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Regulatory Reform Is Inevitable
China to revamp segmented financial supervisory systems
By Wang Jun | NO. 47 NOVEMBER 19, 2015, the first intermediary-to-intermediary Internet finance platform in China, is launched in Hangzhou, capital of east China’s Zhejiang Province, on July 20 (XINHUA)

Great changes will take place in China's financial supervisory framework, said Wang Jian, chief banking analyst with Orient Securities Co. Ltd., in an article for the financial information provider "The current segmented financial supervisory system is not geared to the new conditions in the financial industry, with many blind spots in supervision," he said.

The Central Committee of the Communist Party of China vowed to strengthen the coordination of financial supervision along with other measures meant to improve the regulatory system. These include reforming the financial supervisory framework to suit modern financial market development, improving the oversight rules to keep in line with China's real-time economic situation and international standards, and to realize the full coverage of financial risks. These measures came from the Proposal Formulating the 13th Five-Year Plan (2016-20) on National Economic and Social Development unveiled early November.

The reform of the financial supervisory structure is not a new proposal. Unfortunately, several instances of instability in recent years have pushed the issue to the forefront of the overall financial reform measures that are currently being deliberated. However, the reorganization of the supervising authorities won't be accomplished overnight.

Risk-urged reform

In his article, Wang reviewed three well-known liquidity crises in recent years caused by uncoordinated financial supervision. First, the isolation between the central bank and the banking regulatory authority that caused the lending crisis among small and medium-sized enterprises in Wenzhou, east China's Zhejiang Province in 2011. Second, the separation among regulators that also caused a cash crunch among Chinese commercial banks in June 2013. Third, a lack of coordination between the banking authorities' regulations and the securities oversight which led to the stock market plummet in June of this year.

"Liquidity crises will never disappear if the overall financial system is not reformed and the current supervisory system is not changed," said Wang.

Zhao Qingming, chief macroeconomic researcher with the Beijing-based CFFEX Institute for Financial Derivatives, told the Economic Information Daily  that China is now in a special stage featuring economic restructuring and slower economic growth, facing the challenge of the middle-income trap. During this period, risk-laden events will become frequent in the financial system. As China's financial reform and opening up accelerates, the control of financial risk becomes increasingly important, with adequate supervision being crucial in addressing such issues.

In China, banking, insurance and securities industries are supervised by three different authorities­­--the China Banking Regulatory Commission (CBRC), the China Insurance Regulatory Commission (CIRC) and the China Securities Regulatory Commission (CSRC). The People's Bank of China (PBOC), the country's central bank, is responsible for making monetary policies and controlling money supplies.

The separate supervision model has been greatly challenged by the frequent occurrences of financial problems. When interviewed by the Economic Information Daily , Zeng Gang, Director of Banking Research at the Institute of Finance and Banking under the Chinese Academy of Social Sciences, said many banks, insurance companies and securities companies are engaged in mixed operations, challenging the current separate financial supervision framework.

Newly emerging financial sectors, such as Internet-based finance and privately owned wealth management companies, are also growing rapidly, but they are not under the supervision of any of the four financial supervising authorities.

"The mixed operations of financial institutions makes the whole financial market highly interconnected, raising the possibility of systematic risks," said Zeng. "Integrating financial supervision and incorporating emerging financial institutions into the supervisory framework will be a general trend."

Reform necessities

Mixed operations mean that a financial institution is allowed to provide multiple types of financial services to their customers.

According to Wang, a large number of emerging industries are growing along with China's economic transformation. Having unstable cash flows, it is difficult for these new businesses to get bank loans. They therefore need some new financing methods such as equity financing, private equity, venture capital or crowd-funding. Both banks and other financial institutions are engaging in multiple types of financial services.

However, financial supervision is still conducted separately by the four authorities, which leads to overlaps and absences in supervision. For instance, if a bank is engaged in the securities business, it has to be supervised by both the CBRC and the CSRC. But some newly emerging sectors, such as privately owned wealth management companies, are not yet subject to supervision.

In his book on the theory of broader finance, the newly appointed Vice Governor of the PBOC, Chen Yulu, proposed to set up an integrated financial supervision system. This integration includes monetary, credit and financial control policies aiming to promote financial and economic stability through increased coordination and cooperation between each sector.

Chen also said in an article that integration is inevitable because under the current system, each regulator only cares about the stability of the sector that it is in charge of. To avoid this, China must reorganize its system to establish a new integrated financial regulatory structure.

Integrated supervision has been the general trend in many countries. Ba Shusong, chief economist with the China Banking Association, said at the Sixth Caixin Summit on November 5-7 that after the global economic crisis in 2008, the United States, the United Kingdom and the European Union have all reformed their financial regulation frameworks. The central banks' role in these countries' financial oversight has been increasingly strengthened, he pointed out.

He continued that integrating the monetary policy-making with financial supervision will facilitate the exchange of information and the formulation of policies.

Prudent steps needed

Zeng said that in the future, financial oversight must concentrate more on ensuring the stability of the whole financial system, pay more attention to fluctuations of the whole market and strengthen coordination among the different supervising authorities. But whether the actual reorganization of those regulatory bodies is necessary should be carefully considered.

In the United States, the complicated financial supervisory system is difficult to reform. After the economic crisis in 2008, the country established the Financial Stability Oversight Council (FSOC) to identify and prevent systematic risks and enhance supervisory coordination, with the current surveillance structure left intact.

"China may not copy the experience of the FSOC," stated Zeng. "But we do need to consider the costs and benefits of replacing the current framework with a completely new one."

In 2013 the State Council approved the establishment of an inter-ministerial joint meeting for financial regulation and coordination. Led by the PBOC, the joint meeting is composed of the CBRC, CSRC, CIRC and the State Administration of Foreign Exchange. The National Development and Reform Commission as well as the Ministry of Finance can attend if necessary.

Zeng suggested that the inter-ministerial joint meeting be better implemented, since it is currently too loosely organized to have any real effect in coordinating oversight.

Copyedited by Bryan Michael Galvan

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