The World of Chinese Finance

Of all the landmark laws that were passed during Franklin Roosevelt’s “New Deal” presidency of the Great Depression, the Banking Acts of 1933 and 1935 may have helped the most to stabilize the American financial system. After all, those were the laws that created a national system of deposit insurance to be managed by the fledgling Federal Deposit Insurance Corporation (FDIC).

The system of insurance eliminated the risk of bank failures from the minds of most depositors by creating a legal guarantee that their funds would be insured by the “full faith and credit” of the federal government. The system was lauded, and is still praised, as a critical component of the American “safety net” that ensures the security of bank deposits.

Last week, the Chinese government proposed its own national system of deposit insurance, one that would insure up to 500,000 yuan (i.e. approximately $81,000 at current exchange rates) per bank. Oddly enough, though, the proposal was perceived as an attempt to inject more risk into the banking system.

More risk? How can the introduction of an insurance program create more risk? And why would the Chinese government seek to inject more risk into its banking system?

Apparently, Chinese citizens and businesses now assume that their government will insure all deposits at state-controlled banks. Just as many Americans have come to believe that certain banks are “too big to fail” and will always be bailed out by the federal government, their Chinese counterparts similarly believe that all of their banks will always be bailed out.

Thus, by introducing an explicit limit of 500,000 yuan, the Chinese government isn’t simply adding a new and explicit system of limited deposit insurance. Rather, it is actually replacing an existing, implicit, unlimited system of insurance with one that is new, explicit, and limited in nature.

And why would Chinese government officials wish to do that? Unlike President Roosevelt, who was faced with the challenge of regulating a banking system that had traditionally operated without any government oversight, Chinese leaders are now confronted with the task of deregulating a banking system that had traditionally been managed by Communist government officials.

In other words, in a free market economy like America’s in the 1930s, the federal authorities must focus on reducing excessive market risk. But in a government managed economy like China’s in the 21st century, the federal authorities must focus on increasing market risk.

Given that distinction, it is ironic that the Chinese government is now adopting an insurance framework that is similar to the one that President Roosevelt implemented during the 1930s. Both cases, though, involve government officials who are employing a program of deposit insurance in order to achieve an optimal level of market risk in the banking sector.