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Focusing on Establishing a Firewall to Ensure Better Supervision over Financial Holding Groups
2004-12-13
Xia Bin Research Report No 127, 2004
I. The Urgent Need of Formulating Supervision Stipulations on Financial Holding Groups
At present, China already has a huge number of various financial holding groups, which take various forms many of which attempt to avoid supervision. Undisputedly, due to their low level of risk management expertise, complex equity structure and large scale of internal affiliated transactions, they face many potential risks. In addition, due to lack of standardization and lack of coordinated supervision, some financial groups engage in secret business transactions in gray areas, made lots of investments, adopted some practices that may be prohibited in future, and incurred huge losses. Some financial groups took full advantage of the current insufficient oversight of supervision departments, insufficient communication among supervision departments and inconsistent policies, or even used ambiguous language to mislead investors. As a result, they have turned many potential risks into huge capital losses.
As early as in 2001 when financial holding groups started to emerge in China, in light of the mistaken ideas of some leaders who prematurely advocated single-business operation, I clearly pointed out that China was not ready for mixed-sector operation. I stated that a realistic option at the time might be to set up financial holding companies. I also expressed my opinions on whether it was necessary to supervise financial holding companies, how to supervise them and what to supervise. Meanwhile, I warned that “we should not mend the fold after the sheep are stolen, and should not pay any more fees to learn the lessons”. However, the appeal received no response from relevant departments. Since the financial supervision departments have always played the role of “firefighters”, they have been constantly pushed forward by the market. At present, with losses of billions of capital, “the sheep are already dead” but the “fold” has not yet been fully repaired, and a substantial system of coordinated supervision over financial holding companies is still lacking. Is there any accountability? Who is accountable for that?
II. Relevant Departments Should Formulate the Stipulations within a Given Time and Establish an Operational and Coordinated Supervision System
1. From the point of view of economics, the emergence and development of financial holding groups in China is somehow inevitable. The acceleration of the opening up of the financial sector in China, the scarcity of financial resources, the advantages of financial functions and the incentives of financial innovations are macro factors that lead to the emergence of the financial holding groups. Whereas, the gradual stabilization of the market status of industrial and commercial enterprises and the continuous pursuit of profits are the micro factors.
2. The establishment of financial holding companies is in line with existing laws and regulations in China. In another word, in light of the existing financial laws and regulations in China, especially the stipulations on external investment by financial institutions and qualification of shareholders of financial institutions, the emergence of financial holding groups is not a result of positive promotion by competent departments, but a possible and inevitable result of market development.
3. Relevant departments should set a time-limit to establish a system of supervision over financial holding groups. Since financial holding groups as well as large capital losses are already facts in China, we can no longer turn a blind eye to their threat to financial stabilization. However, the existing regulations covering businesses of various financial areas of financial holding groups were formulated by relevant departments with their own points of view. Little consideration was given to intersecting financial areas, and the overall financial legislation lacks consistency and coordination. Therefore, there is no time to lose, and relevant departments must quickly establish a system of supervision over financial holding groups.
4. The three supervision departments and the People’s Bank of China (PBC) must seek common points and resolve their differences, and take up the supervision responsibilities together as soon as possible. At present, although the three supervision departments have already sponsored two joint meetings, determined the major supervision system for supervising financial holding companies, and clarified the division of responsibilities and the framework of information sharing among all supervision agencies, such consensus generally remains at the level of only a framework. They have not yet completely established a particularly coordinated supervision system. For the issue of different financial institutions engaged in the same types of business, the supervision measures remain inconsistent and conflicting. Moreover, with regard to the issue of financial holding companies, what is the relationship between the three supervision departments and the central bank in stabilizing the financial system and building up the financial control mechanisms? What are their respective functions? How should they exchange supervision information? There are no answers yet. Therefore, to improve the current status of unharmonious and insufficient supervision, the three supervision departments and the PBC must take account of the overall situation, seek common ground, set up a coordinated supervision system and take up appropriately divided supervision responsibilities together.
III. Appropriately Solve Conflicts between the Firewalls and the Coordinated Effect
The relevance of establishing financial holding companies is that they can achieve scope economy and scale economy, and thus create a coordinated effect. However, bad management of such coordinated effects will generate negative synergistic effects, namely risk transmission among financial institutions of a financial holding group, as well as risk transmission to investors outside the group. Therefore, it is necessary to create conditions for existing financial groups to exert their positive coordinated effects, while setting up necessary firewalls to reduce the effect of risk transmission within financial holding groups and risk transmission to outside financial groups.
The design of firewalls is a highly specific and complex institutional construction. According to operation mechanism, the firewall system may be divided into legal person firewalls and general firewalls. The legal person firewalls refer to the legal system that stipulates the various financial businesses that independent legal persons may engage in based on the stipulations on the limited liabilities of legal persons, so as to separate their respective risk transmission. The general firewalls refer to the system that prohibits or restricts information exchange, personnel arrangements, business association and financing among affiliated agencies engaged in various financial businesses. In particular, firewalls include information firewalls, personnel firewalls, business firewalls and capital firewalls.
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