New Rules for Chinese Finance
China has set about taming its unruly financial sector with characteristic vigor. Its government is busy investigating dubious banks, detaining suspected insider traders, and proposing overhauls of its regulatory system. All of which would be fine, so long as the authorities were also focused on a deeper concern.
More than anything else, China's financial regulators need independence. Financial regulation should be mainly about promoting prudence and safety, not advancing the government's aims in industrial and economic policy. That's a principle Beijing hasn't yet fully embraced.
Just last week, authorities busted a $64 billion underground bank for illicitly shifting funds overseas. They've detained at least 16 people -- from a hedge-fund high flyer to top securities regulators -- on suspicion of insider trading. And they're reportedly considering merging various agencies into a single "super-regulator" to oversee an increasingly complicated and sprawling financial sector.
One can understand the government's urge to clamp down. China's casinolike financial sector is rife with bad behavior. But the authorities' initiatives too often seem erratic and arbitrary: It's anybody's guess where their attention will turn next. This discourages not just the misconduct the authorities want to stop, but honest risk-taking as well -- and it blocks the investment that China needs to diversify and develop its financial sector. It may help to explain why trading volumes on the Shanghai bourse are sharply lower since last summer's meltdown, and why a vaunted Hong Kong-Shanghai stock-trading link has failed to entice outside investors.
At first sight, the proposal to unify banking, securities and insurance regulators looks sensible. China's financial sector has grown enormously more complex since the current system of oversight was established more than a decade ago. E-commerce companies such as Alibaba now offer retail investment plans; banks invest in securities through shadowy umbrella trusts; and the central bank, securities regulator and economic planning agency all oversee different bits of the bond market.
To detect budding problems, regulators need a view of the whole financial system. Efforts to improve coordination among the three main regulators and the People's Bank of China haven't fared well, largely because of bureaucratic turf battles. Closer integration, perhaps under the PBOC's leadership, might help.
Yet a so-called super-regulator is no panacea. The growing sophistication of China's financial sector demands many different kinds of expertise. Acquiring these skills needs to come first. With few exceptions, Chinese regulators are inexperienced and poorly paid. The securities regulator pays its department heads around $24,000 a year; they could make multiples of that in the private sector.
The biggest problem, though, is that regulators have conflicting aims. They are Communist Party bureaucrats whose careers depend on supporting party goals -- goals that aren't always aligned with financial rectitude. Chinese securities regulators, for instance, didn't miss the startling buildup of credit that sent the Shanghai index skyrocketing early in the summer; they encouraged it. Instead of concentrating on systemic risk, they worried more about the political consequences of bursting the bubble.
Breaking that habit won't be easy. Under the current system, the party's survival is bound up with ensuring rapid growth, come what may. That's why, in some cases, it might be better to just ask regulators to do less. For instance, the current system for initial public offerings asks regulators to approve every listing, which lends itself to rent-seeking. Authorities say they've drafted rules to switch to a Western-style registration system instead. It should be implemented swiftly.
The main thing is that Chinese regulators, like their counterparts elsewhere, should concentrate on stability: monitoring risks, controlling leverage, building up adequate capital buffers. Make the rules an instrument of industrial policy, and they're likely to fail.
--Editors: Nisid Hajari, Clive Crook.
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