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Crisis Focus
Special
UPDATED: July 20, 2009 NO. 29 JULY 23, 2009
Three Balances
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Since the outbreak of the global financial crisis, the safety of the financial system has become the center of much attention. Wang Huaqing, Disciplinary Secretary of the China Banking Regulatory Commission, delivered his opinion on July 4 at the Global Think Tank Summit held in Beijing. Edited excerpts follow:

On the face of it, this round of financial crisis was triggered by the subprime mortgage crisis; in a broader and deeper sense, it has exposed the institutional deficits and risks that the global financial system has developed over the past two decades. When we look back on the whole process of the financial crisis, we find it was caused by three factors: the financial industry's lack of discipline, its severed connection with the real economy, and faulty macro policies and insufficient regulation.

From a macro perspective, the long-term overly loose monetary policies of the United States and European countries laid a foundation for excessive market liquidity and encouraged reckless investment, while the regulatory administration's deregulation further drove market development away from regulation.

From the middle perspective, the financial system's decoupling from the real economy caused serious information asymmetry and increased leverage ratios while evading supervision.

From a micro perspective, driven by the desire for excessive competition and profits, the corporate governance and incentive mechanisms of financial institutions were distorted in exchange for short-term return and excessive risks.

The three factors above lured capital away from the real economy and into the financial market. In pursuit of short-term return, the capital accumulation pushed up the price of financial products and finally caused financial bubbles.

Based on what we know now, I think we should achieve three balances in the international financial system.

First, a balance between the development of the financial system and the demands of the real economy. Development of the financial system should never break away from the development level and rational demands of the real economy. Financial instruments that are aggressively expanded and marketed easily become the tools of price speculation; especially in markets with limited capacity. Under certain circumstances, prices in the financial market may react to prices in the real economy, which was, to some extent, verified by the dramatic ups and downs of international energy prices last year.

Second, a balance between financial innovation and supervision. Financial innovation and supervision, the important means to secure financial development, are not enemies. Financial supervision plays an irreplaceable role in disclosing investment risk, correcting market imbalance, balancing individual and common interests and preventing market risk. Financial innovation should go hand in hand with financial supervision; neither of them should be ignored.

Third, a balance between profit and risk. Basic financial theory holds that profit is the pricing of risk and excessive profit is the premium of risk. The high profits that financial institutions are chasing are usually obtained at the cost of high risk. Amid this round of financial crisis, financial institutions should profoundly rethink their imprudent behavior.

A sound and effective financial security mechanism could well combat financial risk. Few countries have been immune from the sweeping crisis. With China's deepening involvement in the global economy, China is also a stakeholder in global financial security and stabilization.



 
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