Last week, Chinese central bank governor Zhou Xiaochuan penned a letter, published on the bank’s website, discussing problems in China’s financial sector. His letter focused on the private sector, where poor regulatory oversight has encouraged the creation of bubbles in areas such as online lending and real estate. It also discussed the uncertainty over where local government authority ends and central authority begins, citing this as a reason for the difficulty of managing the financial system.
This coincides with recent central government efforts to better control outbound and inbound investment—efforts that have proven hard to enforce. Taken together, this shows that top government officials in China understand, and aren’t afraid to talk about, the problems in the financial system. But there are no simple solutions. Creating new committees and regulations is easy; pre-empting problems and enforcing changes are not.
Of all the Chinese economy’s problems, none are more serious than those in its financial sector, because a failure of the financial system would hurt the entire economy. Firms starved of finances would shut down or slim down, creating unemployment and thus social instability. Instability in a tightly controlled country of 1.4 billion people is potentially catastrophic. To fight this threat, China last week did what it does—it created a new regulatory body, the Financial Stability and Development Commission, to regulate shadow banking, asset management, peer-to-peer Internet finance, and financial holding companies.
The FSDC, under the control of the People’s Bank of China, joins a fleet of other regulatory commissions that manage insurance, banking, and securities. Its members will be selected from those other commissions. In this sense, it’s not really a new body. And there’s no reason to believe it will be more effective than the others.
Cat and Mouse
The new commission still fails to address the fundamental divergence of interests between the central government and local governments. When Beijing assesses the performance of local officials, it looks at the economic growth of areas under their jurisdiction, so attempts to slow down credit expansion and rein in risky financial schemes threaten careers. Local regulators and government officials thus have little incentive to stop the expansion of credit—not that it was easy in the first place. China is a vast country, and it’s impossible for Beijing to micromanage everything. A large institution like the central bank can be regulated, but the thousands (and counting) of online lenders are a different story.
