China was largely shielded from the Asian Financial Crisis in the late 1990s, but the tumult brought weakness and disorder in the country’s financial system to the surface. In 1998, the central government let Guangdong International Trust and Investment Corporation go bankrupt, even though it was the country’s second-largest trust company at the time and thus a major financing platform for local governments.
As many foreign banks and investors were involved, the case attracted a huge amount of international attention. After that, the government launched a campaign to sort out China’s chaotic financial market, with a focus on stopping the muddling of trusts, banking and securities.
On top of this, billions of US dollars of public money were spent on bailing out and restructuring State-owned commercial banks bogged down with bad loans.
Cai E’sheng helped make and implement these decisions as a senior official in China’s central bank from the early 1980s to 2001.
He also served as vice chairman of the China Banking Regulatory Commission from 2005 to 2013.
In a recent interview with NewsChina, Cai explained why China should stay vigilant against systematic financial risk, especially at a time when the Internet is making financial services a larger part of everyday life.
NewsChina: What potential financial risks does China face today?
Cai E’sheng: Although we are reasonably capable of mitigating systematic risks, we have no reason to be complacent. Once such a risk flares up, it affects all of society.
This has been made evident through the US’s subprime mortgage crisis. It spilled over into the global market and the real economy.
The world is in a fragile state of recovery and still struggling with a slowdown in growth.
Financial risk reaches more deeply into people’s lives than ever before, directly affecting the safety of their assets. As an example, millions of Chinese investors suffered huge losses in two cases of financial fraud in 2015.
Systematic risk spreads through the financial chain. That is why it is necessary to look into particular financial products and services to see how they would most likely influence other links in the chain [in a time of crisis].
Even a minor loophole must be treated carefully, otherwise it could trigger big, unintentional problems. The trick is how to do this without overreacting.
NC: What changes have you observed since the late 1990s in China’s financial environment and in the means of dealing with financial risks?
CE: I was part of the team dealing with those financial risks at that time. We lacked financial and institutional resources. The State-owned commercial banks were new and burdened with bad loans left behind from the planned economy. The Commercial Banking Law had just come into being in 1995. The market was not sound, either, providing no price signal to steer supply and demand. The national coffers were not full enough to offer any help.
In this context, we had no choice but to shut down insolvent enterprises [that would never have been able to pay back loans]. The top priority was to protect at least 70 percent of depositors to avoid a bank run. The next step was to sift out any bigger savings accounts connected to illegal activity. In this way, we managed a relatively smooth transition.
Things are much more complicated today, although our banks’ balance sheets are far stronger than they were 20 years ago. Both enterprises’ and society’s exposure to systematic risk is the most terrifying issue today. Even without a bank run, an economic disaster could happen once risk starts spreading.
For example, paying via mobile-based financial platforms has become a part of our daily life. In this area, the potential risks are not simple, like bad loans; the risks are an insecure banking system and leaked personal information.
Our regulatory framework needs to be reformed so it covers all of these risks.
NC: In 2015, many online peer-to-peer lending platforms disappeared and their founders absconded with investors’ money. In January 2016, for example, executives of an online peer-to-peer lending platform under the Anhui Province-based Yucheng Group were arrested for running a Ponzi scheme through which they defrauded 900,000 investors out of US$7.7 billion. How do you think that online financial services should be regulated?
CE: The peer-to-peer lending market is big enough now to merit being put under scrutiny.
This should include improving investors’ awareness of the risks involved. Lack of transparency from online platforms is compounded by some investors’ weak professional judgment.
The Yucheng case was a trap that lured investors in with [promises of] high returns from phantom projects that never existed.
New business models always come with risks. The key to improving the efficiency of a regulatory framework is better coordination between regulators that are responsible for different areas. It simply does not work to have one department responsible for market growth and another for supervision if both do not consider the broader picture. The mindset that unresolved problems are always someone else’s concern never helps.
NC: China’s stock and foreign exchange markets suffered significant volatility last year.
One of the lessons from that was how necessary it is to reform the regulatory framework of the financial market. What are your suggestions for this reform?
CE: There are legal and institutional restrictions which have made it barely possible to put all banking business under scrutiny. Regulatory agencies are still divided, while the market is increasingly integrated.
There is the question of how we should define a particular service that involves two financial areas, and who should regulate it.
For example, securities regulators are supposed to distinguish what sectors within a bank are securities-related and put only those under their scrutiny. Standards that are too suffocating could hamper the banks’ growth, while standards that are too loose would make no sense. Given this, sorting out the different functions of every part of the market and the regulatory structure needs to be our first priority.
Before reform can happen, we need to understand more clearly how capital would slosh around the financial market and the economy as a whole in the context of either sufficient or insufficient liquidity. In this sense, it is not just a choice between putting all the existing financial regulatory bodies under one umbrella, or having them do their jobs completely independently.
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