June 29, 2009
Vince Cable makes the point (see yesterday’s post) that the centre of gravity of the economic world has moved to the east, particularly to China.
Today’s Financial Times carries an op-ed by Liu Mingkang, chairman of the China Banking Regulatory Commission. He rightly asserts that, unfortunately, many people have forgotten the old-fashioned principle of setting up firewalls between banking and capital markets.
In his view, the global financial crisis can be attributed to five factors. First, the firewall between capital and banking markets was eroded by unsound financial innovations. Second, macro-prudential regulation was neglected. Third, financial institutions had too much leverage and were too opaque. Fourth, incentives for staff at financial institutions were driven by short-term gains, rather than long-term benefits. Fifth, the bail-out put the cart before the horse by pumping in capital and liquidity before cleaning up balance sheets.
Cable also argues that hitherto the Chinese official reading of the crisis has been in terms of US economic weakness and lack of financial discipline, rather than a recognition of shared responsibility and mutual weaknesses. Liu Mingkang does not address the sixth factor, the availability of the huge current account surpluses of China and other Asian countries.
The writer accepts that further reform of the Chinese banking sector faces Herculean tasks but claims that the current better shape of the sector compared to the west is partly as result of China’s prudential banking regulation.
I do not have the expertise to judge this, but he is right that banks are deeply rooted in the real economy, and while the financial sector can temporarily outpace the real economy, this cannot continue for ever. Liu Mingkang says that banking regulators must look at the whole system as an organic body since individual banks sometimes ignore or lack the means to look at risks at a systematic level. When hordes of market players move in the same direction it will often result in irrational exuberance and a herd mentality.
It is doubtful whether we will ever know why Chinese banks avoided derivatives and were not seriously affected directly by the sub-prime mortgage disaster. Was it due to able regulators, government ‘guidance’, sensible bankers or all three?
However, the chairman of the China Banking Regulatory Commission writing an op-ed for the Financial Times is a sign of the future. The invitations for the Commission to join the Basel Committee on Banking Supervision and the New Financial Stability Board are welcome. The sooner the Bretton Woods institutions also reflect today’s world, the better.
Only by allowing full participation China Banking Regulatory Commission in the global financial bodies can we expect China to recognise shared responsibility and mutual weaknesses.
Author : Stanley Crossick