Strengthening Regulation of Cross-Border Financing

The establishment of a macroprudential regulatory system for cross-border financing is related to the scale of institutional capital and entails restrictions on total financing volume. It is a system that is convenient for government departments as they manage cross-border financing and it is a system that can be adjusted according to economic conditions as well as changes in the balance of payments and the nation's ability to make repayments. It also allows unified management over local and foreign currency borrowings.

The People's Bank of China unveiled its Announcement of the People's Bank of China on Launching Pilot Projects for Expanding Full-coverage Macro Prudential Regulation over Cross-border Financing in January. The announcement applied to 27 financial institutions and some enterprises registered in free trade zones in Shanghai,Tianjin,Guangzhou and Fujian province. The free trade zones rolled out pilot projects on unified management over local and foreign currency financings in compliance with the central bank's policy. According to the policy announcement,pilot financial institutions and enterprises can make cross-border financings in both local and foreign currencies without needing to obtain approval from the central bank or the State Administration of Foreign Exchange (SAFE),as long as the financing amount is below a ceiling set according to their levels of capital or net assets.

New Ways to Manage Capital Flows

The People's Bank of China and SAFE have been working actively in the past few years to promote pilot reforms in the management of cross-border financing in order to quicken the pace of renminbi convertibility and reform the current management model under which all cross-border financings are supposed to be approved. Three kinds of pilot management models have been launched and the first was the   model unveiled by SAFE in the Shanghai Pilot Free Trade Zone. There is also a management system for external debt which largely relies on corporate self-discipline. This model was devised for some multinational companies in the Shanghai Pilot Free Trade Zone as well as the Zhongguancun National Innovation Demonstration Zone in Beijing,the Zhangjiagang Free Trade Zone in Jiangsu province,and the Qianhai Shenzhen-Hong Kong Modern Service Industry Cooperation Zone in Shenzhen. There is also a project for borrowing renminbi from overseas,a model launched by the central banks in industrial parks in Qianhai,Kunshan,Suzhou,the Sino-Singapore Tianjin Eco City,and development zones in border areas in Yunnan and Guangxi provinces. 

The Shanghai Pilot Free Trade Zone has adopted unified management of cross-border financing in local and foreign currencies. In this model financing is linked to the capital of financial institutions and enterprises and is regulated by leverage ratios and macroprudential parameters. The Shanghai headquarters of the central bank adjusted financing leverage ratios,conversion risks and macroprudential parameters according to "macroprudential principles" to conduct counter-cyclical regulation over external borrowings by institutions within the zone. In addition,the requirement of regulatory approvals for cross-border financing was scrapped,allowing market players to decide on their borrowing levels according to their own financial conditions. The open,transparent,and predictable policy is in line with international practice. It has the advantage of guiding market players to use self-discipline and operate in a prudent way as they make medium-and-long term development plans.

China's economy has been integrated into the global system,and there has been greater convertibility of the currency under the capital account. This means we need to explore new and effective ways to manage capital flows to prevent systemic risk as a result of these reforms. To meet the higher requirements following the addition of the renminbi to the Special Drawing Rights of the International Monetary Fund and maintain cross-border financing at levels that reflect the state of the economy,the central bank decided to set up a macroprudential regulatory system for cross-border financings that is related to the scale of an institution's capital.

The policy of full-coverage macroprudential regulation over cross-border financing requires a certain correlation between cross-border financing and capital levels or the net assets of market players. The central bank can adjust that correlation according to actual needs to control debt leverage levels and prevent currency mismatch risks.

In the Shanghai free trade zone model,the full-coverage macroprudential regulatory system requires all participants -- financial institutions and enterprises -- to keep risk-weighted cross-border financing within a ceiling,and the total amount of cross-border financings in local and foreign currencies within a "safe range."

Improving Financing Management

First,the pilot program had to get around the existing model which requires approval for each instance of cross-border financing. We must set a limit on risk-weighted cross-border financing balances related to capital and leverage ratios for financial institutions and enterprises respectively. Risk-weighted cross-border financing balance of financial institutions and enterprises,adjusted by borrowing terms,categories and currency mismatch,must stay within their limits. We set such differentiated limits for financial institutions and enterprises because debt and risk-bearing abilities of banks are restricted by capital levels set in the bank regulatory system under Basel III and macro prudential regulations set by the government. Enterprises,especially those small and medium sized ones,may have limited capital levels but are growing rapidly,thereby accumulating large amounts of surplus reserves. In many cases their net assets are much larger than the size of their capital. As such,requiring external debt levels to be related to net assets can better demonstrate an enterprise's solvency and help reduce financing costs.

To promote foreign trade,investment and the use of the renminbi in the international market,we excluded trade credits and renminbi trade financing by enterprises,as well as passive debts such as renminbi deposits by financial institutions from risk-weighted cross-border financing balance calculations.

Second,we set regulatory parameters for cross-border financing. There are multiple parameters in the full-coverage macro prudential regulation over cross-border financing to demonstrate different levels of risk from various types of cross-border financing.

Total volume regulation parameters include cross-border financing leverage ratios and macroprudential regulation parameters. Cross-border financing leverage ratios are linked to the total amount of cross-border financings by market players overall. The parameters are a factor of 1,or 100% ,of net assets for enterprises and 80% of core capital for financial institutions. Macro prudential regulation parameters can be adjusted.

Structural regulation parameters include three risk convention factors,namely borrowing terms,categories and currency mismatch. The first factor demonstrates risk differences between medium- and long-term financings and short-term financings. The second factor demonstrates risk differences between on-balance sheet financing and off-balance sheet financing (contingent liabilities). The third factor demonstrates risk differences between financing in local and foreign currencies. As short term on-balance sheet foreign currency financings are of higher risk than medium and long-term off-balance local currency financing,it will take more financing space.

Third,there is a need to regulate the use of financing capital. Financed capital of enterprises in the pilot program must be used for the enterprise's own operation. If necessary,foreign exchange from external financing can be used for settlement. Borrowings by pilot financial institutions can be used to boost capital and serve their development in line with China's macroeconomic regulations. Foreign exchange financings approved by SAFE can be used for settlement.

Clarifying Regulatory Responsibilities

The central bank will take the macroeconomic situation into consideration when adjusting leverage ratios,exchange risk conversion and other fac