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Print Edition> Business
UPDATED: November 29, 2010 NO. 48 DECEMBER 2, 2010
Crisis Focus: Inadequate Macro Supervision

Policymakers worldwide are seriously reconsidering macroprudential regulation in response to the financial crisis, but the efforts they have introduced are primarily micro oriented. In a recent China Business News article, Xia Bin, a researcher of the Development Research Center of the State Council and a member of the Chinese Central Bank's Monetary Policy Committee, criticized the incomplete framework of their approach. Xia argued the flawed international monetary system dominated by the U.S. dollar, as opposed to the loose supervision of banks, is the institutional root cause for the crisis. Edited excerpts follow:

The macroprudential approach to financial regulation has sparked debate worldwide, and China's economists and policymakers cannot afford to ignore this approach while working on the country's financial strategies and policies.

The concept of macroprudential regulation originated in the late 1970s, but it was first defined by Andrew Crockett, former General Manager of the Bank for International Settlements, in September 2002. The concept was recently revisited and used to address risks in the global financial system.

In contrast to a microprudential approach that focuses on stability among individual banks, the macroprudential approach aims to ensure the stable performance of the entire financial system. But recent financial reform schemes introduced in the international community are basically technical solutions, such as limiting the leverage ratio for banks.

The newly agreed Basel III, which reflects the consensus of a majority of nations, for instance, is in essence aimed at reducing banking sector credit expansion and safeguarding the sector's stable operation by imposing stricter requirements on capital bases, leverages, provisions and liquidity. Banks are required to have a higher capital adequacy ratio and a new capital conservation buffer. But the rules targeted individual banks and failed to offer satisfactory solutions to international cooperation within the framework of macroprudential supervision, or to address systemic risks within the global financial system.

The Dodd-Frank Wall Street Reform and Consumer Protection Act also has similar provisions on systemic risk prevention, customer and investor protection, executive pay and bonus limits, as well as supervision system improvement. But the ultimate goal of the act is to prevent credit expansion and banking sector risks through measures targeting individual banks.

The institutional framework for macroprudential supervision, therefore, is incomplete and far from thorough.

Supervision failure was not the root cause of the 2008 financial crisis. It was instead the U.S Government's long-term practice of low interest rates that was to blame. The practice, a result of the U.S. Government's incorrect perception or taking advantage of this round of globalization, has stimulated credit expansion in the U.S. banking sector. And while enjoying benefits from globalization, export-reliant countries with cheap labor and resources involuntarily encouraged the U.S. to continue this problematic practice. In addition, the international monetary system dominated by the U.S. dollar, which was the institutional cause of the crisis, has facilitated the adoption of low interest rates in the country.

The crisis was essentially a monetary crisis like many other financial ones across the world. A lesson from insufficient supervision of banks is not enough for the world to avoid similar crises in the future.

Unless a restraint mechanism is formed to restrict the issuing of major international currencies, such as the U.S. dollar, a new round of crisis is inevitable, because current systemic risks are not risks within a single country but global under the existing international monetary system.

Under such circumstances, developing countries and non-reserve currency countries, China in particular, should be aware the current framework for global financial supervision is not complete, nor can it meet the needs of every individual country.

While basically agreeing to the post-crisis institutional framework for global financial regulation, countries in this category should never be satisfied with supervision. Instead, they should play a more active role in calling for and participating in the international monetary system reform, seeking an exchange rate stabilizing mechanism for major countries. While aware of the flaws within the framework for macroprudential regulation, individual countries should handle external economic policies with due prudence and continue to build up safeguards against external impacts, if they have to rely on themselves.

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