Realization of the “dual goals” of economic and financial stability cannot be achieved without coordination between the monetary policy and the macroprudential policy. The differences in risk preferences, behavioral patterns, and monetary policy transmission among different types of financial intermediaries dictate that “dual-pillar” regulation should be carried out using differential strategies.

China’s practice

Macroprudential policy was introduced when monetary policy was “overstretched” and unable to achieve price stability and financial stability at the same time. The 2008 Global Financial Crisis happened when inflation was well-controlled. This fact disrupted the belief that “price stability was equivalent to financial stability.” In response to the financial cycle, traditional monetary policy framework limitations which used currency stability as a policy anchor have been highlighted. Meanwhile, macroprudential regulation, represented by the Basel III accords, can effectively prevent and control financial risks caused by cross-institutional and cross-market transmissions from a macro counter-cyclical perspective, forming an important complement to the traditional monetary policy regulatory framework.

China has begun a relatively early exploration and practice of the “dual-pillar” regulation framework, and it has achieved obvious results. The window guidance and credit policy adopted by the People’s Bank of China (PBOC) contained macroprudential concepts, especially the introduction of loan-to-value ratio requirements in 2003, which were highly forward-looking in regulating real estate finance. In the process of rebuilding the regulatory framework during the 2008 Global Financial Crisis, the macroprudential policy framework was continuously strengthened and improved in accordance with the deployment of the CPC Central Committee and the State Council recommendations. The “Law of the People’s Republic of China on the People’s Bank of China (Revision Draft for Comments),” issued in 2020, established the basic framework for China’s current implementation of the “dual pillar” regulation framework. The “Guidelines on Macroprudential Policy (for Trial Implementation),” issued in 2021, clarified the elements for establishing a sound macroprudential policy framework in China. In order to effectively strengthen financial supervision, the organizational structure of China’s financial supervision has also changed, forming a financial supervision system led by the Financial Stability and Development Committee (FSDC) under the State Council, the PBOC, the China Banking and Insurance Regulatory Commission, and the Securities and Futures Commission, which provide a strong impetus for the implementation of the “dual-pillar” regulatory policy. The “dual-pillar” policy has been implemented alongside a strong organizational guarantee.

Theoretical logic

It is necessary to carry out a differentiated “dual-pillar” regulation framework. The differences in behavior patterns and monetary policy transmission for different types of financial intermediaries often lead to large differences in their impact on macroeconomic and systemic risks. The use of homogeneous “dual-pillar” regulation not only weakens policy effectiveness, but may even be counterproductive. This makes it necessary to explore the implementation of differential monetary and macroprudential policies for different banks to enhance the effectiveness of the countercyclical regulation.

For effective differential “dual-pillar” regulation, three different scenarios need to be considered: (1) a single negative economic imbalance (downturn) with financial activity within the normal target range; (2) a single positive financial imbalance (rising risk) with economic activity within the normal target range; (3) a negative economic imbalance with financial activity within the normal target range. Negative imbalances coexist with positive financial imbalances, corresponding to a decline in the real economy with rising systemic risks.

In the first scenario, differential monetary policies for different leveraged banks can effectively achieve economic and financial stability. In the second scenario, differential macroprudential policies should be implemented for traditional banks and shadow banks. In the third scenario, differential regulation should be carried out for banks with heterogeneous ownership.

Differential regulation

At present, China should combine different bank behavior patterns with appropriate macroprudential policies, actively prevent and resolve financial risks, and ensure the realization of the “dual goals” of stabilizing the economy and finance.

First, under the requirement of stabilizing the economy and finance, we can match appropriate macroprudential policies for state-owned banks and tighten regulatory policies for other share-holding banks to restrain their excessive financial risk-taking behaviors.

Second, “deleveraging” banks should focus on “structural deleveraging.” It is advisable to introduce flexible leverage supervision, and pay special attention to highly leveraged banks, especially under the easy monetary policy, and implement tight macroprudential supervision to deleverage those highly leveraged banks and curb their financial risk spillover effects.

Third, the “dual goal” requirement specifies that shadow business governance should adopt a macroprudential policy with the credit scale as the fixation target, or provide special capital and provisions for shadow business, and adhere to a “situational approach” when resolving financial risks, to strictly prevent financial risks from being transmitted and intertwined.

Shen Peilong (professor) and Guo Lijuan are from the School of Finance at Shanxi University of Finance and Economics.