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Background Information for the Regulations on Administration of Foreign-funded Banks

China Banking Regulatory Commission

November 16, 2006

As an integral part of China's national economic reform and opening up as well as a natural outcome of China's increasing integration into the world economy, the opening-up of the Chinese banking sector is instrumental in promoting the banking industry reform and thereby improving the competitiveness of China's banking sector as a whole. The government attaches great importance to the banking sector opening up, and is committed to promoting the banking industry reform and opening up concurrently, and at the same time strengthening the supervision and improving the services quality. It is the government's conviction that strengthened supervision and improved services will pave the way for further opening-up.

Today, China's banking system and market are undergoing significant changes. In a bid to honoring China's WTO commitments, further promoting banking sector opening up and supervision by law, and thereby ensuring safe and sound operations of the banking system, the Chinese government, after wide and numerous consultations, recently made amendments to the Regulations of the People's Republic of China (PRC) on Administration of Foreign-funded Financial Institutions (hereinafter referred to as the original regulation). The amended regulation is re-named the Regulations of the PRC on Administration of Foreign-funded Banks (hereinafter referred to as the new Regulations). The new Regulations was promulgated on November 11, 2006 in the form of the State Council Decree and will become effective on December 11, 2006. The promulgation of the new Regulations signifies the Chinese government's resolve to further promote the banking market opening-up, further strengthen the prudential and risk-focused supervision, and thereby ensure the sustainable and healthy development of the banking industry.

1.History of the banking sector opening-up

The Chinese banking sector has been developing and gradually opened in pace with the overall economic reform and opening up. Starting in certain regions, the banking market opening has rolled out to cover the entire country. At the same time, it has extended from foreign currency business to local currency activities, from foreign residents and enterprises to local customers. Along the process, the foreign banks have been growing steadily in numbers and asset scale, and the range of products and services permitted to foreign banks has expanded progressively. Meanwhile, the foreign banks are encouraged to forge business and equity partnership with the local banks, and thus become an important component of the Chinese banking sector.

1.1Development of foreign-funded banks in China

After its accession to the WTO, China has faithfully honored its WTO commitments and taken a series of opening-up measures on its own initiative. As of end-September 2006, the wholly foreign-funded banks and joint-venture banks registered in China numbered 14, which opened 17 branches and sub-branches. In addition, 73 foreign banks from 22 different countries and regions established 191 branches and 61 sub-branches in 24 Chinese cities; 183 foreign banks from 41 countries and regions established 242 representative offices also in 24 cities. The total local and foreign currency assets of the foreign-funded banks amounted to US$105.1 billion, accounting for 1.9 per cent of the total banking assets in China. The total deposits amounted to US$33.4 billion, and the loans totaled US$54.9 billion.

It is provided in relevant regulations that a Chinese branch of a foreign bank, a wholly foreign-funded bank or a joint-venture bank is defined as an operational foreign-funded bank. Subject to approval, its permitted scope of business covers deposit-taking, loan-making, clearing, custodian services and insurance agency business. Additionally, such bank can apply to conduct local currency business as long as it is in business and profitable for a certain period of time and has fulfilled some other prudential requirements. At the same time, the foreign-funded banks are allowed to engage in derivatives trading, QFII custodian services, personal wealth management, offshore banking services on an agency basis (QDII), electronic banking, etc. In general, the range of products and services offered by foreign-funded banks has expanded over the years. The foreign-funded banks are now permitted to engage in over 100 categories of business activities. As of end-September 2006, 25 Chinese cities were opened to the RMB business by foreign-funded banks, of which 5 cities were opened one year ahead of the schedule. 111 foreign-funded banks are now permitted to undertake RMB business, while the volume of such business has been growing 4.6 times since 2001 at an annual average rate of 92 per cent.

1.2Improvement of the banking legal framework

In recent years, the Chinese government amended and promulgated a series of laws and regulations governing the banking institutions and their business activities. Thus, a legal framework for banking regulation and supervision has taken shape, featured by three categories of legislation: namely, laws, regulations and government rules. The major legislations include the Law of the PRC on Banking Regulation and Supervision, the Law of the PRC on Commercial Banks, the Regulations of the PRC on Administration of Foreign-funded Financial Institutions, the Rules for Implementing the Regulations of the PRC on Administration of Foreign-funded Financial Institutions, and the Rules Governing the Representative Offices of Foreign Financial Institutions in the PRC. Such a legal framework provides a solid foundation for the continuous opening up of the Chinese banking sector.

Meanwhile, the Chinese government attaches great importance to mitigating the risks arising in the process of opening up through prudential supervision. By drawing upon the international supervisory standards and best practices, China has endeavored to create a fair and transparent supervisory environment, and has made notable progress in integrating the supervisory standards and requirements for both local and foreign banks. China also keeps improving its processes and procedures for the supervision of foreign-funded banks, including adopting a risk assessment system, together with the systems of ROCA and SOSA for the supervision of foreign bank branches. In addition, China has endeavored to strengthen the cross-border supervision through supervisory cooperation agreements with many countries and regions.

II. Principles and Contents of the new Regulation

The principles embodied in the new Regulation are as follows: faithfully honoring China's WTO commitments, promoting an all-around opening up of the Chinese banking sector, and according the national treatment to the foreign-funded banks based on China's WTO commitments. At the same time, by promulgating the new Regulation, China also intends to strengthen the prudential supervision of foreign-funded banks, ensure the efficiency, effectiveness and adequacy of supervision, and thereby ensure the safety of China's financial system and protect the interests of depositors.

The new Regulation consists of 73 articles. In comparison with the original regulation, the amendments mainly fall into five categories. The first category refers to the amendments made with a view to honoring China's WTO commitments. For instance, it was provided in the original regulation that a foreign financial institution shall obtain the approval of the regulatory authority for the geographical coverage and range of customers of their RMB business. Such requirement is abolished in the new Regulations, and replaced by the provision that a wholly foreign-funded bank or a joint-venture bank may conduct full RMB business when it has "opened business for at least three years" and "been profitable for two consecutive years" prior to application and has met other prudential requirements; a Chinese branch of a foreign bank may conduct RMB corporate business and receive time deposits of no less than RMB1 million yuan per transaction from the domestic citizens. The second category refers to the amendments made with a view to strengthening prudential supervision. For instance, the provisions on information disclosure and corporate governance are added in the new Regulations. It was provided in the original regulations that "the foreign currency deposits taken by a foreign financial institution within the PRC territory shall be no more than 70 percent of its total foreign currency assets held in the PRC territory". Such provision is abolished in the new Regulations, and replaced by the provision that the total RMB and foreign currency assets of a foreign bank branch held in the PRC territory shall be no less than the branch's total RMB and foreign currency liabilities held in the PRC territory. Such provision aims to protect the interests of domestic depositors by ensuring that the foreign bank branch will have adequate liquidity to pay the debts at the time of crisis. The third category refers to the amendments made with a view to integrating the supervisory requirements applying to the Chinese and foreign banks. For instance, the foreign-funded banks incorporated in China and their branches are subject to the same requirements with their Chinese peers on registered capital and operating capital. In addition, the requirements provided in the new Regulations such as the foreign-funded banks shall determine their interest rates on deposits and loans as well as the rates of various service fees, place required reserves with the central bank, draw loan loss provisions and maintain appropriate asset/liability ratio are all applying to the Chinese banks as well. In light of the difficulty for those foreign-funded banks that are converted from foreign bank branches to meet the asset/liability ratio requirement in a short time, the new Regulation gives the banks a grace period. The fourth category refers to the amendments made with regard to the application scope of the Regulations. The new Regulations no longer applies to foreign-funded finance companies, which are covered by the Regulations on Corporate Finance Companies. However, the new Regulations provide more requirements on the representative office of a foreign bank. It should be noted that the new Regulations mainly regulates the foreign banks' establishments and their business activities within the PRC territory, and dose not concern the foreign banks' equity participation in the Chinese banks, such business activities are to be regulated separately. The fifth category refers to the amendments made with a view to embodying China's regional economic development strategy. In order to implement China's regional development strategy that gives priority to the development of the north-east, west, central China and Tianjin Binhai Economic Region, the new Regulations gives foreign banks some favorable treatment in market access if they intend to launch businesses in these areas. Also, in a bid to implement the CEPA agreements between the mainland of China and Hong Kong SAR and Macao SAR, the new Regulations gives some preferential treatment for banks from Hong Kong and Macao in doing business in the mainland. The Regulations also apply mutatis mutandis to the banking institutions established in the Chinese mainland by financial institutions from the Hong Kong Special Administrative Region, the Macao Special Administrative Region, or Taiwan region.

III. Full embodiment of the principles of national treatment and prudential supervision by the Regulations

The new Regulations have fully embodied China's commitments to opening up the banking sector in an all-round manner, and have removed all the non-prudential restrictions on foreign-funded banks. According to the new Regulations, foreign banks are allowed to choose the form of its presence in China based on its business strategies and on a voluntary basis. In line with the international practices, the foreign-funded banks incorporated in China are allowed to conduct full RMB business, and will be regulated under the same supervisory standards with the Chinese banks. In other words, they enjoy full national treatment.

The Chinese branches of foreign banks, apart from engaging in foreign exchange business and RMB business, are also allowed to take RMB time deposits from domestic citizens with each transaction of no less than RMB1 million. These provisions, which are also prudential requirements, are designed to improve the efficiency and adequacy of supervision. As a result, foreign bank branches will enjoy simplified business authorization procedures and less operating capital requirements, while their operating costs and business scope are expected to remain the same. Moreover, the foreign bank branches are also allowed to apply for converting themselves into locally incorporated banks at any point of time based on their own choice and their business strategies.

The new Regulations encourages foreign banks to establish or convert their branches into locally incorporated subsidiaries, while allowing the Chinese branches of foreign banks to receive the time deposits from the Chinese citizens of no less than RMB1 million per transaction. Such a policy is based on the following considerations:

First, in order to protect the interests of domestic depositors, it is prescribed in the laws and regulations of many countries that, in terms of the order of debt repayment, domestic depositors enjoy priority over the overseas depositors. Once the parent bank of a foreign bank branch encountered liquidity risk or payment crisis, the depositors of the branch in the host country would not be guaranteed to have priority in repayment. Moreover, in an increasingly globalized banking environment, the risks a multi-national bank incurs in one region or in a business field can easily spill over to its globe-wide branches, and the supervisory agencies in the host countries can hardly help in isolating the local branches from these risks. However, as a locally incorporated subsidiary of a foreign bank is subject to the supervisory requirements on capital adequacy, loan loss provisions, large exposures, cross-border capital flow and deposit repayment capacity, etc, the local supervisory agency can play an effective role in isolating the subsidiary from the risks of its parent bank. And by so doing, the supervisory agency will be able to maintain the stability of the domestic financial system and safeguard depositors' interests in the best way.

Secondly, the deposit insurance schemes of many countries only cover the locally incorporated foreign banks, and do not cover the foreign bank branches. Therefore, in order to protect the interests of domestic depositors, the supervisory agencies of many countries impose different degrees of restrictions on foreign bank branches' ability to receive deposits from local citizens.

The policy to encourage the local incorporation of foreign banks embodies the prudential principles and is in fact an internationally prevailing practice. First, in line with the General Agreement on Trade in Services promulgated by WTO, its member countries are allowed to protect depositors' interests and maintain the soundness and stability of domestic financial system by introducing prudential measures. According to the Basel Committee on Banking Supervision, the banking regulators of all countries are entitled to stipulate and utilize prudential regulations to control risks, so as to refrain banks from reckless risk-taking. Meanwhile, it is a consensus among the supervisory agencies that the supervisory measures are considered prudential as long as they are intended to protect the depositors’ interests, mitigate banking risks, and ensure the safe and sound operations of the banking system. It is a common practice for the supervisory agencies of different countries to adopt various prudential requirements in their capacity for risk controlling purposes. Second, opening the business of deposit-taking from local citizens to foreign competition is recognized to have a significant bearing on the well-being of the domestic economy. Given such recognition, all the supervisory agencies are usually very cautious in addressing this issue. The commonly adopted practice is to allow locally incorporated foreign banks to conduct a full range of business, and allow the foreign bank branches the market access only to the corporate business. Also, more often than not, the supervisory agencies would classify the different client base for different types of foreign bank establishments through setting up a minimum volume for each deposit received from local citizens. In fact, the restrictions of various degrees on allowing foreign bank branches to receive deposits from the local citizens are adopted in many countries and regions, such as the US, European Union, Canada, Australia, New Zealand, Mexico, Malaysia, and Singapore.

To conclude, the new Regulations signify the Chinese government's resolution to carry on economic opening-up and to honor China's WTO commitments. We believe that, the steady development of China's economy and financial market, together with the continuous improvement of China's financial regulation and supervision, will surely create a more enabling environment for the prosperous development of foreign banks in China.

(China Development Gateway November 16, 2006)

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