context: The move to limit PBoC’s lender of last resort commitment may foreshadow the undercurrent of dangerously high aggregate debt obligations. The moral hazard risk in the PRC context is more of a problem stemming from the lack of central bank independence, allowing financial decisions to be ‘hijacked’ by political incentives, rather than one of market-driven mal-investment.
PBoC’s (People’s Bank of China) 2021 China Financial Stability Report mentions that financial institutions and local governments have long gamed the system in which PBoC upholds responsibility for financial and social stability. While bound to fulfill its LLR (lender of last resort) commitment, PBoC lacks regulatory authority over institutions covered by this commitment. PBoC is forced to face higher financial risk disposal costs as its expansive LLR commitment encourages moral hazard risks.
PBoC will establish a stricter LLR mechanism, providing financial support only to financial institutions with liquidity risks. Financial institutions and their shareholders are the primary responsible persons for financial risk disposal, while local governments should contain financial risks and maintain stability within their jurisdictions. Deposit insurance and industrial insurance funds must compensate investors’ losses and dispose of financial risks under their supervision. PBoC’s LLR responsibility is only activated when all these actors cannot prevent systemic risks.
Additionally, PBoC will enhance risk monitoring and evaluation to assess whether financial institutions suffer liquidity or insolvency risk; in principle, PBoC only provides support to financial institutions suffering liquidity risks. PBoC will also build the analytical framework for systemic risks and offer assistance if a single financial institution’s difficulties trigger systemic instability. When handing out refinancing, PBoC will strictly implement the guarantee measures and ask borrowers to offer qualified collateral.
Finally, PBoC will enhance supervisory intervention through the revision of PBoC Law, which is the prerequisite of its LLR commitment. PBoC must be equipped with the authority to impose restrictions on business activities, dividends, asset transfers, recapitalisation, share transfers, management reshuffles, etc. to ensure the safety of its funds.