FINANCIAL REGULATION: Why reform must go further

07/10/2010 | Liu Mingkang

China's top banking regulator Liu Mingkang argues that recent efforts at global financial reform have fallen short

Two years after the collapse of Lehman Brothers, we are still studying what caused the financial crisis, and what needs to be done to heal the wound and prevent another blow in the future. In appearance, the financial crisis is cross-sector and cross-border. In nature, it is systemic and global. It stems from human greed, unleashed by the dysfunctional regulatory system.

Amidst the calls for financial reform, many countries launched reform plans. From the Dodd-Frank Act in the US to the consolidation of the UK’s FSA into the Bank of England and the attempt to establish three pan-EU financial watchdogs, the national and regional authorities are searching hard for solutions to rebuild the resilience of the financial system. Most recently, the world cheered the announcement of the long-awaited agreement on substantially raising global capital standards, viewing it as a milestone in international reform endeavours.

Evidently, the ongoing reforms have addressed cross-sector risk, and, to a lesser extent, cross-border risk. These moves are right in direction and concept, and build on the hard lessons learned. But to apply the concept in practice, more needs to be done. Especially when it comes to cross-border risk, engaging national authorities to find solutions presents a severe challenge. To avoid another crisis, however, we have to face up to this challenge.

Three issues illustrate the need for cross-border efforts.

Cross-border resolution. With concerted effort, significant progress has been made in strengthening the supervision of systemically important institutions (SIFIs). However, the harsh reality is that we still seem to lack the ability to deal with a large, complex cross-border financial institution.

There are three major obstacles here. First, there is a lack of adequate and timely communication among different national regulators. Second, there are inherent incentives for national authorities to favour the welfare of their domestic institutions at the expense of foreign jurisdictions. Third, there are huge variations in legal frameworks and supervisory rules across different jurisdictions, which are naturally of hindrance to effective cross-border resolution.

Given this situation, it would be ideal to harmonize legal frameworks across countries, which apparently is a daunting task, if not a mission impossible. A more promising alternative is to introduce an international treaty, which sets fundamental rules for information-sharing, equal treatment of stakeholders across jurisdictions and depositor protection.

National authorities are expected to refer to these uniform rules in conducting resolution within their respective jurisdictions. As such, the treaty will provide clarity and predictability regarding applicable rules for resolution, and limit the discretion of national authorities to take unilateral actions. In addition to mitigating ring-fencing and fragmentation of cross-border resolution, the international treaty has the additional benefit of promoting a credible resolution regime in each jurisdiction.

Data and information sharing. The current crisis has revealed the lack of timely and reliable data about institutions, products and markets as well as inadequate information sharing among stakeholders. To mitigate the chance of future crises, decisive action is necessary to improve data and information sharing.

For financial institutions, this means substantive improvement in corporate governance, IT capability and human resources management. For supervisors, it means gaining full access to the data of each regulated institution and promptly sharing meaningful information with both the institutions and the regulatory counterparts home and abroad. Only by doing so, will the industry and regulators be able to make informed analysis and decisions, in a forward-looking way.

Accounting standards. The convergence of accounting standards remains another huge challenge in cross-border collaboration. Currently, the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) differ greatly in many areas. This is certainly not what the G20 leaders have sought for accounting reforms, and it will inevitably lead to unnecessary costs and burdens both on the industry and supervisors. Without addressing the problem of divergence, without having a single set of high-quality global accounting rules and standards, building a strong and robust international financial system will simply turn out to be empty talk.

These three subjects, among many others, exemplify how the cross-border issues are so interconnected that they warrant further international effort for solution. As a member of the Basel Committee on Banking Supervision and the Financial Stability Board, the China Banking Regulatory Commission has been actively contributing to the formulation of new standards, and is committed to upholding these standards. In fact, many of our existing practices are consistent with the Basel III in substance. Our approach is to make reference to the respective merits of Basel I, Basel II and Basel III to formulate a pragmatic capital regulation framework in China.

Prevention, as a rule, is better than cure. Two thousand years ago, the Great Wall came into existence in China to shield the natives from “barbarian attack”. Today, we need a global “Great Wall” to keep us all safe. We all have a stake in the wall, and it takes our joint effort to build it.


Liu Mingkang is chairman of the China Banking Regulatory Commission

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