Six Things that Make Us Concern

 

LIU Mingkang

Chairman of China Banking Regulatory Commission

Keynotes Speech at the 16th International Conference on Banking Supervision

(Singapore, September 23rd, 2010)

Thank you for that kind introduction, Chairman. Ladies and gentlemen, good morning.

The ICBS, as any sensible person knows, is one of the greatest organizations in the world.  Truth be told, I shouldn’t have to explain why, especially to audience of this esteemed organization, but needs must. Summing our least thankful job up isn’t hard, though of course, we are always modest about our many heaving-going achievements and shy about our concerns, even if some of these might not be obvious at first for the politicians, economists, press and the bankers.

The interconnectedness.  Size, at first glance, was shocking, outrageous, horrible, woeful and bad to many people in this crisis. But I’ll say, interconnectedness was and still is the major trigger for this crisis, partly because it amplifies the spillover effects, and partly because it is closely related to complexity. Looking back to the past two decades, the globalization and so-called innovation have attracted so many people to dream they are everything to every person. Cross-sector and cross-border financial transactions have blossomed into the most incredible trend the world has ever known, and bank funding has heavily relied upon the volatile capital market instruments with the risks to bang their heads and nowhere to claim their compensation. Worse, our supervision is the best by a mile.

Even funnier, the bankers, at least some of them, have the greatest sense of humor in the globalization, without a doubt. They were talking and started to run the so-called “universal banking”, and what do that suggest: relying on takeaway food for sustenance without quality and safety control?

If it wasn’t the crisis of that scale, we wouldn’t have any sense of place where we are. Now the proposals came, putting proprietary trading restrictions and higher capital requirements, etc. on those interconnected SIFIs, complemented by the “bail-in” and “living will” measures. It was late and uncomfortable, so the cure was born. However, in my view, prevention is, as a rule, better than cure. In China, we had our Chinese wall 2,000 years ago, and today, my mission is to make sure that the firewall has been kept in mind by each and every banking institution as well as its supervisors.

The moral hazard.  Leading up to the crisis, many supervisors felt pressures from various stakeholders to lighten their regulatory regimes. Governments had an ambitious passion for establishing their core cities as international financial centers with global competitiveness. Moreover, without a doubt, they took care of their people. They were making the most of their countries by “financial innovation”. Financial institutions tried hard to make fortunes without moral standards. Incentives mechanisms were distorted by extremely high leveraging embedded in tiers and layers of those toxic products or through shadow banking vehicles and negligence of risks and costs, which led to short-sighted behaviors. The dreams became crazy, no need of down payments or jobs, everyone could have his house by mortgage loans. Today, the ridiculous moral hazard is still with us somewhere, partly because people at the trading floor are turning over quickly and shopping around for better incentives, and partly because people in this business always have short memories. So, for the service of making them know their duties better and keep longer memories, we, the supervisors make many great sacrifices, to be the least thankful reminders of our noble government officials, banking board directors and even some so-called experts.

The cross-border issue.  The hallmark of this crisis is that it is global and systemic in nature, and we don’t have the ability to resolve a large, complex cross-border financial institution. Actually, two years after Lehman’s bankruptcy, it is still the situation, even though the new Dodd-Frank Bill in the U.S. has made significant progress on this front. This is the harsh reality we are facing today.  

There are three major obstacles here. First, there is a lack of adequate and timely information sharing. This is complicated by both incentives and technical issues. Second, there are inherent incentives for national authorities to favor the welfare of their domestic jurisdictions at the expense of foreign countries. During a crisis, national regulators usually take unilateral supervisory and resolution measures, which often lead to inefficiency and ineffectiveness in cross-border bank resolution. Third, there are big variations and differences in legal frameworks and supervisory rules across different countries, which caused ineffective cross-border resolutions. At the heart of the problem are the differences in national interest and legal systems. The challenge is how we can prevent ring-fencing given that it is in the national interest of each country to do so.

To solve the perplexed issue, it would be ideal to have a harmonization of legal frameworks across countries regarding resolution of cross-border financial institutions. However, it would be an enormous task, and extremely complicated and time-consuming. The more promising alternative is to have an international treaty, to establish a binding framework on the cross-border resolution of banks, under which, resolutions in each jurisdiction are still conducted through national authorities. Such a treaty should set rules on information-sharing, equal treatment of stakeholders across jurisdictions and depositor protection and so on. The treaty would provide clarity and predictability regarding applicable laws in bank resolution process, and limit the discretion of national authorities to take unilateral actions. In addition to mitigating ring-fencing and fragmentation of global resolutions, the international treaty has additional benefit of promoting reform and establishment of credible resolution regimes at each jurisdiction. 

Before we have such an ideal treaty, stand-alone subsidiarization of global banks may not be a bad idea [in my eyes], because this kind of pre-arranged measures would mitigate harmful “front run” behavior in ring-fencing by national authorities in the middle of a crisis.

The models.  You would probably agree that the models have ever played some positive roles in facilitating our observations, information processing and logical thinking. But the point is that, the mighty, solemn model experts stood on history [though actually when they got their Noble Prize, they were not as great as until their models are applied in banks] with models about which the banker users know nothing whatsoever, what we do know is:

First, models are models. Instruments can help but never replace our clear, logical and professional judgment. Second, the seemingly complex models often over simplify the real world. Models see things happen in a way of normal distributions, which is in most cases actually not. Third, by models, we bear risks to use the past to predict the future. Fourth, we follow the same models everywhere, so we have hand in hand made the most astonishing stories in historysale at the fire sale price on rainy days and buy at the sky shooting price on sunshine ones.

The data.  The current crisis has uncovered the problem of lacking timely, reliable data and information about institutions, products and markets. Even worse, some banks find funny ways to let us, the supervisory authorities fail to have access to their data. That got me thinking. Data without quality is springing up everywhere. It should be noted that what’s behind this problem is really about corporate governance, in-house risk control, IT and human resources problems. Currently, the new Basel requirements have become more demanding, so we must take decisive actions to better our data and the system. To attain the aim along the timetables given by Basel, we should never confuse movement with action. What is the action? It is now to allocate adequate talents for IT system, risk management and design in a building-block approach with a broad vision and a sequence in implementation. For supervisors, it is also important to be able to access to data of all the regulated institutions and share our information with them as well as with relevant authorities both at home and abroad. This can facilitate the timely collection of macroeconomic situation, policy changes, as well as other inter-market and cross-border CCP data. Supervisory authorities should devote more to doing our own homework, conducting in-depth analysis of risks, making regulatory judgment and providing guidance whenever necessary.

Last but not the least is the teeth problems.  Two weeks ago, finally the news came from Basel about our missions and timetables. We, the regulators have a proud tradition of thinking more than being told. Because we all know, implementation is more important than rules and standards. So here, if we decide to reduce the probability of crisis reoccurrence, to reduce the impact of failures of SIBs, and to reduce the public sector costs, we can never reduce our teeth. To that end, I recommend the following: 

1. Supervisory authorities must have and should have the mandates and independence to do their jobs and to resist any relaxation of supervisory and regulatory standards over time.

2. Supervisory practices should be invasive and interactive, keeping an eye on what banks are doing, especially their capabilities to control. To achieve these goals, we must employ an invasive approach to the relationship with the Board, senior management and the bank’s controlling functions (eg. the Supervisory Board).

3. Risk assessment for banks should be forward-looking. We should make use of macro-prudential tools and stress testing to round out a future picture about the solvency of the firm.

4. All banks should not be allowed to become too complex to manage or supervise.

5. Intervention should be early and frequent.

6. Supervisors must have the power access to the most senior decision-makers in the bank.

7. Supervisory agencies should have access to timely and accurate data from the banks, including from their data warehouses.

8. The extent of use of models must be understood by both banks and supervisors, and stress tests should be well performed independently by both as well.

Concluding Remarks

To conclude, there we have it, six good and sound reasons why we are not easy and why we are great. Take these with you to the panel discussions, to your lunch tables, to your workplaces, or even, if you must, to the Formula One race. You will find your least thankful life endlessly enriched and there won’t be an argument, if we pay more attention to them, not the ratios and timetables only, we will win.  Thank you all.

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