PREFACE 1 THE DIRECTION OF FINANCIAL TRANSFORMATION：BUILD A MODERN FINANCIAL SYSTEM

Finance is the core of the modern economy and an important instrument for a nation. Since the founding of New China，especially since the reform and opening-up，China's financial industry has achieved historic changes. The monotony，isolation and insignificance have been replaced by diversity，integration and considerable weight. The world today is witnessing unprecedented changes. Therefore，during the course of the reform and opening-up of China's financial industry in the new era，we must constantly ask ourselves how to seize the strategic opportunities and utilize finance to vitalize high-quality economic development.

The painful lessons we learnt from many international financial crises，in particular the 2008 Global Financial Crisis，have taught the world that an imprudent shift to the virtual economy，a deviation of the financial industry from its mission，and self-circulation，self-expansion and prevailing speculation can easily create bubbles and lead to systemic financial crises in a country. The root causes are nothing less than misguidance by the national authorities，loose monetary policy，lax financial regulations，failure of financial supervision，failure of financial market constraints，disorder of financial infrastructure，improper countermeasures and imbalanced global financial governance. Now China is working hard to build a socialist market economy with Chinese characteristics，comprehensively promote the rule of law and continuously deepen financial reform and opening-up.This necessitates financial transformation and devotion of our efforts to building a modern financial system.

Establish a mature and more reliable financial legal framework. The development of a modern financial system must be based on the rule of law and a solid financial legal framework where things from administration to operation to supervision to punishment are run according to the law. Such higher-level laws as the Company Law，the Banking Law，the Securities Law，the Fund Law，the Insurance Law，the Trust Law，the Financial Supervision Law，the Financial Rights and Interests Protection Law and the Financial Institution Bankruptcy Law should be used as the foundation to formulate and improve various regulations，measures，rules and implementation instructions.

Establish a more effective financial control system. In order to build a modern financial system we should let the market play a decisive role in the allocation of financial resources while encouraging the establishment of a variety of financial institutions and the development of a multi-level financial market，including but not limited to the stock market，bond market，money market，inter-bank market，foreign exchange market and futures market. Nevertheless，the state must exercise timely financial control and build a highly efficient financial control system to prevent financial volatility and dramatic ups and downs in the economy. An effective financial control system can guide and stabilize expectations，boost investor confidence and prevent market volatility. That is one of its core functions. Moreover，it can bring about forward-looking counter-cyclical adjustment，curb excessive speculation and bubbles，and prevent overheating and overcooling of the economy as well as major cyclical fluctuations. Therefore，the financial control body must，first of all，have an up-to-date，full and accurate picture of the economy and the market. Secondly，they must strengthen monitoring，analysis and evaluation. Last but not least，they must put in place effective measures and mechanisms to conduct targeted adjustment of the market in a forward-looking and flexible manner. In order to stabilize expectations and confidence and ensure that financial control is sufficiently forward-looking and adequate，the financial control body must hold dialogues with the market participants and the general public whenever and wherever necessary，do a better job of disclosing information and enhance policy transparency as well as credibility. In order to achieve better synergies and avoid internal disputes，all financial control departments must strengthen information sharing，coordination and collaboration，including the information each of them published and the policy actions taken separately.

Establish a more efficient financial regulatory system. Nowadays financial institutions are engaged in a broader range of business activities. In parallel，financial operations，tools and products are gaining diversity，while financial transactions and risks are becoming more and more complicated. Therefore，financial risks are increasingly interlinked，correlated，contagious and resonant with spillover effects on the rise. This new phenomenon threatens the financial system more than ever before，jeopardizing its safety and stability. In order to effectively prevent systemic and regional financial risks，we must speed up the establishment of a more efficient financial regulatory system. No matter who takes charge of financial supervision and whether it has a divided or integrated structure，is institution or function-oriented，and relies on the central government or the local authorities，a clear division of responsibilities remains to be one of the essential building blocks for an efficient regulatory system. In a word no regulatory vacuum should be allowed to exist. It does not matter whether the entity is licensed or non-licensed，formal or of a shadow banking nature，and online or offline. It must be subject to effective financial supervision all the same. Another essential building block is the collection，processing，sharing and use of information. Regulatory departments should take full advantage of modern information technologies to obtain a sufficient amount of up-to-date，precise information about financial institutions，businesses and transactions with the aim of detecting，identifying，analyzing and evaluating financial risks in a timely manner. Only in this way can we prevent financial risks from accumulating，expanding and spreading. The third essential building block is the early detection，warning，control and disposal of financial risks. Early intervention，rectification and prohibition is necessary for dealing with financial misconduct and risky financial businesses as well as transactions. Failure to identify financial risks in time is a serious oversight on the part of the regulators，while failure to give timely reminders and take prompt countermeasures constitutes a grave mistake.

Establish a mature and more reliable financial corporate governance system. At the micro level financial institutions are the main bodies engaged in business and market activities. They can create financial risks and at the same time bear the main responsibility of preventing financial risks. Therefore，we must establish a corporate structure that clearly denotes ownership，is effectively governed，ensures stable operation and safeguards information transparency. Such a structure is the cornerstone of the modern financial system where sound corporate governance plays a key role. From the practical point of view，a satisfactory corporate governance structure，first of all，should have the right objective and culture. A simple focus on pursuing shareholder returns，short-term profits and high compensation for the executives should be abandoned. Instead，we should take into account the interests of all stakeholders，including the state，society and community（investors，depositors，financial consumers and ordinary employees，etc.）and pay more attention to the long-term，sustainable development of the institution. Secondly，the decision-making process of the board should be democratic，professional and scientific with checks and balances put in place. This measure can effectively prevent major shareholders and insiders from seizing the power，avoid suspicious internal related party transactions and negate radical decisions that can undermine the long-term development of the institution. Moreover，the internal incentive mechanism should be built around the stability，sustainability and long-term development of business operations and the coordination of social and corporate benefits. Finally，it should have a high level of transparency for both external and internal parties，be willing to accept their scrutiny，care about social and market reputation and have the courage to conduct self-rectification and self-revolution.

Establish a more effective system to impose financial constraints. Effective financial constrains can encourage the financial institution as the main market participant to operate more prudently and steadily，rely on their scientific and strict risk control capabilities and core competitiveness for survival and development，and achieve success through fair and just competition. An effective constraint system that goes hand in hand with the financial market has the following five aspects. First，in accordance with the requirements concerning external audit and information disclosure，anyone who is found concealing or fabricating information should bear legal responsibility. Second，all relevant stakeholders（shareholders，creditors，financial consumers，etc.）should supervise the financial institution through “foot voting”，“hand voting”，administrative complaints and legal proceedings. Third，the press should supervise the financial institution through public comments and PR exposure to impact its reputation so as to influence public trust. Fourth，those low-performing，risky，and weak financial institutions will be acquired or merged，with loss inflicted on the interests of the shareholder and executives. Fifth，those financial institutions deep in payment difficulties or insolvent will be forced to exit from the market，close down and get liquidated. In this case，the shareholder will lose their investment and the executives as well as employees will suffer a significant loss too. The relevant responsible person should be made legally accountable in order to prevent financial moral hazards.

Establish mature and more reliable financial infrastructure. Financial infrastructure is one of the important pillars of the modern financial system which can ensure the efficiency of the financial system and the market as well as safeguard financial control and regulation. Well-developed financial infrastructure contains，but is not limited to，the following components：a secure and efficient financial information technology（IT）system；a sound and transparent financial product registration and trading system；an accurate and efficient valuation and pricing system for financial assets（products）；a secure and efficient system for money transfer and clearing；an independent and impartial credit rating system；a sound and accessible enterprise and personal credit information management system；a strict and effective system for the education and protection of financial consumers and investors；and a sound and effective financial safety net of deposit insurance and liquidity support.

Establish a more efficient financial crisis response system. It does not matter whether the cause is internal or external. Once a systemic financial crisis occurs，we must respond immediately to prevent it from spreading and deteriorating，minimize the impact，damage and losses，and restore the normal operation of the economic and financial system as quickly as possible. A highly efficient financial crisis response system has the following five aspects. First，it should be able to raise a red flag in advance. Early warnings can give us extra time to find solutions and early response can help to reduce the impact and destruction. Second，it should allow the financial system to be replenished with liquidity and capital in a timely manner and provide deposit insurance and government credit so as to stabilize and enhance market confidence. During the course of resolving a financial crisis，confidence is the key. Third，financial regulation and monetary policy should be aligned with counter-cyclical adjustments. Measures such as adjustment of the benchmark interest rate and reserve requirement ratio，open market operations and refinancing can be used to increase the supply of money and credit and stabilize market expectations. Fourth，policy coordination should be enhanced to achieve synergies，improve expectations and confidence，and boost the recovery of the economy. For example，fiscal policy and monetary policy should be well coordinated. The same logic applies to tax policy，investment policy and consumption policy. Fifth，international collaboration should be strengthened，since financial risks and crises in an open financial system are interlinked and contagious. The international community should come together and act in unison，including the coordination of policies and actions，the sharing of information and the disposal of risks. If any country acts alone or refuses to cooperate out of a selfish concern，it could undermine confidence，protract the crisis and dash the hopes of fast economic recovery.

Facilitate the establishment of a balanced global financial governance system. Today economic and financial globalization is in full swing. China's opening-up of the financial industry and its integration into the global financial market is irreversible. We have already become the world's second largest economy and a financial powerhouse. It can be said that China and the world rely on each other to maintain financial stability and security. Therefore，China should be involved in global financial governance more deeply，play a more constructive role in building a more orderly and effective system in this regard and contribute our wisdom and solutions to that end. First，while continuously promoting the internationalization of the RMB，we should aim to increase its share of global currency reserves and the IMF's Special Drawing Rights. China needs to have a bigger say in the global monetary system and IMF governance，and China can play a greater role in maintaining global monetary and financial stability. Second，taking advantage of China's membership in international organizations such as the G20，the Global Financial Stability Board and the Basel Committee on Banking Supervision，we can jointly promote the reform of the global financial system and financial supervision，actively participate in and influence the formulation and implementation of global rules and standards on financial governance，keep increasing China's “discourse power”，establish a fairer and more transparent global financial order conducive to the financial development of the developing countries and promote global financial security and stability. Third，we should help strengthen coordination and cooperation between bilateral and multilateral monetary authorities and financial regulators to jointly cope with financial market shocks and regional financial crises as well as safeguard regional financial security and stability.

WANG Zhaoxing

Counsellor of the State Council，

Former Vice Chairman of China Banking and

Insurance Regulation Commission

February 28，2020