Fi­nan­cial Re­form:

Bal­anc­ing the Books/cap­i­tal De­ci­sions

NewsChina - - CONTENTS - By He Bin

On April 8, China of­fi­cially de­clared the merger of the China Bank­ing Reg­u­la­tory Com­mis­sion (CBRC) and the China In­sur­ance Reg­u­la­tory Com­mis­sion (CIRC) to cre­ate the China Bank­ing and In­sur­ance Reg­u­la­tory Com­mis­sion (CBIRC). The new body, along with the Peo­ple's Bank of China (PBOC) – China's cen­tral bank, and the China Se­cu­ri­ties Reg­u­la­tory Com­mis­sion (CSRC), will re­port to the Fi­nan­cial Sta­bil­ity and De­vel­op­ment Com­mit­tee (FSDC), a new agency set up un­der the State Coun­cil last Novem­ber.

Be­sides the new in­sti­tu­tional ar­range­ment, the cen­tral bank has been en­trusted with draft­ing leg­is­la­tion for the bank­ing and in­sur­ance sec­tors to im­prove co­he­sion in the reg­u­la­tory sys­tem. The cen­tral bank and the FSDC will be re­spon­si­ble for fi­nan­cial pru­den­tial reg­u­la­tion at the macro-level, while the CBIRC is ex­pected to fo­cus on mi­cro-level reg­u­la­tion.

‘Con­ta­gious Risks’

Ob­servers say the over­haul is a move to head off in­creas­ing con­cern over what the au­thor­i­ties call “sys­temic fi­nan­cial risks.” Much of the risk comes from the emer­gence of a group of fi­nan­cial con­glom­er­ates, whose cross­sec­tor busi­ness model has blurred the lines be­tween banks, in­sur­ance com­pa­nies and stock mar­kets, pos­ing a great chal­lenge to China's frag­mented reg­u­la­tory sys­tem.

In a speech to the 2018 China De­vel­op­ment Fo­rum held in Bei­jing on March 25, Yi Gang, the new gov­er­nor of the cen­tral bank, al­leged that some “sav­agely grow­ing” fi­nan­cial con­glom­er­ates had con­ducted a wide range of fi­nan­cial frauds that had re­sulted in “cross-in­sti­tu­tional, cross-mar­ket, cross­sec­tor” and “con­ta­gious” risks to the en­tire econ­omy.

The lat­est ex­am­ple is the An­bang In­sur­ance Group. De­vel­op­ing from a small car in­sur­ance com­pany in 2004 to be­come China's top in­sur­ance com­pany, with as­sets es­ti­mated at over 1.9 tril­lion yuan (US$301.1B), An­bang has been a big player in the global real es­tate mar­ket in re­cent years. Its most prom­i­nent pur­chase was a US$2 bil­lion deal to buy New York's land­mark Wal­dorf As­to­ria ho­tel in 2015. But in March, au­thor­i­ties seized con­trol of the com­pany and charged its chair­man Wu Xiao­hui with em­bez­zle­ment, il­le­gal fund-rais­ing and fi­nan­cial fraud. In early April, the au­thor­i­ties in­jected 60.8 bil­lion (US$9.66B) into the debt-rid­den com­pany.

For China's fi­nan­cial reg­u­la­tors, the com­plex own­er­ship struc­ture of fi­nan­cial con­glom­er­ates like An­bang is a ma­jor chal­lenge. A re­port by Caixin magazine pub­lished in 2017 re­vealed An­bang's mul­ti­lay­ered cor­po­rate struc­ture and found the com­pany was ac­tu­ally con­trolled by 86 in­di­vid­u­als through 101 busi­ness en­ti­ties.

Con­trary to its nominal reg­is­tered cap­i­tal of 61.9 bil­lion yuan (US$9.8B) on pa­per, the Caixin re­port found that the 86 stake­hold­ers had only in­vested 560 mil­lion yuan (US$89M) in the com­pany. Com­pared to its peak as­sets of 1.9 tril­lion yuan (US$302B), the lever­age level of the com­pany was an as­ton­ish­ing 340,000 per­cent.

Ac­cord­ing to Pro­fes­sor Wu Xiao­qiu, vicedi­rec­tor of the Ren­min Uni­ver­sity of China, the boom in fi­nan­cial hold­ing com­pa­nies in past years has made lack of trans­parency a top is­sue for reg­u­la­tory au­thor­i­ties, who have found it in­creas­ingly dif­fi­cult to track down cap­i­tal flows, es­pe­cially cross-sec­tor ones.

For many ex­perts, in­clud­ing Cao Xiao, an economist and as­sis­tant di­rec­tor of the Shang­hai Uni­ver­sity of Fi­nance and Eco­nomics, China's reg­u­la­tory au­thor­i­ties are also to blame for the ex­ces­sive ex­pan­sion of fi­nan­cial con­glom­er­ates. Cao told Newschina that in the past years, lo­cal level au­thor­i­ties en­cour­aged non-fi­nan­cial com­pa­nies to en­ter fi­nance, partly to help solve their fi­nan­cial dif­fi­cul­ties. In some places, lo­cal gov­ern­ments even fa­cil­i­tated the es­tab­lish­ment of fi­nan­cial hold­ing com­pa­nies that in­volved lo­cal busi­nesses, which of­ten led to slack im­ple­men­ta­tion of fi­nan­cial reg­u­la­tions, mak­ing the process vul­ner­a­ble to cor­rup­tion and fraud.

Ac­cord­ing to State Coun­cilor Wang Yong, the new in­te­grated reg­u­la­tory sys­tem will strive to solve the prob­lems of “blurred lines of re­spon­si­bil­i­ties, over­lap­ping su­per­vi­sion, and reg­u­la­tory gaps” in the pre­vi­ous sys­tem.

A ‘Su­per’ Cen­tral Bank?

A ma­jor fea­ture of the on­go­ing re­form is that it ex­tends be­yond sim­ply merg­ing the bank­ing and in­sur­ance watch­dogs. The new body will trans­fer its pol­icy-mak­ing func­tions, in­clud­ing pru­den­tial reg­u­la­tion and draft­ing of fi­nan­cial laws and reg­u­la­tions, to the Peo­ple's Bank of China. Com­bined with the es­tab­lish­ment of the FSDC last Novem­ber, which now shares its of­fice with the cen­tral bank, many an­a­lysts see this re­form as ev­i­dence China will adopt a “su­per cen­tral bank” model in its fu­ture fi­nan­cial reg­u­la­tion.

Yi Xian­rong, an economist and pres­i­dent of the In­sti­tute of In­ter­net Fi­nance at Qing­dao Uni­ver­sity, told Newschina that the source of China's fi­nan­cial risk was not lax reg­u­la­tion, but mon­e­tary pol­icy. “China's mon­e­tary sup­ply (M2) ex­panded from 47 tril­lion yuan in 2008 to 168 tril­lion yuan in 2017, al­most qua­dru­pling in 10 years,” Yi said.

Yi said that in past years, the cen­tral lead­er­ship en­cour­aged fi­nan­cial in­no­va­tion, but since 2017, “pre­vent­ing sys­tem­atic fi­nan­cial risk” has be­come the top pri­or­ity. But strength­en­ing reg­u­la­tion alone will not achieve the goal, Yi said – the key lies in chang­ing the fun­da­men­tal ap­proach to mon­e­tary pol­icy.

“China can­not ad­dress its fi­nan­cial prob­lems by sim­ply strength­en­ing the co­or­di­na­tion be­tween the cen­tral bank and its bank and in­sur­ance watch­dogs,” Yi said. “The so­lu­tion can only be a ‘su­per cen­tral bank' model, which is nec­es­sary if China is to avoid a fi­nan­cial cri­sis.”

Yi's ar­gu­ment was backed by other econ­o­mists, in­clud­ing Ren Zeping, chief economist for China Ever­grande Group. In an ar­ti­cle en­ti­tled “The New Mis­sion of the Fu­ture ‘Su­per Cen­tral Bank,'” Ren says that China's on­go­ing new reg­u­la­tory re­form is a re­sponse to two chal­lenges: a reg­u­la­tory sys­tem based on sec­tors that are un­suited to in­creas­ingly more in­te­grated fi­nan­cial op­er­a­tions, and a mon­e­tary pol­icy that fo­cuses on in­fla­tion but ne­glects as­set prices.

Ren said that like many other coun­tries, China is chal­lenged by the fact that mon­e­tary ex­pan­sion has not driven up the in­fla­tion rate, but has led to an as­set price bub­ble and fi­nan­cial in­sta­bil­ity, phe­nom­ena that un­der­mine the the­o­ret­i­cal foun­da­tions of tra­di­tional mon­e­tary pol­icy.

Ac­cord­ing to Ren, in an in­creas­ingly lib­er­al­ized fi­nan­cial sec­tor, the rise of off-the-bal­ance-sheets op­er­a­tions and shadow bank­ing (in China's case, the rise of fi­nan­cial con­glom­er­ates), is to blame for ex­ces­sive money cre­ation be­cause new mon­e­tary liq­uid­ity does not flow into the real econ­omy, but is ab­sorbed by as­set mar­kets for real es­tate, eq­uity or debt. This pushes up debt and leads to a lever­age rate, is­sues that pose con­sid­er­able fi­nan­cial risks to China's econ­omy.

Ren says China's cen­tral bank will now grad­u­ally ex­pand its role as a macro-pru­den­tial reg­u­la­tor. “In the fu­ture, the cen­tral bank will fur­ther im­prove the macro-pru­den­tial pol­icy frame­work, and ex­plore the in­clu­sion of shadow bank­ing, real es­tate fi­nanc­ing and on­line fi­nanc­ing in the macro-pru­den­tial pol­icy frame­work.”

Chal­lenges Ahead

But ac­cord­ing to Ren and oth­ers, there are still a num­ber of chal­lenges. Cao Xiao, a pro­fes­sor of bank­ing at the Shang­hai Uni­ver­sity of Fi­nance and Eco­nomics, told Newschina that stream­lin­ing and separat­ing the spe­cific re­spon­si­bil­i­ties, func­tions and pow­ers be­tween the cen­tral bank, the CBIRC and the FSDC will be a con­sid­er­able chal­lenge.

First, new cen­tral bank gov­er­nor Yi Gang and Guo Shuqing, the newly ap­pointed Party sec­re­tary of the cen­tral bank and the head of the CBIRC, ap­pear to have the same ad­min­is­tra­tive rank within the cen­tral bank. In most of China's gov­ern­ment agen­cies, Party sec­re­taries have a higher rank, but ac­cord­ing to the cen­tral bank's web­site, Yi ap­pears to be listed ahead of Guo, usu­ally a sign that Yi has a higher rank. It re­mains un­clear who can over­rule whom in the case of a dis­agree­ment.

At the in­sti­tu­tional level, the re­spon­si­bil­i­ties of the Peo­ple's Bank of China, the cen­tral bank and the Fi­nan­cial Sta­bil­ity and De­vel­op­ment Com­mit­tee, which now share the same of­fice, are yet to be clar­i­fied.

Be­yond the in­sti­tu­tional level, both Cao and Ren warn that the hard­est part of the reg­u­la­tory re­form will be find­ing a bal­ance be­tween achiev­ing fi­nan­cial sta­bil­ity and main­tain­ing fi­nan­cial ef­fec­tive­ness. As China as­pires to up­grade its econ­omy, in­creas­ing the ef­fi­ciency and ef­fec­tive­ness of its fi­nan­cial mar­kets re­mains a must for its fi­nan­cial reg­u­la­tion. “Even­tu­ally, the real chal­lenge for China's reg­u­la­tory re­form will be find­ing the equi­lib­rium point of risk and in­no­va­tion,” said Cao.

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