China is considering a central bank reform to give itself more clarity and control
The Chinese central bank is quietly considering a change that says a great deal about the progress and perils of China’s broader reform project. According to Caixin, Beijing may abolish the nine regional branches of the People’s Bank of China, each of which oversees several provinces, and replacing them with more than 30 provincial-level branches – effectively returning to a system it abandoned in 1998. The plan is expected to kick in by the end of the year.
Now, we realise that a bureaucratic overhaul in China is not very dramatic. But as we discussed following President Xi Jinping’s overhaul of the state bureaucracy during the spring, Xi is in a make-or-break wrestling match with the system he heads, and there are still several rounds to go. China is a big and unwieldy place that’s ill-suited for micromanagement. Chinese history is littered with sclerotic, unresponsive governments getting blindsided by crises bubbling up from the provinces. And if the Communist Party of China has any chance of surviving amid slowed growth and trade tension with the West, it will need all the help it can get.
Reversing Course
On the surface, at least, this change seems like an admission of defeat. Until 1998, the PBOC had a branch in each of China’s 31 provincial-level administrative units (i.e., provinces, autonomous regions and biggest cities) that answered directly to the central bank leadership – a similar structure to the one under consideration.
The problem with this setup was that local governments simply proved too adept at hijacking monetary policy and financial resource allocation to support their immediate interests, often at the expense of Beijing’s macroeconomic goals. Part of the problem was that the incentives of local governments and provincial PBOC branches were too tightly aligned.
The quickest way to gain promotion up through the Chinese system, whether as a local administrator or a central bank branch official, was to ensure that your province was producing sparkling economic data. PBOC branches were also too dependent on assistance from local governments, which since the 1980s have had considerable sway over local economic activities and ample wariness of prying eyes, to be able to carry out their mandate.
Thus, a province’s success was the branch’s success, creating incentives to overlook financial risk and support reckless lending and development in the name of economic growth. (And, if all else failed, there were mutual incentives to simply cook the books).
In other words, what Beijing wanted from the bank branches was a clear view into local economic activity and prudent allocation of liquidity. What it got was regulatory capture. This was just the latest manifestation of an age-old problem in China, where the center has always struggled to control the country’s disparate parts.
And so, in an effort to boost the central bank’s independence, the PBOC was restructured to resemble the U.S. Federal Reserve. The provincial branches were abolished, replaced by nine regional branches responsible for overseeing several provinces.
More than 300 municipal sub-branches and more than 1,000 county-level sub-branches remained, but their responsibilities were confined to financial supervision, with little ability to alter policy or issue credit independently – and thus leaving local governments with less influence over the PBOC.
But this system fostered its own problems. In particular, the regional branches have reportedly struggled to uniformly