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.

Global Banking: The Head Winds Of Regulation

It’s easy to argue that the global financial system is biased in favor of the banking industry. After all, the largest international financial entities have actually grown larger since the 2008 / 09 economic crisis, while benefiting from the now-institutionalized presumption that our governments consider them “too big to fail.”

But there are times when an entire industry finds itself facing the head winds of governmental oversight. Recently, for instance, a wide variety of news stories in the United States and across the globe addressed new proposals for the banking industry. And none of them – not a single one – proposed a policy in favor of deregulation.

Last week, for domestic banks that operate within the United States, three American financial regulators proposed doubling (yes, doubling) the capital reserve requirements of the financial institutions. Although the proposed standards would greatly surpass the reserve levels that are currently required under the global Basel system, the regulators asserted that they would provide reasonable protections against future fiscal crises.

Then another American financial regulator proposed that mysterious “dark pools” of trading activities, now operated by private organizations, should be required to disclose their activities. Finally, a trio of United States Senators announced an effort to reincarnate the Depression-era Glass Steagall prohibitions that separated traditional banking lines of business from speculative trading activities.

Meanwhile, on the global stage, Great Britain’s banking system stripped its own British Bankers Association (BBA) of authority over the deeply flawed London based Libor rate setting mechanism and handed it to NYSE Euronext. And the Swiss authorities agreed to move one step closer to the elimination of tax haven benefits within its once secretive banking industry.

Even the single news story that appeared to contain a glimmer of good news for the banking industry was, in fact, a story that pleased proponents of government oversight. The American financial regulator that sought to extend domestic bans on derivatives trading activity to foreign banking subsidiaries agreed to delay this extension for six months. Although lobbyists favored the outright cancellation of these extension plans, they were forced to accept a six month delay instead.

On the one hand, these news stories will likely fail to satisfy the Wall Street critics who continue to complain that very few financial professionals went to prison or were otherwise punished in the wake of the global economic crisis. On the other hand, though, the global financial industry is clearly tacking against the prevailing winds of regulation.

Global Banking: BIS Disses Our Political Leaders!

Have you heard of the Bank for International Settlements (BIS)? It’s the financial institution that serves as a global clearing house for most of the world’s major national banks. U.S. Federal Reserve Bank Chairman Ben Bernanke, European Central Bank (ECB) President Mario Draghi, and their colleagues on the BIS Board of Directors help the organization coordinate regulatory activities at the international level.

You wouldn’t expect the BIS bankers to be a rambunctious group, would you? And yet, in the 2012 / 2013 Annual Report that they published last week, they heatedly criticized our political leaders for failing to adapt to the new regulatory realities of the post-Crash banking era.

How heatedly? Well, for instance, the text of the Report asserts that “Continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system.”

Ouch! For a banking regulator, those are fighting words! Clearly, the BIS Directors are peeved that our political leaders haven’t done more to restructure the global banking system.

You may not necessarily agree that our leaders have done too little to implement meaningful reforms. Former United States Representative Ron Paul, for instance, believes that they have done too much to regulate the banking system. In fact, Paul has stated that laws such as the Dodd Frank Act impose “disastrous costs” on Americans.

Whether you side with the BIS or with Ron Paul, though, perhaps you would agree that our banking regulators and our political leaders should coordinate and communicate their strategies more effectively.