Financial Institution Management and Regulation for Banking

Question: Discuss about theFinancial Institution Management and Regulation for Banking. Answer: Introduction: Due to the tight regulations of the Chinese banking system, shadow banking system has grown rapidly in the nation. The current report would focus on the ways the Chinese banks are regulated. In addition, the concept of shadow banking system is discussed along with the reasons behind its rising growth in China. The third section would lay stress on highlighting the risks that shadow banking has on the Chinese economy. Finally, the report would shed light on whether the government of China needs to enforce strict policies in order to regulate or control shadow banking system within the nation. Ways of regulating the Chinese banks: China used to follow the monolithic banking system, since its central bank, the Peoples Bank of China (PBC) is the sole entity authorised to conduct operations in the nation. The banking system was introduced in 1980 and during that time, four specialised banks were established for accepting deposits and carrying out banking operations (Bottelier 2015). In 1994, the government had established three more banks for particular lending purpose and with the passage of time, it had established a dozen joint stock commercial banking institutions and above 100 city commercial banks to operate in the nation. The major regulatory body governing the banking system of China is the China Banking Regulatory Commission (CBRC) and it enforces the rules and regulations for governing banks in the nation. In addition, the body carries out investigations and oversight of banks, accumulates and releases banking system data, approves bank foundation or diversification along with saving liquidity and solvency issues (Elliott, Kroeber and Qiao 2015). In addition, the PBC has significant control over the banking system of the nation. PBC has an important role to play in minimising total risk along with promoting solidity of the financial system. Furthermore, PBC is involved in regulating foreign exchange and lending between banks along with supervising the settlement and payment system of the nation. Shadow banking and reasons behind its rapid growth in China: In the words of Hsu and Li (2015), shadow banking system could be defined as the financial intermediaries carrying out banking functions in the absence of access to liquidity of the central bank or credit guarantees of the public sector. This system denotes the unregulated activities that the regulated institutions perform as well. The primary reasons that shadow banking has grown rapidly in China are the following: Failure of export-led growth: The net export demand of China has fallen drastically to -10% of GDP in 2009 after the global financial crisis. For combating with the recessionary effects, it had initiated a stimulus plan of RMB 4 trillion (Huang 2015). Even though the macroeconomic conditions are maintained effectively, the debt burden of the economy had increased. A huge portion of such lending had passed through the channel of shadow banking. Financial exclusion: Since the commercial banks could not meet the rising need of SMEs credit, shadow entities have grown up in the form of investment firms, rural credit cooperatives, investment firms, pawn shops and loan organisations. However, these entities charge greater interest rates in contrast to the bank rates generating adequate profits and these are transferred again to the shadow banking system. Risks of shadow banking to the Chinese economy: There are four risks of shadow banking to the Chinese economy, which are elucidated as follows: Liquidity risk: When credit intermediation took place, long-term investments are lent to current liabilities. Hence, this could lead to mismatch of liquidity, which could result in systemic risk. This is because such entities are associated with formal banks (Li, Hsu and Qin 2014). Leverage risk: Since there is absence of any regulatory prohibition on shadow banks, the leverage would be greater. This could raise the stress in the real economy and financial system of China due to development of inflationary tendencies in the economy. Hence, the overall financial system might be fragile highly. Regulatory arbitrage: Due to the presence of tight regulations in the Chinese formal banking system in relation to sources of finance and use of public deposits, the shadow banks evade them by transferring the credit intermediation technique to less or no regulated areas of the financial system. Contagion risk: Since there is strong linkage of the formal banking system with sides of assets and liabilities, the risk related to spread contagion is extremely high at times of uncertainty or loss of confidence (Li 2014). Necessity of governmental actions in regulating or controlling shadow banking: It is necessary for the Chinese government to regulate shadow banking for minimising the associations between capital markets and commercial banks. The commercial banks need include off-balance sheet exposures in its statement of financial position at a minimum rate per quarter (Lu et al. 2015). The trust companies are required to calculate risk capital for the trust loans that the banks have issued and loans obtained via notes and mandate financing need to be abolished. The Chinese government could make efforts to include the shadow banks in the formal system through conversion of underground shadow banks into local banks for meeting the requirements of SMEs (Wei 2016). Finally, CBRC could ask the banks to clear their pools of assets for adopting standalone accounting on the plans of financial management. Conclusion: Based on the above evaluation, it could be stated that China follows the monolithic banking system, in which PBC and CRBC comprise of the primary regulatory agencies governing the banking system of the nation. The reasons identified behind the expansion of shadow banking in China constitute of failure of export-led growth and financial exclusion. The major risks of the shadow banking system in China include liquidity risk, leverage risk, regulatory arbitrage and contagion risk. The primary intention would be to avoid the instability of the financial system of the nation and protection during inflationary times. Finally, it is necessary for the government of China to enforce strict control on the shadow banking system for minimising the associations between capital markets and commercial banks. References: Bottelier, P., 2015. Shadow banking in China.World Bank 1818H Association, Economics and Financial-Chapters [-EB/OLT.(2015-09-12) 2015-09-12. http.//siteresourees, worldbank, org/1818SOCIETY/Resources/Shadow_banking. pdf. Elliott, D., Kroeber, A. and Qiao, Y., 2015. Shadow banking in China: A primer.Brookings Institution,13. Hsu, S. and Li, J., 2015. The rise and fall of shadow banking in China.Political Economy Research Institute, Working Paper Series Number,375. Huang, R.H., 2015. The regulation of shadow banking in China: International and comparative perspectives.Banking Finance Law Review,30(3), p.481. Li, J., Hsu, S. and Qin, Y., 2014. Shadow banking in China: Institutional risks.China Economic Review,31, pp.119-129. Li, T., 2014. Shadow banking in China: expanding scale, evolving structure.Journal of Financial Economic Policy,6(3), pp.198-211. Lu, Y., Guo, H., Kao, E.H. and Fung, H.G., 2015. Shadow banking and firm financing in China.International Review of Economics Finance,36, pp.40-53. Wei, S., 2016.Shadow Banking in China: Risk, Regulation and Policy. Edward Elgar Publishing.