Regulation and supervision for foreign banks in China

Part 4: Personal suggestions for problems in part3(Based on Basel Accord) 

                                                 Overview of Basel Accord II

Suggestion 1: Regulators need pay more attention on risk regulation for foreign banks

According to the first pillar(minimum capital requirement) of Basel Accord II , banks should accept the standardized approach of credit risk rating generated by the external rating agency, which can be used to predict and measure risk. Also banks need have a internal risk rating system(Foundation IRB and Advanced IRB). So, I think Chinese banking regulators should learn the specific approach of Basel Accord and set up a complete and perfect the external rating agency system and the internal rating system, for example, set up some independent external rating agencies, develop the appropriate and competent risk rating model, also, banking regulators need a internal fundamental rating database for all foreign banks to regulate the credit, operational and market risk.

Suggestion 2: Regulators need strengthen international co-operation on foreign banks regulation

According to Basel Accord I, foreign bank regulation need a good co-operation between the home countries and the host countries. Home countries should be responsible for regulation on liquidity of their foreign bank branches, host countries should be responsible for regulation on capital adequacy of the foreign bank. Therefore, I would suggest China bank regulators strengthen co-operation with other countries. For instance, we can develop a system which can share the information of bank regulation between different countries. Also, we can set up some laws and regulations with other countries, which specify a appropriate information disclosure system for the foreign bank. All in all, every country in world are responsible for the financial security and stability, financial regulators of each country should get together to reduce the international financial risk.

Regulation and supervision for foreign banks in China

Part 3 : Problems in current foreign banks regulation and supervision system in China.

There are some problems documented by people did research about this topic, for example: Duan(2007) reported current laws and regulations system on foreign banks is incomplete, Su(2008) indicated that current bank regulation and supervision for foreign banks is inconsistent and low efficiency. Here, I would discuss other two problems from my research.

The first problem: Prefer compliance management to risk management.

This table compared the regulations for domestic and foreign banks, the first five restrictions for domestic and foreign banks are almost the same, however from the criterion of Branch bank foreign Asset liability ratio, Branch bank capital ratio in prescribed form, Branch bank liquidity ratio, Branch bank capital adequacy ratio we can know, regulations for foreign banks is more strictly than for domestic banks in China. The problem is the regulators rely on these ratios too much, which means they focus on the compliance management in bank regulation. These ratio can reflect risk of break the law of the foreign banks but cannot reflect the potential credit risk, market risk and operational risk. According to Basel II, the credit risk, market risk and operational risk are link to each other, therefore I think Chinese regulators need a appropriate risk management system to supervise the foreign banks, not just copy some standards from American ROCA and CAMELs risk assessment system.

The second problem: Lack International co-operation for foreign bank regulation

From the data in Part 2 we can find, the large proportion of foreign banks in China are the foreign bank branches. As we know, regulation for foreign bank branches is much more difficult than foreign legal person banks, because the host countries cannot get the whole business information of the foreign bank branches(their business information managed by bank in their home countries), so host and home countries need co-operation for foreign bank regulation. However, The Regulation on Administration of Foreign Banks (2006)documented that regulation on foreign banks liquidity is the responsibility of the host country and there is not a specific treaty and regulations about international co-operation for foreign banks regulation in China. Also, China do not use Basel Accord system, therefore, even the regulator can get the regulation information of the foreign bank from the home countries, these information might invalid under the Chinese regulation system. These problem would increase the potential risk of the financial market.

Regulation and supervision for foreign banks in China

Part 2：Why China need regulate and supervise foreign banks

On December 2006, Chinese government published The Regulation on Administration of Foreign Banks, which is the first regulations specify rules for foreign banks in China, also it indicated, from Jan 2007 China would carry out comprehensive national treatment for all foreign banks. Since 2007, foreign Banks no longer restricted by industries and region in China.

According to the report from China Banking Regulatory Commission about foreign banks we can know, by the end of September 2011, there were 39 foreign legal person banks( included 247 branches and affiliates) and 93 foreign bank branches, 207 representative offices set up in China. Compared with the data before China entred into WTO, there was a huge increasing(increased 175 foreign bank branch and increased 374 foreign bank representative offices after entering WTO ). At the end of 2011, the total capital of foreign banks in China is 2.06 thousand billion RMB and the capital of top five foreign banks( HSBC, Citibank, Bank of East Asia, Standard Chartered Bank, Hang Seng Bank) all excess one hundred billion RMB.  (Data Source: http://www.cbrc.gov.cn/chinese/home/docView/F66A0967E8A74157AD58642D5A1BEF76.html)

These figures tell us, foreign banks play a more and more important role in the financial market of China. On the one hand, foreign banks can stimulate and perfect the Chinese competitive financial market, and also enhance the management quality and competitiveness of the domestic banks. On the other hand, domestic banks would lose some business and market during competition, also foreign banks would increase the instability of financial market of China. therefore, if Chinese government did not use an appropriate way to regulate and supervise foreign banks, it might had some negative impact on the economy and finance, even might result in finance crises.    

Under the principle of national treatment for foreign banks, the regulation for foreign banks in China should not be a specially issue. However, China is a developing country, the previous financial system in China are closed market type, now the financial system are changing into a open market type and this system is still incomplete during these period. Therefore, foreign banks would have significant difference with domestic banks in many areas. For instance, foreign banks have stronger financial innovation ability, have rich experience on off balance sheet business and widely use various financial derivatives in business. These difference make it difficult to use the same regulations for foreign banks and domestic banks. Therefore, within this period, Chinese government set up the appropriate regulations for foreign banks would improve the effectiveness of regulation and reduce the financial risk that might caused by foreign banks.

Regulation and supervision for foreign banks in China

Part 1： What is bank regulation and supervision？

As an essential parts of modern economy, the performance of banks have a great influence on to the stability of the economy and politics for each country. Recent years, bank regulation became an interesting issue.Economists had different views on bank regulation and supervision. The free banking believer Selgin and White(1988, 1996) thought there was no necessary to have bank regulators and central bank, because under the situation of free market and competition in bank industry, all banks would act as a responsible role in financial world. 

However, Hickson and Turner (2002, 2004) thought bank regulation and supervision was very important and from the result of empirical studies on historical data of bank regulation, they found evidence that against for free bank theory. Also, Levine et al (2003)documented " the importance of banks for economic growth connected with their fragility has led governments to establish official agencies to regulate and supervise banks".

Bank regulation and supervision is a kind of government regulation that use the central bank(People's Bank of China) and some independence regulators(China Banking Regulatory Commission) to control other banks follow certain rules, restrictions and requirements, which is good for creating a transparent and fair competition environment in banking industry, also it is good for ensuring a good development capability and financial security of  the economy.

There is a famous bank regulation system - the Basel capital adequacy regulation (Basel I 1994, Basel II 2004, Basel III 2010) that accepted by many developed countries (G10 and some other countries). Under this system, regulation and supervision for domestic and foreign banks seems not very difficult for those countries, because the home country of most foreign banks are these developed countries. China is a developing country, and do not use Basel Accord, now bank regulation system is still in a  rapid developing stage in China, especially after entry into WTO, many foreign banks enter the Chinese financial market, which bring great opportunties and challenges for China about regulation and supervision of domestic and foreign banks.