By Michael G. DeSombre and Weiheng Chen, Sullivan & Cromwell LLP, Hong Kong

On February 23 2004, the China Banking Regulatory Commission (the CBRC) fulfilled its promise¹ to modernize its capital adequacy standards by promulgating the Administration of Capital Adequacy Ratios of Commercial Banks Procedures (the Capital Adequacy Procedures, or the Procedures) after approval by the State Council. The Capital Adequacy Procedures, the first regulations in China to set forth the precise mechanism for calculating capital for commercial banks, are based on the 1988 version of the Basel Capital Accord (Basel I) but also draw on the proposed new Basel Capital Accord (Basel II).² The Procedures have also been drafted in light of China's commitments under the WTO to open its commercial banking sector to foreign competition by January 1 2007.

Since its promulgation in 1995, the PRC Commercial Banking Law (the Commercial Banking Law) has required all commercial banks to maintain a minimum 8% capital adequacy ratio. The People's Bank of China (PBOC), however, never promulgated regulations detailing how the capital adequacy ratio was to be calculated, and there has never been any enforcement of the 8% minimum capital adequacy ratio. In its first step at modernizing the capital adequacy regime for commercial banks in China, in 2002 the PBOC mandated the adoption of the internationally recognized risk-based, five-category loan classification system.³ All commercial banks in the PRC have been required to implement the five-category loan classification system from the beginning of 2004.