The Beijing government has decided to regulate its chaotic financial sector with the full might of the Chinese Leviathan. This involves laudable steps, such as investigating shadow banks, arresting insider traders, and completely overhauling the regulatory framework.
Unfortunately, the Beijing authorities are fighting symptoms while the underlying system itself is at the root of the problem—and fixing the system would require three ingredients that are anathema to socialism: transparency, accountability and an independent regulator.
China’s financial regulators need independence much more than the clout the Party is giving them now. Financial regulation should be about propagating prudence and safety, not propagandizing the government’s industrial policy and economic principles.
A regulator that is part of an opaque political system will never have the power to burst bubbles inflated for political reasons, rein in risky lending to state-owned enterprises or a politically connected business elite, let alone punish the misbehaving bankers who belong to the same political elite. One of the more colorful metaphors I heard on the market floor was that the Party was ‘giving the horny uncle the task of castigating incestuous relatives’.
Nevertheless, last month the financial regulators broke apart an underground bank which catered to the rich and corrupt by illicitly moving funds abroad. In November alone at least 16 people in the financial world were detained without access to a lawyer, suggesting politically sensitive cases. Among the detainees are a hedge-fund manager and a securities regulator, as well as a midlevel Party member at one of the large banks.
One investment banker I interviewed said: “President Xi’s anti-corruption crackdown has reached us now. I expect most banking officials will stop making decisions altogether, out of fear of being accused of ‘violations of the ethics code’.”
Beijing’s eagerness to clamp down is understandable, because China’s rambunctious financial sector, like the more mature ones in Western countries, is unloved by the common people and characterized by immoral behavior. Where Western governments have tried to distance the regulators and the financial elites from politics, Beijing has tightened the political oversight of the system.
Putting bureaucrats without clear mandates or accountability in charge discourages not just the actual misconduct, but honest risk-taking as well. Moreover, it undermines the real changes that the mainland economy needs to diversify and develop its financial sector. Too much political involvement in the market is the most likely explanation of significantly lower trading volumes on the Shanghai bourse since last summer’s crash and a clear lack of investor enthusiasm for the Hong Kong-Shanghai stock-trading link that the state media trumpeted loudly earlier this year.
Even casino capitalism had a better run in the West than Casino Socialism with Chinese Characteristics.
Change is certainly needed. After all, China’s financial sector has become much bigger and vastly more complex since the creation of the current system of oversight in the early 2000s. Different Party offices of varying importance now oversee small parts of the system. Jurisdictions overlap while some areas of concern are too lightly regulated.
Government regulation is almost always stifling, but if it is required, let it at least be comprehensive and transparent. By merging various regulators the comprehensiveness will be solved. Transparency, unfortunately, continues to be lacking. Instead, I learned that bureaucratic turf wars are paralyzing the regulatory bodies at the People’s Bank of China, the mainland’s central bank. After last summer’s stock market crash a few initiatives to open the bank up to a modicum of scrutiny were abandoned altogether. Dominique Grandjean, of the Dutch Rabobank calls the culture at the People’s Bank of China ‘dangerously compartmentalized’.
Subservient to the Party
Then again, the newly proposed super-regulator that is supposed to end all turf wars will be under even tighter political control than the smaller regulatory bodies and the increasing complexity of China’s financial sector demands many different kinds of expertise, not just the all-important Party connections. Anti-corruption crackdowns provide accountability after the fact, but a stable financial system cannot afford the insecurity and arbitrariness this entails. It needs a regulator above politics, but subject to the rule of law. The nature of the proposed super-regulator will be exactly the other way around: above the law, but subservient to the Communist Party.
The mainland’s system has survived a lack of transparency, accountability and independence in other sectors and it might even work its mercantilist wiles in financial oversight, were it not for another major shortcoming in this instance: the fact that the regulators themselves are Communist Party bureaucrats whose careers depend on promoting Party goals that often trump prudence.
Ever since the policy of Modernization and Opening Up under Deng Xiaoping, the Party’s survival is bound up with ensuring rapid economic development and appeasing the laobaixing, the Chinese equivalent of Joe Sixpack and soccer moms, with the trinkets of growth. The Party’s shibboleth has made it paranoid about the price of slowdown, witness the heavy-handed reaction to last summer’s crash.
Indeed, Chinese securities regulators were not asleep at the wheel during the startling buildup of credit that sent the Shanghai index surging early in the summer; they actively stepped on the accelarator. Instead of warning against systemic risk, they worried more about how bursting the bubble would risk their own upward mobility on the Party ladder.
Too big to fail
For a Party that is steeped in Marxist dogma but obsessed with economic growth it is counter-intuitive to actually make regulators do less. A more transparent but hands-off system would have let off some of the steam of last summer’s the bull market. Instead, the government stimulated the bull and the regulator loosened credit, creating a mechanical bull with an unspoken government guarantee. In general, a less micromanaged system of oversight would decrease endemic rent-seeking.
By making the entire financial system politically ‘too big to fail’, the Party is betting it can combine oversight with political involvement and still deliver its end of the tacit social contract of the Hobbesian state: stability and prosperity in return for absolute power. However, if a more pronounced economic slowdown of the kind often called a ‘hard landing’ would lead to the bursting of more systemic bubbles, the Chinese might one day be surprised to find out the Party itself was not too big to fail.