Jun 12, 2018 01:20 PM

Editorial: Financial Regulation, Innovation Can Go Hand in Hand

After 16 years of hesitation, China is finally putting into place strengthened supervision of financial holding companies. The central bank is leading a pilot program to test supervision measures, and the relevant regulations are expected to be introduced by the end of this year. This will be a major turning point for financial supervision and for financial markets. It has long been clear to the market that financial holding companies can present enormous risk. This risk is often intertwined with risks from “shadow banking,” asset management and internet finance, and could have disastrous consequences if supervision is not imposed as soon as possible.

China has for many years struggled to settle on supervision measures for financial holding companies. There are many reasons for this. The main cause is the limitations of the regulatory system. Under the model of separate supervision for banks, insurance companies and securities companies, there is serious fragmentation between sectors, inevitably causing both regulatory overreach and blind spots. Regulatory capture, such as in the case of disgraced insurance regulator Xiang Junbo, further corrodes the system. The roles played by ideology and public opinion should also not be ignored. There are always people who see a false dichotomy between supervision and financial innovation, and see every supervisory action as a sign that regulators have no tolerance for innovation. In China, where serious financial repression still exists, the market is easily persuaded by the argument that regulation hinders innovation. This view actually relies on a distorted definition of innovation. The idea that there is necessarily a conflict between regulation and innovation is flawed, and does serious harm. We must do our best to clarify and eliminate this idea.

Boosted by a surge in profits, financial holding companies have expanded enormously in a short period of time. Central and local state-owned enterprises (SOEs), as well as private enterprises, have all entered the fray. For a while, when it was still unclear what development momentum these companies have, regulators had to adopt a wait-and-see attitude. However, the massive impact of financial holding companies on the public interest and the security of the financial sector were clear from the outset. Risks related to these companies have surfaced repeatedly in recent years. Some private companies have violated the rules governing related transactions and used financial institutions as their ATMs, sending shock waves through the capital market.

The behavior of the Tomorrow and Anbang conglomerates directly violated existing laws and regulations, and had nothing to do with innovation. Regulators do not need to wait for new rules before increasing the effectiveness of their existing toolkit. When faced with premature financial developments made in the name of innovation, strengthened regulation may appear to some onlookers as the wrong choice. But tolerating transgressions by financial holding companies will ultimately lead to disaster, and regulators will learn their lesson the difficult way. So, as part of the central government’s larger drive to shrink financial risk, the central bank is determined to set standards for financial holding companies, and to fully demonstrate the supervisory authorities’ unambiguous stance that development and innovation must not be equated to a loosening of all restrictions.

The inclusion of new internet financial holding companies, like Ant Financial Services Group, in the central bank’s supervision pilot program is a highlight of the new regulatory system. Ant Financial has grown into a leviathan, but there is still debate over whether it should be regulated like other financial holding companies. Many argue that the business model of Ant Financial is so novel that regulators couldn’t possibly understand it, and that the best way to regulate internet finance is to do so very lightly. Actually, even though the shape of financial services and products is ever-changing, their nature is constant. If a company offers financial services, it must accept supervision. The current financial regulatory system is the result of many years’ experience, and is changing with the times. What’s more, regulation is not intended to hinder companies’ innovation, but rather to establish basic conditions and boundaries to ensure long-term stability.

For a long time, it was “politically correct” to prioritize innovation in market economies. Even while China’s regulators were grappling with the chaos of peer-to-peer lending, many continued to insist that supervision should not hinder innovation. But the past few years have shown that many so-called financial innovations amount simply to supervisory arbitrage. When regulators fail to supervise, or supervise incorrectly, they are failing to perform their duties. In the future, regulators should be confident in exercising their powers even in the face of populist sentiment agitated by stakeholders in the financial market. Inclusiveness should not be equated with indulgence.

Regulators can formulate the correct supervision policies by being clear about their guiding ideologies, and by rationally facing the issue at hand. It should be noted that regulating financial holding companies requires the involvement of more than just one aspect of regulation, and is inseparable from economic restructuring and the overall deepening of SOE and financial reform. SOEs have become involved en masse with financial holding companies combining financial with nonfinancial businesses, and they have received strong support from the State-Owned Assets Supervision and Administration Commission (SASAC). However, these companies did not end up using their financial businesses only as a way to support their main businesses. Instead, they began to compete for financial licenses, exacerbating the Chinese economy’s tendency to ignore the real economy in favor of the “virtual” one. It is easier to make quick money in the financial industry, with higher profits than in other industries. This is an abnormal situation, which shows how urgently China needs to eliminate financial monopolies. The central government is currently calling for financial services to serve the real economy. Now that SASAC no longer encourages SOEs to invest in finance, the companies that do not have finance as their core business should take the initiative to distance themselves from their secondary businesses and withdraw from the financial sector as soon as possible to fulfill their social responsibilities.

Regulators should also make more comprehensive plans to tackle any resistance to supervision of financial holding companies. In particular, they must deepen reform of the financial supervision and improve legislation to avoid giving naysayers a reason to argue that regulation impedes innovation. The central bank is now leading moves to strengthen supervision of financial holding companies, which can be seen as the result of the previous period of regulatory reform. However, some still question the legal basis of supervision. The relevant legal amendments should be put on the table as soon as possible. The supervisory authorities themselves must also resolve to fix longstanding problems like an emphasis on approval and neglect of supervision and punishment, and follow greater central government trend of streamlining administration, delegating power, transforming functions and improving services.

The relationship between innovation and regulation has been a persistent topic of debate in China ever since the country’s reckoning with funds’ shady practices in the early 2000s. In most cases, it is absolutely untrue that China must choose between one or the other. Few novel ideas have been offered on this topic over the past two decades, and the debate has mainly rehashed old concepts. This situation is worth some consideration. Behind this debate, there is a clash between how different parties understand the situation. It is also an intense game between the different interests involved. We look forward to regulatory actions strengthening the supervision of financial holding companies, and are confident that this long-drawn and unnecessary debate will reach a conclusion.

Translated by Teng Jing Xuan (

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