For years China’s government has debated whether the financial system needed a super-regulator, one agency that would be responsible for the disparate parts of an increasingly complex ecosystem. Over the weekend, Beijing delivered a watered-down version, a committee that will—hopefully—wrangle the existing regulatory agencies into working in lockstep. Implemented earlier—say, six years ago when talk of the need for a super-regulator first started circulating—such a reform could have helped prevent the financial system from evolving into the incredibly risky, complex, and opaque leviathan it’s become. Today, however, while the reform is still necessary, it won’t make a meaningful impact on the problems underlying China’s financial sector.
On Sunday, China’s National Financial Work Conference resolved to establish a Financial Stability and Development Committee which, according to a central bank official will “choreograph China’s financial reform, development and supervision.” That such choreography has hitherto been absent is testimony to a financial regulatory system designed for simpler times. China’s regulatory regime was built in the early 2000s to supervise a plain vanilla financial system that was neatly siloed into three industries: banking, insurance, and the stock market. Each industry got its own dedicated regulatory agency. That worked as long as everyone stayed in their silo and there was no cross pollination between financial industries.
Things started to break down in 2009 when shadow banking emerged from the cracks between regulatory silos. Some financial institutions, most notably trust companies, engaged in such a diverse array of business that they didn’t naturally fall under the remit of any one regulator. Trusts had to report to an alphabet soup of agencies, but because no one agency took the lead, they were more lightly regulated than banks, insurers, and brokerages. They exploited their relative freedom of operation such that today they are the second largest class of financial institution behind banks, exceeding both insurers and securities companies in terms of the volume of funds they manage. If Beijing had rolled out a body geared toward plugging regulatory holes during the early days of shadow banking, things could have evolved very differently.
Still, having a body that can help mitigate future regulatory abuses is incredibly useful. Moreover, the committee might help rein in some of the risks emanating from the regulators themselves. As my colleague Houze Song pointed out in a post last week, the regulators routinely abdicate their prudential responsibilities by acting as promoters and cheerleaders of the industries they’re supposed to be supervising, relaxing rules and their enforcement so that their industry can grab a bigger share of the financial pie. Having someone supervise the supervisors might help clean up their act.
But even if the new committee manages to get everyone working under the same, grand umbrella of financial supervision, the challenges remain huge. The banking regulator has been in a constant game of whack-a-mole with the financial sector since 2009. No sooner does it crack down on one practice than the banks design a way to get around the rules. The regulators are at a permanent disadvantage. Whereas the criticism routinely levelled against the US financial regulatory regime is that there’s a revolving door between the investment banks and the agencies that regulate them, China’s problems are diametrically opposite. Rank-and-file employees at the regulators, almost without exception, have no experience working for the institutions they regulate. That didn’t matter during the days of vanilla banking, but in a fast evolving and increasingly complex system, that puts the government permanently on the back foot.
However, the single greatest factor complicating reform efforts is cultural. In any financial system, there’s a tension between mitigating financial risks and ensuring that the financial system has sufficient latitude to support economic growth, but in China that tension is weighted heavily in favor of growth. That was no more clearly on display than in the early days of shadow banking when Xiao Gang, then Chairman of the Bank of China, published a column in the China Daily in which he called wealth management products—the main part of shadow banking—a Ponzi scheme. But in the same 2012 column, only a couple of paragraphs later, he argued that “shadow banking has advantages” in helping generate GDP. Strictly speaking, wealth management products aren’t a Ponzi scheme, and measures have been taken over the years to make them less so. But that’s hardly the point. For a senior bank chairman—who would later be promoted to chairman of the securities regulator—to shrug off what he deemed Ponzi finance because of the economic benefits speaks to the degree to which senior officials are willing to tolerate financial shenanigans in the name of growth.
And therein lies the problem. China’s financial regulators—whether individually, in concert, or merged together—will always find that they have to put the political imperatives of growth ahead of the needs of financial prudence, so no amount of fiddling with the structure of regulatory institutions will result in significant change. Until the culture changes, and the importance of growth diminishes, regulators will be forced to live by the economic equivalent of St. Augustine’s plea: ‘Lord, make me chaste—but not quite yet.’