Shadow banking risks should be limited through unified regulation

[Photo/Sipa]

Global financial supervision has been strengthened since the global financial crisis. But to make high profits, banks began to circumvent regulatory barriers and launched off-balance sheet activities, giving rise to shadow banking.

When there is a mismatch between asset maturity and liquidity, lax supervision and information asymmetry, high leverage can easily lead to liquidity and/or systemic risks, or even a financial crisis, undermining the financial market stability. On the other hand, the dismantling of the high-risk shadow banking system could contribute to preventing major risks.

China should therefore put in place strict regulatory rules for credit-type financial products and strengthen the supervision of innovative financial products. Chinese regulatory agencies have long sought to unify financial market supervision, especially for high-risk wealth management products, and to establish supervisory standards for different industries.

It is particularly important to treat the market for wealth management products as a unified whole and to improve coordination between different regulatory authorities. But supervision must be unified and a compliance system built step by step; it should be a long-term goal and aim to reduce the cost of supervision, avoid duplication of supervision, and improve the effectiveness of supervision.

Closing gaps and loopholes in the supervision of innovative financial products will help to better monitor the shadow banking system. China’s high-risk shadow banking sector resembles quasi-credit, and it’s easy to get loans under the guise of promoting innovation. No wonder that with the development of the Chinese financial market, innovative financial products are emerging at a faster pace.

Since China formulates regulatory rules for a financial product – private equity funds for example – after it appears in the market, some people and institutions use the regulatory loopholes in the legislation to their advantage. The flexibility and high yield of private equity funds can help inject new momentum into the financial market, but many private asset management firms that use private equity and/or venture capital funds, or even various forms of private financing, operate outside the law, involving different micro and systemic risks.

Therefore, China should introduce a collective investment plan to maximize legalization and standardize private equity funds, private collective financing methods and new financial products to fill the legislative gap, fill the gaps in the supervision of innovative financial products and ultimately achieve healthy and stable development of the financial market.

But since the high-risk shadow banking system cannot be eliminated overnight, China should learn from the horizontal financial services regulations of the UK, Japan, the Republic of Korea and other countries to control the shadow banking system.

Moreover, since the unification of the regulatory system is a major reform that cannot be achieved in the short term, China should use the introduction of a collective investment plan as a catalyst to help establish and improve the Chinese legal system of financial products and services.

China has different types of collective financial products and faces the problems of unclear regulatory responsibilities, unclear legal nature of products, vague definitions of legal relationships, which trigger disputes and make it difficult to protect consumer rights.

The introduction of the collective investment scheme, which will cover all financial products, should also help to unify market access rules, transaction rules, information disclosure rules, persuasion rules and rules of financial consumer protection, thus laying a solid foundation for the legal system of financial services. .

Although China has made remarkable progress in shadow banking governance, the hidden risks are still relatively high. It is therefore important to remain attentive to new variants of shadow banking and the resulting increase in risks. There is also a need to introduce new financial products operating beyond the scope of regulated market law, unify the regulatory system, establish rules for credit-type financial products and better regulate innovative financial products.

Yang Dong is Director of Financial Technology and Internet Security Research Center, National Academy of Development and Strategy, Renmin University of China; and Sha Han is an associate researcher at the same institute.

Opinions do not necessarily represent those of China Daily.