Part 5: the suggestion of Chinese government supervises and regulates the shadow banking system

In the last paper, I was talking about the regulation of Shadow Banking System in foreign countries, and both these method are very useful of shadow banking system in China, however, like the Part 2 said, the private financing organizations is typical Chinese style shadow banking, and the regulation method of foreign countries do not covered this part. Therefore, in the following part, I will combine the regulation method of foreign countries and the Chinese reality to make suggestions.

1.     Regulation of the formal financial institution

       For the formal financial institutions, due to the shadow banking system in China is different from the western countries; do not have lots of financial innovation, therefore, the regulation of Chinese shadow banking system is relatively easy. Use the method 3 in last paper which strengthen banking supervision, to reduce the relevance of the traditional banking and shadow banking, strengthen the supervision of bank off-balance sheet business, create relevant laws and regulations, avoid arbitrage of banks, increase the intensity of risk monitoring, strictly prohibited the corporation between commercial bank and such the investment banks, equity funds, private lending which have a high risk, prevent securitization of bank capital. Speed ​​up financial innovation, make the borrowers have more choices, meanwhile, study the experience of the financial crisis, financial innovation should base on services the substantial economy and prevent risks, to development the Chinese financial industry. 

2.     Regulation of the informal financial institution

       Regulation the informal financial institutions is a hard work, financial regulatory authorities need to scientific and comprehensive assess and judge those informal financial institution, to take differentiated measures to these institutions. Not only to resolutely crack down the underground banks, illegal fund-raising and other illegal activities, but also need to guide and regulate the behavior of private financing. Accelerate the legislative process of the investment fund, pawn, finance lease, Micro-credit, warranty and other emerging financial sector; clear the main body of supervision and the method of regulation, made the shadow banking system become “sunshine bank”, this not only makes the Chinese near-monopolistic financial system become more diverse, but also effectively avoids the potential risks posed by the shadow banking.

3.     Strengthening the cooperation between each regulatory authorities

        Because there have lots of financial regulation authority in China, therefore, it need to establish a unite regulatory mechanism, lead by a specify department, such as centre bank, and the relevant departments as members, make the regulatory policies together and Joint Law Enforcement. Strengthen the Statistics of All-system Financing Aggregate, strengthen the supervision of the M0, in order to control the amount of private lending.

These are my humble opinions, probably is not helpful for China, but I will keep study in this topic; hope can help my country avoid the potential risk of shadow banking system.

Part 4: The regulation of Shadow Banking System in foreign countries.

The proper inflation helps economic development, but over-inflation can lead to national bankruptcy. Monetary policy can control inflation, but the existence of the shadow banking system can make the monetary policy failure, causing serious inflation, resulting in the bubble economy, leading to economic crisis. Therefore, government must supervise and regulates the shadow banking system. 

After the 2008 global financial crisis, each government in the world have to strengthen the study of the shadow banking system, made a series of laws and regulations aimed at strengthening the supervision of shadow banking system.

The following part is the summary of the relevant supervisory method.

 1.     Strengthen the supervision of “shadow institutions”

First, begin to regulate the hedge funds, private equity funds and other shadow institutions.

Second, strengthen the regulation of information disclosure. Like the US. Securities and Exchange Commission issued new rules to enhance the liquidity of money market fund industry, credit standards and information disclosure, implementation a higher standards for money market mutual funds.(detail click here)

2.  Strengthen the supervision of “shadow products”

First, strengthen the supervision of the repo market, the Federal Reserve System was be given the power to establish a more stable financing system, to solve the problem of volatile short-term repo market, and ensure the operation of the markets are more health.
Second, regulate OTC derivatives trading. The United States government authorized the Commodity Futures Trading Commission and Securities and Exchange Commission on OTC derivatives regulation. They have the right to decision the trading institution's capital and margin requirements in swap, and limit its risk.(detail click here)

3. Strengthen banking supervision, to reduce the cooperate between the traditional banking and shadow banking

First, according to the Volcker Rules require, prohibit banks own or investing in private equity and hedge funds.

Second, strengthen the consolidated supervision, begin to supervise the Off-Balance Sheet Activities of the traditional bank.
Third, limit the size of the shadow banking system which support by the traditional banks, set higher capital requirements to shadow banking’s risk exposure.
Fourth, strengthen the coordination between the regulators; reduce the structural arbitrage between the banking system and financial system. (detail click here)

4. Establish mature and feasible monitoring methods to strengthen the monitoring of the shadow banking system.

Part 3: Does the government need to regulate the shadow banking system in China

In the previous study of Chinese shadow banking system, most scholars are focus on the question “to be or not to be of shadow banking system in China”, some of them think shadow banking system can bring the financial crisis, need to regulate the shadow banking system, the other think shadow banking system can accelerate financial reform, diversification of financial products, therefore, do not need to regulated.  However the Chinese government do not show it attitude of this question at the whole time.

In order to answer this question, it should base on the relevant data. However,  because this is a new topic in China, and the shadow banking system is not regulate by the centre bank, cannot get many official data, it makes this question hard to analysis. Although the Chinese centre bank made a new statistics of All-system Financing Aggregate in 2012, but it only available the data in January 2012, meanwhile, in this statistic, there do not have the relative data of informal financing institution, therefore, in the following part, the data that I used is based on some newspaper, probably do not have strong persuasion, but I will keep focus on the topic, and revise this blog.

There have a picture show us the growth of lending activities in China.

(source from: http://s.wsj.net/public/resources/images/OB-QG723_chinao_K_20111025111829.jpg)

By this picture, we can easily find the ratio of Chinese shadow banking system is keep increase, and in 2011, it has grown to 22% of all new financing in China, but the bank loans is still the main financing channels (click here see details). Compare with the ratio of shadow banking assets divided by the total bank assets 65% in the U.S. before 2008 financial crisis (6.5 trillion US$ of shadow banking assets, Timothy Geithner, 2008), there still have a huge gap.

However, this picture do not consider the informal financial sector, as the last blog said, form Jan.2011 to Jun. 2011, the scale of social financing increased by 7.76 trillion yuan, bank loans increased 4.17 trillion yuan, 53.7% of the total (click here see details), and 46.3% are from the shadow banking system. However in this statistic, it do not include the private lending, according to the statistic of Securities Daily, it estimate there have 3.38 trillion yuan provide by Private lending, it means in China, there have 6.88 trillion yuan increase by shadow banking system, 62.26% of the total, approaching the data 65% of the U.S. before financial crisis. Therefore, in my opinion, if the Chinese government do not want to recommit the same error like the U.S., it needs to regulate the shadow banking system. If not, I think the next financial crisis will be occurring in China. 

However, based on the high percentage of shadow banking assets and the special characteristics of Chinese shadow banking, the regelation of shadow banking system will be a hard work. If China wants to regulate the shadow banking system, it not only need to study the regulation method of other countries, but also need to connect the reality, and established some targeted regulatory programs.

Part2: The characteristics of the shadow banking system in China

In the last blog, I am talking about what is “shadow banking system”, however, after this week’s research; I suppose the shadow banking system I talked last week is a typical U.S. style. Compare with the shadow banking system in China, although the operation method are the same, but the project of the operation have a huge different.

Compare with the U.S. style shadow banking system and Chinese style. We can observe the following different.

1.      The formal financial sector

Chinese financial market is a typical mode of indirect financing, which leading by commercial banks. Although the develop speed of Chinese financial market is fast, but the capital market in China is still lag behind, the proportion of direct financing is still very low, it made the Chinese shadow banking system are still focus on the traditional bank financing business, few financial innovation like the western countries, therefore, the cooperation between commercial banks and trust companies become the major part of shadow banking system.

 2.      The informal financial sector

The another major part of shadow banking system is the private financing organizations, which include pawnshop, underground bank, private equity fund, civil RCAs and so on. According to the statistical report by People's Bank of China (central bank), form Jan.2011 to Jun. 2011, the scale of social financing increased by 7.76 trillion yuan, bank loans increased 4.17 trillion yuan, 53.7% of the total, in other words, 46.3% are from the shadow banking system, nearly half of the total.

As Lv (professor of Beijing university) said: The Chinese version of the shadow banking system is different from the Western developed countries’ traditionally defined, the main form is not securitization of real estate loan, is the "trust and bank cooperation", “underground banks” and other such financial form. (detail click here)

Part1: what is shadow banking system?

The shadow banking system is means the non-bank intermediate entities which excise banking functions but unregulated or less regulated by the financial regulators, which include in financial instruments and financial products, such as investment bank, hedge funds, private equity funds, Structured Investment Vehicle, Collateralized Debt Obligation (the reason of 2008 global financial crisis), Credit Default Swap, Asset-Backed Commercial Paper, Repo and so on.

Compare with the Traditional commercial banking system, there have huge different between these two "bank", after summarized of these different, I suppose there have three major different parts.

1. Source of fund

Although both the shadow banking system and the traditional commercial banking system are the intermediates between depositor and borrower, but the commercial bank can absorb deposits from the individual and firms, however, the shadow banking system cannot absorb deposits, and the source of fund are mainly from the financial markets, through short-term wholesale funding and debt to raise the funds, and then use the fund to the long-term investment. 

2. Regulation

The traditional commercial banks regulated by the Central Bank, need them to publish accounts, keep plenty of capital reserve, and severely restricted those commercial banks operate high risk behaviour. But the shadow banking system is outside the regulatory system, do not need to publish their accounts, do not have limit of capital reserve and the use of leverage, therefore, the shadow banking system have a significant competitive advantage in the financial markets. 

3. The ability of risks resistance

The commercial banks can get the protection of the central bank, when there faced emergencies like the bank run, it can get the financial support by the central bank. However, because the shadow banking system is outside the regulatory of central bank, therefore, they cannot get the protection of the central bank, meanwhile, based on the use of high leverage, if a run on these shadow banks, these shadow banks must bankrupt.  As everybody knows, the 2008 financial crisis was contributing by the shadow banking system.

Part 0: To be, or not to be: that is the question for shadow banking system

In the 2008 global financial crisis, the shadow banking system acts as a major role to produce the financial crisis. Therefore, in recent years, the financial regulators increase the supervision of the shadow banking system, and the term "shadow banking system" also appeared in the economic news and research papers more and more. In those articles, there has one attracted my attention, the Wall Street Journal’s paper. And the view point of this paper is:  Based on the Chinese shadow Banking System, the nest sub-prime will be occurring in China. Because China is my hometown, I really care about the future of my country; however in our class, the study of regulating shadow banking system is not detailed, therefore, in this blog, I will focus on the regulation of shadow banking system in China. Try to understand the following question: What is shadow banking system, the characteristics of the shadow banking system in China, does the government need to regulate the shadow bank in China, the regulation of Shadow Banking System in foreign countries, and the suggestion of Chinese government supervises and regulates the shadow banking system.

Before the main body of my blog, there have a video, can explain the relationship between the shadow banking system and the 2008 economic crisis faultlessly, hope have fun.

Some related articles and news


English articles (click the title, it will link to the paper)
Pozsar, Z. Adrian, T. Ashcraf, A. and Boesky, H. (2010) Shadow Banking, FederalReserve Bank of New York Staff Reports

Anon (2011). Shadow Banking: Scoping the Issues. A Background Note of the Financial Stability Board
Gorton, G. and Metrick, A. (2010) Regulating the Shadow Banking System. Research paper of Yale and NBER

Adrian, T. and Shin, H. (2009) The Shadow Banking System: Implications for Financial Regulation, Federal Reserve Bank of New York Staff Reports

Hu, Y. (2011) China Banks: Shadow banking conundrum, Research paper of HSBC


Chinese article
Li, S. (2011). Regulation of Shadow Banking System. Journal of China Bond.
Xin, Q. (2010) The Shadow Banking System. Taipei: Meilin Press Ltd.


News:
http://topic.eastmoney.com/financeearn/
http://www.bbvaresearch.com/KETD/fbin/mult/110821_Shadow_Banking_EN_tcm348-266397.pdf?ts=332012
http://doc.mbalib.com/view/215ed85d978d8d3cfcf531c8a754989a.html
http://doc.mbalib.com/view/314537b622402d6b95bb30abbbd7ea4f.html
http://blogs.wsj.com/marketbeat/2011/10/25/chinas-shadow-banking-system-the-next-subprime/
http://www.csstoday.net/Item/8264.aspx
http://finance.sina.com.cn/review/jcgc/20111209/113610965496.shtml
http://www.ftchinese.com/story/001041183
http://xb.21cbh.com/HTML/2012-1-26/1MMDAwMDI1OTI1Mg.html
http://www.51tot.com/n5842.html
http://news.xinhuanet.com/fortune/2011-05/31/c_121476544.htm