification. Further, as a response to the global financial crisis, the CBRC also required commercial banks to implement stricter credit policies, initiate more structured policies and procedures for loan reviews and approval, minimize risks associated from misconduct, and conduct more loan-related compliance examinations, states the CBRC 2008 annual report. The CBRC prohibited banks from making “bundled loans,” revolving project loans, securitizing NPLs, and developing zero-return real estate investment trusts (REITs). Lending to the manufacturing sector has also been circumscribed through formal approvals from relevant authorities. By way of statistics, the CBRC annual report states that the NPL ratio reached 2.4 percent in 2008, which was substantially lower than in 2007. The commercial banks also made efforts to improve their asset quality through NPL write-offs. Despite the information provided above, the available sources do not directly address China's compliance with this principle.

II8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

The Guidance for the Calculation of Loan Loss Provisions was formulated by the CBRC in 2002 to reduce the risk of bank failures caused by NPLs, as noted in the 2004 study by Brehm & Macht. The Guidance notably addresses "adequate policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and loan loss reserves" (p. 320). However, according to the Brehm & Macht report, rules on prudential regulations and requirements do not provide for detailed criteria, clear quality standards and an explicit timeframe for their implementation. Bank loans continue to provide the vast majority of credit in China, accounting for roughly 85 percent of formal financial sector financing. According to the IMF's 2006 Article IV Consultation report, banks accounting for 75 percent of total banking assets were compliant with the 8 percent capital adequacy requirement with full provisioning at end-2005. That figure has increased to 99.9 percent of the banks with the 8 percent CAR level at end-2008, per the CBRC’s 2008 annual report. Further, the CBRC has also instructed banks to increase their loan-loss provisions in the light of the financial crisis. Large commercial banks increased their provisioning coverage ratio to 109.8 percent and their adequacy ratio of loan-loss provisions to 153 percent. Joint stock commercial banks also increased their ratios of loan-loss provisions and provisioning coverage to 198.5 percent and 169.6 percent, respectively. Despite the information provided above, the available sources do not directly address China's compliance with this principle.

II9. Prudential limits and management information system on concentration of exposure.

The CBRC, according to its website, has urged banks to limit risks from large exposure and loan concentration by requiring them "to report to the supervisor detailed account information on large borrowers over and above Rmb100m or US$12m." The Guidance for Implementing a Unified Lending System of Commercial Banks was further formulated by the CBRC in 1999 to mitigate the concentration of high risk exposures, as noted in the 2004 study by Brehm & Macht. However, according to the Brehm & Macht report, rules on prudential regulations and requirements do not provide for detailed criteria, clear quality standards and an explicit timeframe for their implementation. To combat concentration of exposure, the CBRC, per its 2008 annual report, has set concentration limits, capping the maximum exposure to a single client at 10 percent, and to a group client at 15 percent. The CBRC encourages banks to practice syndicated lending to large clients or to issue bonds to fund them, the annual report notes. Despite the information provided above, the available sources do not directly address China's compliance with this principle.

II10. Arm's length rule and monitoring for connected lending.

The 2004 study by Brehm & Macht states that banks are required "to set up an internal control system that ensures sound unified credit management and prevents abuses arising from connected lending" (p. 320). During 2004, according to Podpiera's 2006 study, Chinese authorities strengthened on-site examination and monitoring of large exposures and connected lending. Despite the information provided above, the available sources do not directly address China's compliance with this principle.

II11. Policies and procedures for country risk and transfer risk.

The CBRC, as stated on its website, has issued rules regarding bank's market risk and operational risk. New Capital Rules entered into force in 2004 to include the calculation of various risks such as credit risk, country and transfer risk, market risk, interest rate risk, and liquidity risk. However, rules on prudential regulations and requirements do not provide for detailed criteria, clear quality standards and an explicit timeframe for their implementation. Per the 2008 annual report of the CBRC, the commercial banks are required by the CBRC to “optimize risk management for foreign currency assets and liabilities” (p. 77). Despite the information provided above, the available sources do not directly address China's compliance with this principle.

II12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.

The 2008 CBRC annual report notes that in an effort to enhance banks’ market risk management mechanism, the CBRC requires banks to have effective systems in place to identify, measure, monitor, and control market risk, and to improve the market risk management framework. The banks are also required to distinguish banking and trading accounts clearly and to increase independent pricing capacity. Further, since the beginning of 2008, the CBRC has sought to create greater firewalls between the banking sector and the capital market by, inter alia, identifying and penalizing illegal bank funding to the stock market, and prohibiting banks from providing guarantees on corporate bonds and client-based derivatives trading. Nevertheless, there is insufficient information as to China's compliance with this principle.

II13. Comprehensive risk management processes.

The CBRC, according to its website, has taken measures aimed at "enforcing prudential rules, promoting sound risk management so as to avoid an excessive build up of exposures in individual banks and the banking system as a whole." As noted in the 2004 study by Brehm & Macht, the New Capital Rules entered into force in 2004 to include the calculation of various risks such as credit risk, country and transfer risk, market risk, interest rate risk, and liquidity risk. On the other hand, operational risk is not covered in the risk management process. Brehm & Macht state, however, that rules on prudential regulations and requirements do not provide for detailed criteria, clear quality standards and an explicit timeframe for their implementation. In this respect, the 2008 CBRC annual report mentions that the regulator has launched the information system for off-site surveillance and the early warning system in 2007-2008, and already practices risk-based supervision and conducts targeted on-site examination. Together, these provide important instruments for a comprehensive risk monitoring framework. Liquidity management at banks also improved, per the annual report, with all commercial banks maintaining the minimum required liquidity ratio of 25 percent, and in fact achieving a ratio of 50.07 percent. In addition, operational risk supervision has also been enhanced and brought in line with Basel II by the issuance of the Guidance on Regulatory Capital Measurement for Commercial Bank’s Operational Risk. Despite the information provided above, the available sources do not directly address China's compliance with this principle.

II14. Adequate internal controls.

According to its website, the CBRC has issued rules regarding bank's internal controls. The 2004 study by Brehm & Macht states that banks are required "to set up an internal control system that ensures sound unified credit management and prevents abuses arising from connected lending" (p. 320). In addition, "corporate governance and internal control mechanisms have become the focus of supervision" (p. 186), according to Liu Shiyu et al’s 2006 article. Brehm & Macht note, however, that rules on prudential regulations and requirements do not provide for detailed criteria, clear quality standards and an explicit timeframe for their implementation. In July 2007, according to the CBRC's 2007 annual report, the CBRC issued the Guidance on Internal Control of Commercial Banks, which establishes a clear definition, objective and detailed requirements for the internal control structure. In an attempt to intensify banks’ internal controls, the CBRC, per its 2008 annual report, directed banks to accelerate restructuring through strategic business units, guided banks in enhancing their internal control mechanisms, nurturing their compliance culture, and instilling self-discipline and checks and balances. It has also enforced the accountability system under which the board of directors and senior management are held responsible for the effectiveness of internal controls in an institution. Despite the information provided above, the available sources do not directly address China's compliance with this principle.

II15. Strict "know-your-customer" rules and high ethical and professional standards.

The U.S. Department of State (DoS) 2008 International Narcotics Control Strategy Report indicates that while significant progress has been achieved by the Chinese government in anti-money laundering (AML) and combating the financing of terrorism (CFT) measures, "money laundering remains a serious concern as China restructures its economy and develops its financial system." The Financial Action Task Force (FATF) in its 2007 mutual evaluation assessed China's AML/CFT regime against the FATF's forty recommendations and nine special recommendations. The report highlighted several important weaknesses in China's customer due diligence (CDD) regimeChina’s record keeping regime was largely effective, except that there was an absence in Chinese law and regulations of the requirement that financial institutions retain business correspondence and similar documents. As for China's internal control, compliance and audit system, the regime was not designed to address terrorist financing risk; there was no explicit requirement in the AML Law for financial institutions to have an adequate audit function to test compliance with internal AML/CFT controls; and the AML Law does not require financial institutions to provide relevant employees with CFT training. The Chinese AML/CFT regime was found to be especially weak in addressing foreign branches and subsidiaries. The two main shortcomings were, namely: (1) lack of specific provisions in Chinese law or regulations requiring Chinese financial institutions to apply the higher standard where the AML/CFT requirements of China and the host country differ; and (2) lack of requirements in Chinese law or regulations to inform the home country supervisor when a foreign branch or subsidiary is unable to observe appropriate AML/CFT measures. Regarding supervisory powers, the FATF report states that the Law on the PBC, the AML Law, the Banking Supervision Law, the Large-Value Transaction (LVT)/Suspicious Transaction Reporting (STR) Rules, and the AML Rules give the PBC and the CBRC the power to supervise the observance of the AML/CFT regulations by credit institutions and to impose administrative penalties on those who fail to fulfill their obligations. In terms of supervisory sanctions, the FATF report finds that the Chinese sanctions regime "focuses excessively on minor deficiencies and does not appear effectively to target structural weaknesses" and that "the level of the sanctions provided in the AML Law appears relatively low for major deficiencies" (p. 152).
The IIB's 2007 Global Survey reports that CFT Regulations were released in June 2007, requiring suspected terrorist-linked transactions to be reported to the banking authorities. Furthermore, the 2009 U.S. DoS report notes that in August 2007, China adopted the Administrative Rules for Financial Institutions on Customer Identification and Record Keeping of Customer Identity and Transaction Information, which requires all financial institutions to identify and verify their customers, including the beneficial owner. Despite the above information as regards to progress made by China in implementing the FATF recommendations and strengthening its AML/CFT regime, none of the sources mentioned above explicitly address China's compliance with this principle.

II16. Effective supervisory system consisting of on-site and off-site supervision.

The 2004 study by Brehm & Macht states that the Banking Law's compliance with the BCP on methods of ongoing banking supervision is strong. Pursuant to the Law, the CBRC is authorized to conduct on-site and off-site examination. Per the same report, the CBRC will need to set up a supervisory information system, as well as rating and early warning systems to determine the frequency and the scope of on-site inspections. Results of the third self-assessment reflected the CBRC's notable progress in improving procedures and processes for on-site examination and off-site surveillance by incorporating international best practices. The information system for off-site surveillance on licensed institutions was officially launched in January 2007. The 2008 CBRC annual report notes that the information system has “functioned smoothly” (p. 67), and has enabled timely, complete, and accurate collection of regulatory reports. It adds that an information system for all branches of banks was also launched in January 2008, while an early warning system for monitoring the onset of bank risks was launched in October 2008. Off-site surveillance also includes peer-group analysis using the CAMELS+ rating system (a supervisory bank rating system assessing the following six components of a bank’s condition: Capital adequacy, Asset quality, Management, Earnings, and Liquidity and Sensitivity to market risk), on the basis of which supervisory resources are prioritized and other supervisory decisions taken. Despite the information provided above, the available sources do not directly address China's compliance with this principle.

II17. Regular contact with bank management and understanding of bank's operations.

According to the 2004 study by Brehm & Macht, the Banking Law's compliance with the BCP on methods of ongoing banking supervision is strong. Pursuant to the Law, per the same report, the CBRC has the authority to set up "supervisory consultations with the directors and senior managers of a banking institution in order to inquire about the major activities concerning its business operations and risk management" (p. 321). Nevertheless, the 2004 Brehm & Macht report does not explicitly address China's compliance with this principle.

II18. Analytical reports and statistical returns on solo and consolidated basis.

As stated in the 2004 study by Brehm & Macht, the Banking Law's compliance with the BCP on methods of ongoing banking supervision is strong. Nevertheless, the report does not explicitly address China's compliance with this principle.

II19. Independent validation of supervisory information through on-site examination or external auditors.

The 2004 study by Brehm & Macht states that the Banking Law's compliance with the BCP on methods of ongoing banking supervision is strong. Legislation in China favors independent validation of supervisory information through on-site examinations, as opposed to the use of external auditors, as indicated by the Brehm & Macht report. There are indeed concerns that the external auditing process in China is more susceptible to misreporting and fraud. Nevertheless, the 2004 Brehm & Macht report does not explicitly address China's compliance with this principle.

II20. Ability to supervise on a consolidated basis.

According to Brehm & Macht, the Banking Law's compliance with the BCP on methods of ongoing banking supervision is strong. The IIB's 2006 Global Survey indicates that consolidated supervision in China is applied to bank subsidiaries, affiliates of domestic and non-domestic financial groups, and unincorporated branches/agencies and affiliates of non-domestic financial groups. In 2007, according to its 2007 Annual Report, the CBRC issued the Guidelines on Consolidated Supervision of Banks with the aim of mitigating financial risks and further enhancing consolidated supervision over banking groups. Further, in 2008, per the CBRC annual report, onsite examination of the consolidated operations of large commercial banks was introduced for the first time. The CBRC focused on the banking groups’ overall operations and associated risk. In 2008, the CBRC also developed the Examination & Analysis System Technology (EAST) for on-site examinations, and this system aims to facilitate comprehensive, integrated, and standardized inspections that follow the principle of consolidated, risk-based supervision. Despite the information provided above, the available sources do not directly address China's compliance with this principle.

II21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.

A 2009 Report on the Observance of Standards Codes (ROSC) by the World Bank notes that the CBRC regulates the financial reporting of banks in China and sets disclosure requirements for banks over and above that required by the Accounting Law. Banks are required to submit monthly, quarterly, and audited annual financial statements to the CBRC. According to the World Bank ROSC,, the CBRC "requires banking institutions to prepare their financial statements within four months after the financial year-end. It also prescribes disclosure requirements, primarily for prudential reporting, that each bank must follow" (p. 7). Auditors approved by the Ministry of Finance and the CSRC are required to audit listed banks. Moreover, the World Bank ROSC states that "the CBRC has set up its own standard review procedures in order to determine whether the financial reporting of banks is adequate. The CBRC carries out both on-site and off-site supervision" (p. 7).
The 2004 study by Brehm & Macht states that "accounting and auditing standards, together with their enforcement are weak" (p. 322). Despite improvements in information requirements under the Banking Law, in line with international standards, concerns remained regarding the quality and reliability of information. In February 2006, according to the CBRC's 2007 annual report, the MoF promulgated the Accounting Standards for Business Enterprises (ASBEs), with compulsory compliance by listed banking institutions from January 1, 2007. These accounting standards are generally compatible with the International Financial Reporting Standards, although differences exist. From 2008-2009, per the 2007 annual report, non-listed banks will be required to implement the ASBEs. Going forward, in its 2008 action plan, the CICPA notes that it will continue to support convergence and maintain an "ongoing process to translate IFRS, providing training and education in IFRS, and actively participate in the IASB's work program." A PricewaterhouseCoopers 2009 report on IFRS adoption notes that financial institutions, in addition to ASBEs must also prepare IFRS-compliant (as issued by the IASB) financial statements. Despite the in depth information they provide, the above sources do not directly address China's compliance with this principle.

EN22. Adequate supervisory measures to ensure timely corrective action.

The 2004 study by Brehm & Macht reports that "formal powers of the Chinese supervisory body are far reaching and seem to be fully consistent with BCP 22" (p. 322). Pursuant to the Banking Law, the CBRC may take remedial measures, ranging from suspensions to the closing down of banking businesses. Corrective actions are further stipulated under the 2004 New Capital Rules. According to the regulatory and standard-setting framework assessment published by the CICPA in December 2004, the CBRC has the authority to take enforcement actions where deemed necessary. Liu Shiyu et al’s 2006 article further indicates that an early warning mechanism has been established in China.

EN23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.

The 2004 study by Brehm & Macht states that, overall, "cross-border banking requirements in the [Banking Law] are consistent with those in the BCP" (p. 322). The Guidance on Supervision of Foreign Institutions of Commercial Banks was formulated by the CBRC in 2001 to require foreign institutions of Chinese commercial banks to be subject to the CBRC's authority. The IIB's 2006 Global Survey indicates that consolidated supervision in China is applied to bank subsidiaries, affiliates of domestic and non-domestic financial groups, and unincorporated branches/agencies and affiliates of non-domestic financial groups.

II24. International exchange of information with other supervisors.

The 2004 study by Brehm & Macht states that, pursuant to the Banking Law, the CBRC is given powers to participate in international activities related to banking regulation and supervision. As of 2008, the CBRC, per its 2008 annual report, had signed 33 bilateral memoranda of understanding (MoUs) with foreign supervisors, including in 2008, with regulatory authorities from Luxembourg, Vietnam, Belgium and Ireland. The CBRC also conducts bilateral meetings with several foreign supervisors on an ongoing basis. Despite the information provided above, the available sources do not directly address China's compliance with this principle.

EN25. Supervision of local operation of foreign banks and information sharing with home country supervisors.

The 2004 study by Brehm & Macht states that, overall, "cross-border banking requirements in the [Banking Law] are consistent with those in the BCP" (p. 322). The Provisions on Consolidated Supervision of Foreign Banks were enacted in 2004 to ensure that supervision of foreign and domestic banks is conducted in a fair manner treatment. The IIB's 2006 Global Survey indicates that China applies it supervisory standards apart from the standards of the foreign banks' home country.