had the somewhat qualified pleasure last week of attending the spring meeting of
the International Institute of Finance — the assemblage of the great and the
good of the world banking industry— which this year was held in Beijing.
as usual for such events there was a certain amount of high-level pabulum, two
clear messages emerged from the cogent presentations by Chinese
China provides some useful lessons for western governments as they contemplate
how to redesign their financial regulatory systems. Second, the prospects for
significant financial-sector reform within China are rapidly brightening. This
week we shall deal with the first.
roughly three years ago, many outside commentators argued that China’s
state-driven financial mechanism, which funnelled cheap credit to state-owned
industrial enterprises with little regard to efficiency or return on capital,
would inevitably generate a huge pile-up of non-performing loans leading to a
generate sustainable long-term growth, they contended, China would have to adopt
the vastly more efficient capital-allocation mechanism of western banking
systems and capital markets.
problem with this argument was that efficient capital allocation matters a lot
in mature economies at the technological frontier with structural growth rates
of 2-3 per cent. But it matters far less in developing economies where
favourable demographics, a high savings rate, urbanisation and technological
catch-up conspire to create a structural growth rate of above 8 per cent.
China, where the financial system is seen as a utility facilitating the
activities of the real economy rather than as an individual source of wealth
creation, it can be perfectly rational to suppress its profits to increase the
profits of firms in the real economy.
resulting reduction in financial-sector rents actually makes a financial crisis
less likely, because excessive risk-taking is suppressed.
given at the IIF meeting by the suave Liu Mingkang, head of the China Banking
Regulatory Commission (CBRC) since its creation in 2003, suggest that there is
another reason to be relatively sanguine about the health of the Chinese
financial system: its regulators appear to have a better idea of what they are
doing than their western counterparts.
contrast to western regulators, who put bank regulation on auto-pilot via the
model-driven and extremely pro-cyclical Basel II capital adequacy system, Mr Liu
made a persuasive case for the enduring value of old-fashioned bank supervision
tools such as limits on single large exposures, a conservative 75 per cent
loan-to-deposit ceiling, limits on simple leverage ratios, and “window guidance”
on exposures to specific companies and sectors.
Mr Liu cogently summed it up: “Basel II is problematic; traditional ratios are
still useful. Small is beautiful and old is beautiful as well.”
is certainly plenty of garbage hidden in China’s banks, and new garbage is being
created at a rapid rate through the vast expansion of lending under the
government’s economic stimulus programme. But strong balance sheets and the
sensible regulatory framework suggest that financial crisis risk in China
Liu concluded with several recommendations for regulatory redesign that western
governments would do well to heed:
monetary policy must take account of asset prices as well as consumer-price
the capital markets should never be the primary source of funding for banks;
traditional prudential ratios should be used where appropriate to supplement
and regulators should use judgment and discretion to modify the actions
suggested by their models.
of these recommendations is incompatible with a light-touch regulatory system
appropriate for a more advanced financial system that enables innovation and
true efficiency gains. They boil down to saying that market ideology should not
be allowed to trump common sense, and that regulators would do best to remember
the basic utility function of banks and treat with grave suspicion claims about
financial institutions as independent sources of value creation.