Challenges for the Unified Financial Supervision in the Post­Crisis Era: Singaporean Experience and Chinese Practice Jing Geng Wenjuan Xie * Guibin Zhang Honggeng Zhou Abstract In an era when financial conglomerates become more and more prominent, and amid the increasing concerns in academia over the effectiveness of supervision by multiple regulatory and supervisory agencies, this paper reviews the origin and development of the Chinese financial system supervisory practice, and it analyses the Chinese case to see whether an integrated financial supervision model is suitable for the economic giant. We focus on the integrated financial supervision adopted by the Monetary Authority of Singapore (MAS) in response to the emerging international trends of blurring boundaries between financial industries of banking, insurance and capital markets, as well as the rapid growth of financial conglomeration. Integrated supervision can centralize regulatory functions and maximize economy of scale, thus reducing the operating costs of financial supervisory entities. However, there are also some drawbacks of the practice and foreseeable feasibility issues in the transition towards integrated financial supervision in a country whose financial system is still in the gradual process of opening and integration. Weighing on the pros and cons and accounting for potential issues in its implementation, the paper finally proposes a gradual solution for China to move towards integrated financial supervision. INTRODUCTION The recent trend of fast finance industry integration and the global financial crises have shown that modern financial companies have become increasingly complex, and if not adequately supervised, they can cause significant harm to the financial system. This phenomenon has prompted countries all over the world to review their financial supervision functions, with the desire to ensure that such companies are properly supervised, hence do not pose significant risks to the financial system in the future. Worldwide, countries such as Australia, Canada, Denmark, Japan, Korea, Norway, Singapore, Sweden, and the UK, have formed an informal club of “integrated supervisors” right after the 1997 financial crisis. 1 These countries have reformed their supervisory functions in response to the emerging international trends of blurring of boundaries between financial industries of banking, insurance and capital markets, as well as financial conglomeration, i.e. formation of financial groups with entities operating in different financial industries. Would the 2008 crisis serve as another milestone for countries to review changes in the financial sector, and whether their existing structure of supervision functions are appropriate, and possibly encourage even more economies toward this direction? This would be the fundamental question we intend to address in this research, and we focus on the comparative case of two prominent economies in Asia: Singapore and China. *Corresponding author is Xie. Geng is the Lee Kuan Yew Fellow at Harvard Kennedy School, Xie is an Assistant Professor at University of New Hampshire, Zhang is a Research Fellow at Monash Asia Institute, Zhou is an Associate Professor at University of New Hampshire. Their emails are jing_geng@hks.harvard.edu, Wenjuan.Xie@unh.edu, guibin.zhang@monash.edu, and Honggeng.Zhou@unh.edu respectively. The authors are grateful to Huang Jing, Chen Kang and Charles Lim for their constructive comments and suggestions. We received valuable comments from discussion participants at Harvard Kennedy School, Lee Kuan Yew School of Public Policy, National University of Singapore and the Monetary Authority of Singapore. All errors and omissions remain the responsibilities of the authors.
The management practice chosen by this paper is integrated financial supervision by the Monetary Authority of Singapore (MAS). As early as the 1970s, Singapore started to bring together the country’s financial supervision functions. By late 1984, all the supervisory functions for the financial sector were housed within MAS. MAS’ supervision regime can be characterized as a unified supervisory authority with oversight of banks, investment banks, finance companies, asset managers, securities brokers and insurance companies. The development of modern finance has resulted in blurring boundaries between financial industries, and the products offered by different types of financial institutions such as banking, securities, and insurance have become more similar. In addition, the number of financial conglomerates has also been increasing. To address this development, in some countries financial supervisory agencies have merged into a single (or unified) financial regulator, responsible for prudential monitoring and business supervision over all financial institutions and activities. 2 Within a single regulator, the nature and intensity of supervision may vary based on the systemic importance of a financial institution and the sophistication of its customers. To some extent, integrated financial supervision can maximize economies of scale and scope, thus reducing the operating costs of having several supervisory entities by centralizing the functions of two or more agencies in a single agency. In China, commercial banks have been permitted to play active roles in the fund management and insurance sectors. Although at present financial conglomerates in the country are arguably still relatively simple and primitive in structures, they are by no means insignificant. As the number and complexity of financial conglomerates increases, there are growing concerns over the effectiveness of supervision by the multiple regulatory and supervisory agencies in China, where the country has been learning from the U.S. in the last few decades. After the crisis, it has been reported that segmented supervision bodies have difficulties conducting an overall risk assessment of a financial conglomerate on a consolidated basis due to the inter­ relationships between the different entities within the conglomerate. As a result, an integrated financial sector supervision body – in which the supervision of entities engaging in banking, securities and insurance is combined within a unified institution – might be considered a good model to supervise a financial conglomerate, and reduce the risks in a complex financial system. The rest of the paper is organized as follows: Section 2 presents the detailed concepts, cost­ benefit analysis and methodology in the theory and practice of financial supervision; Section 3 summarizes the experience of Singapore in developing an integrated financial supervisory structure, including its objectives, principles and practice; in Section 4 we review the history of financial institutions and supervision development in China in the past three decades and particularly analyse the feasibility issue in China’s possible move towards a unified financial supervision system by learning from the experience of Singapore; Section 5 concludes with a proposition to organise an integrated Financial Supervision Coordination Committee and gradually implement unified financial supervision with Chinese characteristics. CONCEPTS, ANALYSIS AND METHODOLOGY Before moving directly to the main argument, this section highlights some concepts and analyses behind the on­going strategic debate between the benefits and shortcomings of an integrated financial supervision model such as the one adopted by Singapore’s MAS. We also present our research methodology at the end of this section. Some of these fundamental matters underlined in the debate will provide guidelines for our analyses of the Chinese case to be presented in subsequent sections. 2.1 Financial Supervision From a functional perspective, various financial institutions and relevant financial markets are essential to realise financial functions of the economy. 3 The optimisation of financial resources requires minimal cost to provide financial function, which in no doubt relies on effective financial supervision. Specifically, nowadays the challenge to any financial supervision system is four folds:
The blurring of traditional industry lines in the financial sector: The classification of banking, insurance, and securities industries is based on traditional sector segmentation. However, current practice shows the ambiguity of the boundaries of these sectors. It is sometimes not easy to classify financial products into a specific industry, given that similar products may be offered by different industry players. As the financial sector develops and evolves, traditional industry classifications may become less meaningful, and therefore there is a need to reconsider the traditional divides between industry supervisors. There is a greater case for having an integrated financial supervisor to ensure that financial players and products are properly and consistently regulated, and to avoid gaps in the regulatory and supervisory architecture. Cost influence of scale of the economy and scope of economy: The penetration of financial services industry into the economy has been increasing at an amazing speed. Although there is a tendency of over­financial­intermediation, the difference of comparative cost among the institutions can never disappear. One of such cost differences is embodied in the financial supervision cost. In theory, the economy of scale and economy of scope could be attributed to the existing differences of comparative costs. The integration of financial supervision, to some extent, takes advantage of such economy of scale in covering all the financial sectors under one roof. Therefore, integrating financial supervision would reduce the cost of supervision. Change from institution­based to market­based financial intermediation: There is always competition between the financial institutions and financial market in terms of providing financial functions to the economy. The comparative cost advantages of the above two competitors caused changing mode of division of labor in the financial economics. The financial system has evolved from indirect intermediation towards direct financing in the market. Traditional banking institutions are entering the securities market at an increasing speed, while the transactional financial assets also grow exponentially. The institution­based intermediation is characterized by low cost with an increasing marginal cost, while the market­based financing mechanism is featured with relatively high fixed cost but decreasing marginal cost. In other words, the financial market itself has a greater effect in scale of economy. At the same time, with decreasing asset speciality, especially from the knowledge point of view, the market realizes more scope of economy than financial institutions. Cross business motivation among the financial institutions: As far as functional perspective of finance theory is concerned, certain financial products or business processes normally exist in the form of combination of several financial functions. On the other hand, the same financial function could be executed by different financial institutions. In order to better serve the financial market, institutions have the incentive to conduct cross business activities. For instance, banks are now selling insurance products (“bancassurance”), and insurance companies are selling endowment plans, which would look like savings plans. Another example would be investment­linked plans offered by insurance companies versus unit trusts offered by fund managers. The rules and regulations covering all these cross business activities should be consistent and harmonized to avoid regulatory arbitrage, and thus there could be benefits in using a more integrated approach. 2.2 Financial Innovation vs. Financial Supervision Along with the human recognition of financial innovation, the regulatory responsibilities of the financial supervisory bodies have been challenged ever since. Innovation is a concept proposed in early 20th century by Joseph Schumpeter, who defines “innovation” as “carrying out new combinations of a new commodity; an innovative production or marketing process; the development of new markets or a new outlet for products; a new source of supply of materials; or an innovative organization of management” (Schumpeter (1959) page 66). With introduction of financial innovation in recent economic history, there is a dramatic change in structure and complexity of the modern financial products. At the same time, various financial innovations also posed new challenges on financial supervision. It is important to examine the relationship between financial innovation and financial supervision. With economic development and changes in financial environment, some regulations are no longer suitable for the economic challenges under new situation, and become obstacles to business
expansion. Therefore, many of the financial institutions have incentives to go around regulations and seek more financial freedom for their development, which created lots of innovative financial tools during this process. To some extent, such financial innovation has greatly promoted financial sector growth as well as economic development. Moreover, financial innovation provides impetus for supervision reforms. The emergence of innovative financial products has raised new challenges to traditional financial supervision methods. On one hand, traditional monetary policies require accurate measurement of financial assets flow, yet the new financial derivatives cause inaccuracy of traditional measures, thus monetary tools such as discount rate and bank reserve rates can only play a limited role. On the other hand, financial innovation has significantly increased financial supervisors’ difficulty in assessing the risks inherent in financial institutions’ activities, which translates into a higher total risk level for the financial sector. Nevertheless, it is the emergence of financial innovation that provides the impetus for reforms in financial supervision and pursuit of a more effective mechanism and operation model to catch up with financial market development. The financial innovation that causes the blurring of the lines between banking, insurance and securities business within the financial sector has also expedited the emergence of integrated financial supervision. However, it is worthwhile to examine the pros and cons of integrated supervision in the literature and in reality. 2.3 The Benefits and Shortcomings of a Unified Supervisory Agency There are several arguments made in favor of a unified financial supervision system. First, there is the proponent of economies of scale, which could certainly improve the supervisory capacity to monitor various types of financial institutions. With centralized regulatory functions, a unified financial supervisor could develop and enhance joint administrative, information technology on a massive scale (Taylor and Fleming (1999)). Second, integrated financial supervision could also pool all available skilled manpower, which is especially important in countries where qualified human resources are scarce. Third, a unified supervisory system favours the monitoring of financial conglomerates specifically. Modern financial development has witnessed an increasing number of financial conglomerates, which provide financial services across different segments of the financial industry (banking, securities and insurance for instance). Such trend poses great challenges for supervisory authorities worldwide. With integrated financial supervision having all duties under “one roof”, the supervisory bodies can better understand the risk in the financial market, not just from a single industry point of view, but also the risks in multi­sector financial institutions. Martinez and Rose (2003) pointed out that if there is regulatory failure at any of the independent supervisory bodies under a multiple supervision system, accountability might be easily diffused, and that there might be a lack of harmonization in the regulations and in their implementation across various institutions. Nevertheless, an integrated supervisory agency overseeing the financial system as a whole would minimize the opportunities for regulatory arbitrage. In addition, integrated supervision can minimize regulatory burden of the financial conglomerates, as financial conglomerates would then only need to answer to a single regulatory agency. Supervision requirements such as capital rules would apply to the whole financial group, and the integrated supervisor is more capable of identifying cross­industry issues and vulnerabilities within the financial system in a timely fashion. On the other side, there are also several arguments against a unified supervisory agency model. First, the success of an integrated financial supervision system is highly dependent on the structure and depth of expertise of pre­existing multiple supervisory agencies. Abrams and Taylor (2000) argue that a newly established integrated supervisory institution has to reflect the structure of the financial sectors that it supervises. Therefore, the merging of existing financial supervision institutions into one will necessarily improve the regulation of the financial sector only under the condition that prior independent supervisory agencies have been well established for each segment of the financial system, as argued in Siregar and James (2004).
Second, a unified financial supervisor may be less effective and efficient than sectoral supervisors. Martinez and Rose (2003) identified many practical issues, such as legal problems, personnel constraints, difficulty in integration of the IT system, and budgetary issues that could cause inefficiency. 2.4 A Gradual Approach to Establishing a Unified Supervisory Agency? Even if countries like China are interested in building a unified financial supervisory agency, how quickly should this be done? There are two contrasting approaches: one is the “gradualist” approach of the Scandinavian countries (Denmark, Norway and Sweden), and the other is a “Big­Bang” approach adopted by countries like the United Kingdom and South Korea. Currently, China’s financial supervision system consists of three main bodies: China Banking Regulatory Commission (CBRC), China Securities Regulatory Commission (CSRC) and China Insurance Regulatory Commission (CIRC). As the political power is divided among these supervisory bodies within the system, it would be a difficult task to integrate these three into one unified supervisory body. However, given the emergence of a significant number of financial conglomerates in China, there is interest in unifying the separate supervisory agencies into a single one. We propose that a gradualist approach strategy where a two stage approach should be adopted if it is the case. In the first stage, the block of the research will focus on the empirical analysis of related research questions and its implications. The immediate task is to improve the coordination among the current supervisory agencies in the financial sector. In the second stage, it is necessary to conduct the integration process of the supervisors into one in a stepwise and well­managed pace. 2.5 Analytics and Methodology In order to test the hypothesis, this paper mainly employs a qualitative approach for possible solutions from a policy point of view. The qualitative perspective of this research mainly involves the authors’ internship with Monetary Authority of Singapore and interviews with relevant government officials. Such in­depth interviews were also carried out during the authors’ field trip in China with Chinese government officials from various financial supervisory bodies. Documentary sources from government authorities are added to academic references during the course of research. Due to the nature of this study, comparative analysis is another major approach for demonstrating the hypothetic points put forward in the previous sections. Two types of comparisons are made here: one is horizontal comparison between the Singaporean experience and Chinese practice; the other is vertical comparison of historical supervisory mechanisms within each country given sufficient data. 3. SINGAPORE’S EXPERIENCE Do integrated supervisory frameworks perform better than non­integrated ones? And which forms of integrated supervision work best? One hypothesis could be that the presence of more integrated financial authorities is associated with higher quality and consistency of supervision across supervised institutions. The Singaporean experience could provide some empirical evidence for this. 3.1 Review of Financial Supervision in Singapore: Objectives and Principles Singapore is probably one of the earliest countries in the world to develop a unified financial supervisory body, which could be traced back to 1970s. After the 1997 financial crisis, Singapore’s MAS began to practice its integrated financial supervision with a more risk focused approach (Lan and Zhang, 2008). Singapore’s organisational structure combines the central bank and the integrated financial supervisor. MAS’ central functions are to “conduct exchange rate policy, manage the official foreign reserves, regulate and supervise the financial sector, and work with the industry to develop Singapore as an international financial centre.” As pointed out by MAS mission statement, MAS aims “to promote sustained and non­inflationary economic growth, and a sound and progressive financial services sector” (MAS 2004). 4 Aside from the central bank’s function, the other major responsibility that MAS has is to conduct integrated supervision of financial services and financial stability surveillance.
According to MAS’s monograph in 2004, the long term objectives of financial supervision in Singapore are the following, and we believe they address the common concerns of most countries’ financial supervisory authority too: A stable financial system: stability of modern complex financial system needs adequate and appropriate supervision over all types of financial institutions, that gives the public confidence in banking, insurance and capital markets activities. Safe and sound financial intermediaries: financial supervision aims to ensure the safety and soundness of financial intermediaries such as banks, insurance companies, and broker­dealers and fund management firms. Safe and efficient financial infrastructure: financial supervision includes the monitoring of the safety and efficiency of platforms such as exchanges, clearing houses, and payment and settlement systems. Fair, efficient and transparent organized markets: financial supervision aims to improve the transparency, efficiency and fairness of the financial market. Well­informed and empowered consumers: financial supervision seeks to ensure that there is sufficient and true information disclosure so that consumers can be well­informed and empowered to assume principal responsibility for protecting their own interests when making financial decisions. MAS has also outlined twelve principles in financial supervision, which were recognized widely by the industry, and considered the basic guidelines for good financial supervision. These principles can be grouped into four categories: 5 Risk­focused: MAS adopts a risk­focused approach in supervising the country’s financial institutions. This approach seeks to ensure that individual institution’s internal risk management systems are adequate for its risk profile, rather than having one­size­fits­all rules for all institutions. MAS’ supervision efforts are to assess whether an institution’s risk tolerance and management level is adequate for the complexity of its financial business. With limited supervisory resources, one major task is to ensure that these limited supervisory resources within MAS are allocated according to the potential risks of the institutions licensed. In order to effectively manage risks in the financial industries as a whole, MAS monitors institutions across their banking, insurance and securities activities. Whole­of­group or consolidated supervision is practised in Singapore. Stakeholder­reliant: As a financial supervisor with limited resources, MAS cannot alone ensure that financial institutions are prudently managed and financially sound. The primary responsibility of ensuring that any financial institution is properly run is with its board of directors. Nonetheless, MAS believes that other stakeholders should also be involved in helping to supervise the institution, such as shareholders, creditors, and external auditors, who have an interest in the financial soundness of these institutions. MAS would work closely with these parties, wherever possible and appropriate. Disclosure­based: The traditional merit­based regulation requires the supervisory body to approve the introduction of a new product based on the assessment of its suitability. MAS moved towards a more disclosure based regime, which allows the consumer to make judgments and decisions based on accurate and adequate information disclosure by the financial institutions. This would allow more scope for financial innovation, as well as allowing more choice for consumers. Under this disclosure­based regime, MAS would require more transparency and information disclosure from financial institutions, and consumers would have the responsibility in assessing and assuming financial risk based on their own risk appetites. Business friendly: One of the advantages of integrated financial supervision is to ensure more consistency and clarity in regulatory rules, and not to impair the competitiveness and dynamism of individual institutions. MAS seeks to be a professional supervisor, by ensuring that regulations are adequate and transparent, and financial institutions are properly managed and prudentially sound, while taking into account the institutions’ concerns as much as possible, and respond to their requests as quickly as possible. When MAS implements any new regulations, it does so in a consultative process, so that financial institutions would understand the reasons for the new rules, and take into account any feedback the institutions may have to avoid major disruptions to their businesses.
3.2 Integrated Financial Supervisory Structure The regulatory function of MAS is characterized by all of the financial sectors supervised under one umbrella to better achieve the objectives of financial supervision. One of the prominent features of MAS’ supervisory function is the risk­based supervision of financial institutions, which can be shown in Figure 1. As pointed out in Pei (2009), there are several drivers for this supervision arrangement: consistency and efficiency in regulating financial conglomerates to prevent regulatory arbitrage; monitoring inter­linkages in financial conglomerates; better management of concentration risks; convergence of supervisory practices; convergence of financial reporting standards. For prudential supervision, MAS has five departments: Banking Supervision Department (BD) and Complex Institutions Supervision Department (CI), Insurance Supervision Department (ID), Prudential Policy Department (PPD) and Specialist Risk Supervision Department (SRD). According to the MAS website, BD and CI are responsible for the licensing and supervision of banks, merchant banks and finance companies. ID is responsible for licensing and supervision of life and general insurance companies, administration of the Insurance Act and has as its primary objective the protection of policyholders' interests. PPD is responsible for formulating capital and prudential policies for banks, insurance companies and securities firms to promote a sound yet dynamic financial sector. Finally, SRD provides specialist risk expertise support to front­line supervisors in the different industry sectors, i.e. banking, insurance and capital markets, and assessment of individual institutions and system­wide risks. The organization structure of MAS and the positioning of financial supervision group are shown in Figure 2. It clearly shows that MAS aims to have both functional focus and sectoral expertise in supervision. Specifically, the groups are organized by objectives of supervision and the departments are organized by industry sectors. MAS has separate functional focus by prudential supervision and market conduct groups, but is coordinated through a higher level committee. In order to retain industry expertise, MAS maintains separate departments for different types of institutions. It is worth mentioning that MAS has a specialist unit maintaining its risk assessment framework applicable to all financial institutions regulated by MAS, known as “Common Risk Assessment Framework and Techniques” (CRAFT). 3.3 Risk Based Supervision One of the key features of MAS’ integrated financial supervision is risk­based supervision (RBS) of financial institutions. MAS’ supervisory objectives and principles outline the principles for MAS’ RBS practice, and also shape its supervisory framework. In Singapore, supervisors take a proportionate approach to assess an institution’s risks. Rather than having a fixed view of what constitutes an acceptable level of business risks or risk management standards, MAS assesses whether risk management systems and internal controls are commensurate with the institution’s risk and business profiles. Institutions that engage in complex financial businesses must be able to demonstrate that their risk management capabilities match their risk appetite and operations, while those engaging in less complex or risky financial activities may find simpler risk management processes adequate for their purpose. MAS also uses a common risk assessment framework “Common Risk Assessment Framework and Techniques (CRAFT)” to assess all risks and adequacy of risk management controls for all institutions, 6 shown in Figure 3. MAS assesses the risks of financial institutions based on their business activities. The assessment process begins with business models, followed with the assessments of inherent risks and control factors. A four rating scale is used to rate all components. Such assessment is quite flexible and is used for various types of institutions. The assessment results are summarized in Table 1. The Inherent Risk is rated on a 4 point rating scale (Low, Medium Low, Medium High, and High) and is considered with reference to existing controls. Each institution is assigned by MAS supervisors into a “supervisory bucket” based on the risk rating and control factor. These buckets are usually shown on a two­dimensional matrix with a vertical and a horizontal axis. The vertical axis measures the risk rating of the institution, and the horizontal axis measures the control factor assigned to the institution.
After the overall risk rating is completed, appropriate supervisory strategies are developed for each supervisory bucket. MAS then has to make a very important decision on how much resources should be allocated to a financial institution with given risk rating and impact profile, as analysed in Palmer (2007). This supervisory approach will make the most effective use of limited resources within MAS to serve the purpose of integrated financial supervision. 4. CHINA’S CURRENT PRACTICE IN FINANCIAL SUPERVISION The financial supervisory body in China has emerged along with the banking industry in the country. Even in the Qing Dynasty (17 th century to early 20 th century), there was a quasi­central bank institution called Hu Bu Bank. In order to compare different policy implications of the "unified regulator" to Singapore and China, it is worth introducing the development of financial supervision mechanism, which would provide some background settings for reforms thereafter. 4.1 A Brief Review on Financial Supervision and Financial Institutions Development in China We first review the history of the evolvement of financial supervision practice in China after the “Economic Reform and Opening up” policy was enacted at the end of 1978. Since the mid­1980s the policy marched in full bloom and financial institutions emerged and grew in exponential numbers, and the development of China’s financial supervision system has the following phases: 1985­1992: The People’s Bank of China (PBC) resumed its supervision function in 1985, separating its business operations to form the county’s four largest commercial banks, namely Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BOC), and Agricultural Bank of China (ABC). At this stage, the PBC’s supervision mainly relied on administrative procedures. Although PBC acted as a supervisory body, its financial supervision function was inadequate. 1993­1994: The PBC began to rectify its supervision function with an emphasis on compliance. In this period, the financial supervision capacity of the central bank was greatly enhanced, and the PBC’s function was changed to supervising activities from the perspective of pure administration of monetary base and scale control. 1995­1997: China started to draft legislation for the purpose of financial supervision so as to enhance supervisory effectiveness and protect the financial market order. In 1994, the Chinese government stipulated new regulations such as Administrative Measures on Foreign Financial Institutions, and Administrative Measures on Financial Institutions. In 1995, the People’s Congress enacted several new laws: People’s Bank of China Law, Commercial Banks Law, Commercial Papers Law, Insurance Law, etc. In this period, China established its legal foundations for financial supervision. 1997­present: With the establishment of China Securities Regulatory Commission (CSRC) and China Insurance Regulatory Commission (CIRC), China has adopted a fragmented financial supervision for different industries. The banking sector and trust companies remained under the supervision of the PBC until 2003 when China Banking Regulatory Commission (CBRC) was formed through spinning off the function of supervising banks from PBC. In this same three­decade period, the landscape of financial institutions in China has also experienced several stages and exhibited multi­dimensional innovation and development of various types of institutions: Emergence of commercial banking institutions in the early 1980s: Ever since China’s reform and opening up in the early 1980s, the country has seen unprecedented financial reforms in its economic history. The emergence of a significant commercial banking sector is one of the consequences of such reforms. The county’s four largest commercial banks, namely Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BOC), and Agricultural Bank of China (ABC) were formed during this period. At this stage, the commercial banks were focused on absorbing deposits
from public and extending loans to the corporate sector. The financial services and products provided by these banks were rather limited. Revival of insurance companies in the middle 1980s: Before the founding of People’s Republic of China, there were some general insurance companies in China, but their businesses had almost been suspended from 1949 to 1978. In the middle 1980s, with the introduction of market oriented economic reforms, the insurance companies resumed their businesses. The People’s Insurance Company of China (PICC) first started to explore property insurance market in China. Later on, PICC set up another company called China Life to conduct life insurance businesses in the country. However, the insurance products were quite simple at that time. Emergence of securities companies in the early 1990s: China officially opened its Shanghai and Shenzhen Stock Exchange in the early 1990s. As a result, investment banking and securities broker businesses have expanded rapidly during this period. The early securities businesses included the basic investment banking functions, which provided IPO advising and relevant services for stock issuers, securities broking and investment consultancy. As the selling side of the capital markets, securities companies provided very few and less complex products to investors in China. Emergence of trust and investment companies: In the late 1980s, trust and investment companies flourished in China. As there were no clear official guidelines for business scope of such companies, they were involved in many types of financial services, including wholesale banking, IPOs, stock broking, project financing, etc. To some extent, the trust and investment companies in China are almost like banks, being able to offer services like a universal bank except without a bank license. This caused lots of problems in terms of financial supervision. Institutional innovations in China’s current financial sector: The financial institutions in China have continued to develop in the recent decades. Cross equity investments among the financial institutions, sharing of expertise between different companies to design financial products and cross­selling to customers was common. For instance, the commercial banks were selling investment trusts, while some securities companies were providing accounts administration services. At the same time, some specialized financial institutions, such as China Union Pay, emerged to offer settlement services for banks and their clients. There was also increasing outsourcing of financial business processes to other companies. Prototype of financial holding companies in China: The emergence of financial holding companies was probably one of the most significant changes in the recent years for financial groups in China. We analyse this type of financial institution in more details. In recent years, there appeared many prototype institutions in China, which were considered the first Chinese financial holding companies: (1) China Ever­bright Group: there are several institutions within the group company, namely China Ever­bright bank, China Ever­bright Securities Co. Ltd., China Ever­bright Investment and Trust Corporation, China Ever­bright International Co. Ltd, and another life insurance company. Within the group company, all the institutions shares a common information database and the co­operation among the group companies are through the agency contract. This sort of cooperation is possible even if there were no group parent company at all. Such institutional arrangement does not violate current laws in China in terms of restrictions on universal banking, thus has not brought out the full advantage of the financial holding company. (2) China CITIC Group: China International Trust & Investment Corporation (CITIC) was founded by Mr. Rong Yiren in 1979 in response to the country’s economic reform, and is now one of the largest multi­national companies in China. CITIC has its focus on financial services industry, with total assets of over 2 trillion Chinese Yuan (300 billion US Dollars) as of the end of 2009. The group company controls China CITIC Bank, CITIC Ka Wah Bank, CITIC securities, CITIC Prudential Life Insurance, CITIC Investment and Trust Co. Ltd. (3) Bank of China Group: as early as 1979, Bank of China established China Construction Financing (HK) Co. Ltd, to conduct capital markets businesses in the international financial market. In 1997, the bank established Bank of China International in London, which was relocated to Hong Kong in 1998. In 1999, the bank collaborated with British Prudential Group to found an asset management company and investment and trust company.
(4) China Construction Bank Group: the bank set up a joint venture with Morgan Stanley in 1996 called China International Finance Corporation as one of the country’s top investment banks, which had successfully launched largest IPOs in China such China Telecom. (5) Industrial and Commercial Bank of China (ICBC) Group: the banks acquired National Westminster Bank’s subsidiary to conduct investment banking business in Hong Kong. In order to enter into the retail banking business in Hong Kong, the bank acquired Affinity Bank. Now ICBC International has expanded to various banking businesses in East Asia. (6) Ping’ An Group: Ping’ An Company was one of the first private insurance companies in China. The company expanded rapidly into securities business, investment trust and banking businesses in recent years. The company also acquired Shenzhen Development Bank in order to strengthen its capabilities in commercial banking. All the above prototypes of financial holding companies in China signified that the country’s financial groups have already evolved to universal banking business models, which features separate business lines belonging to subsidiaries of a group parent company. However, this integration of different financial functions within a financial group poses great challenge on financial supervision in China. 4.2 Constraints of Current Financial Supervision Arrangement in China As introduced above, the financial supervision functions are performed by three main ministry level supervisory bodies in China: CBRC, CIRC and CSRC. In the past, the financial system in China was established in line with the administrative structure, as was the PBC system. Therefore, there was segregation in the supervision of financial institutions, which meant that supervisory bodies focused on the supervision of the commercial financial institutions at the same administrative level, without adequate regard for the overall situation of financial activities. On the other hand, given the complex politics within the governmental ministries, it is very difficult for three supervisory bodies to co­ordinate at the ministry level. Some of the constraints are: a) Within the current segmented financial supervision system, the new businesses or financial products are approved by separate supervisory bodies. As a result, when there are innovations creating a cross sector financial product, the approval process would take quite a long time. For example, a stock mortgage loan product has to be approved by CSRC as well as CBRC, while the two regulators could have different views on the potential risks of the new product. This results in significant costs for financial institutions trying to launch a new financial product. Another example of a new financial product is cross sector innovation such as deposit insurance, which consists of both deposit function and insurance function. For these cross business financial products, there is possibility of duplication in supervision as different supervisory bodies may consider the same factors, thus causing the product to take a long time before being approved to be launched publicly. Amid the emergence of cross business financial products, the complicated nature of financial holding companies especially posed great challenge to the current supervision mechanism. b) For quite a long time, financial supervision in China has focused on ordinary administrative checks and regulation, some specific on­site examinations and administrative penalties. The supervision of the institutions often includes approval of business scope and processes. Even after the rectification in the early 1990s, the supervisory bodies still emphasized on institution supervision, including market entry, governance issues and business scopes, and there was insufficient focus on the financial system stability to prevent the happening of crisis. When there is system risk occurring among the various financial industries, the fragmented supervision exposes limitation of such structures in managing risks in the financial sector. c) Traditional supervision deals with capital adequacy for a single business line, which may not accurately reflect the real risk level of the multi­sector financial institutions. There is a trend in China where more and more multi­sector institutions are emerging, with a very complicated cross­ shareholding structure. The inter connections among the entities increase their ability to manage different kinds of related risks, but at the same time make them more prone to contagion in event of a crisis.
d) The current supervision arrangement in China lacks effective cooperation among the financial supervision bodies, thus there is significant difficulty in trying to control risks in the financial system. With the supervisory bodies being CBRC, CSRC and CIRC respectively, communication problems exist between them. The lack of information sharing has thus limited the effectiveness of financial supervision. With WTO entry, many financial controls in China have been removed, and the boundaries of different financial business sectors become more and more blurred. e) The fragmented financial supervision not only causes inefficiencies in the supervision process but also increases the costs of doing business. The lack of clarity in responsibilities of the different supervisory bodies has led to repeated collection of the same supervisory data. The information flows are also hindered by the existence of separate IT systems. Moreover, the separate inputs from different supervisory bodies could not be coordinated in an efficient way to deal with complex financial products in the market. 4.3 Can China Learn From Singapore? As discussed above, the financial sectors in China have developed to a stage where there are more and more complex and innovative financial products. However, the fragmented supervision bodies are inadequately equipped to meet the needs and challenges of financial development. Singapore’s integrated financial supervision appears to be a good model for China to learn from. Despite sharing some common views from traditional Chinese culture, China and Singapore are quite different in terms of country size, ideology and political backgrounds. Therefore, it is imperative to examine the feasibility of China’s learning from the experience of Singapore and the practical means if this is possible. We compare these two countries in the following dimensions to assess this issue. a) Legal framework Singapore’s MAS performs its supervisory function together with administration of the following statute: Banking Act, Securities and Futures Act, Financial Advisers Act, Insurance Act, Finance Companies Act, Moneychangers & Remittance Businesses Act. Similarly, the present financial supervisory system in China is rooted in the country’s legal framework. CBRC is backed by PRC’s Commercial Banking Law, CIRC is backed by PRC’s Insurance Law, and CSRC is backed by PRC’s Securities Law. From the legal perspective, China already has basic foundations to exercise integrated financial supervisor, probably with some amendments in relevant laws. b) Size of the economy and finance sector By the end of 2008, China’s GDP was 5 trillion USD, while the total financial assets have reached 10 trillion USD. 7 As for Singapore, GDP is 193 billion USD as of end of 2008. 8 The contrast of the size of the two economies suggests that there might be difficulties for the Chinese government in integrating its financial supervision given the difference in size of the financial assets involved. In addition, the financial institutions in Singapore are quite developed comparing with those in China. However, the basic financial sectors components are more or less the same, consisting of banking, insurance and securities businesses. From a macro point of view, it is possible for China to learn from Singapore to implement integrated financial supervision. c) Political interference Both Singapore and China have very strong governments. Compared to Singapore, China has a more complex bureaucratic system, which may pose difficulties in the coordination of government resources. Even if China adopts the practice of integrated financial supervision, it is suggested in this paper that a separate ministry level unit should be established under the direct leadership of the State Council, which has the ultimate power to perform the coordination function. 4.4 Moving Towards Coordinated Integration of Financial Supervision and Risk Based Financial Supervision
As far as the financial reforms are concerned, the Chinese financial institutions seem to favor universal banking. Current cross sector businesses provide some hints that there is a gradual innovation process, which implies that the financial environment is changing for the financial supervisors. The traditional sectoral structure and processes for financial supervision are being challenged as China’s financial marketplace evolves. With China’s entry into WTO, there is increasing cooperation and integration of financial entities into larger conglomerate groups, and also increasing complexity and depth of the financial market. Therefore, the opening up of the financial market in China means that international supervision practices need to be reviewed and adapted for introduction into the country. The present situation has hindered the multinational financial institutions to enter the China market. Although there are some legal obstacles for universal banking in China, cross sector businesses have already emerged in the form of financial holding companies, such as China CITIC group, China Ever­ bright Group, Bank of China Group, etc. Objectively, there is demand to consider the case for integrated financial supervision to be introduced. If integrated financial supervision is adopted, this needs to be a gradual process as well as a dynamic process with an ultimate goal of functional unified financial supervision mechanism. The changes in financial structure in the last 20­30 years have called the Chinese authorities to reform its financial supervision system. First, there should be reforms in financial supervision policies to adapt to universal banking activities. Second, there should be reforms in financial supervision structure to promote the advanced development for the financial structure in China. As mentioned before, the government should provide legal support for such reforms instead of setting legal obstacles. Most of the innovations have to work around financial supervision rules which often limit the innovativeness of the financial institutions. How to minimise the institutional obstacles is one of the most important tasks to move towards coordinated integration of financial supervision. In terms of absolute scale, the total financial assets in China have increased dramatically in the last thirty years. The financial institutions are also constantly evolving with risk factors expanded exponentially. Singapore has set a very good example for establishing a Risk­Based Supervision approach, i.e., building its supervisory framework with risks for all the financial institutions taken into consideration. If China wants to improve its financial supervision efficiency, Risk­Based Supervision has to be adopted. Ideally, the RBS supervisory cycle might include the following phases: a) The supervisory authority should gather all available information about the financial institutions and their relationship to the risk levels of the financial system. b) The supervisory authority then makes the preliminary risk assessment of the financial institutions (this can be one­dimensional, but it is better to learn the Singapore CRAFT two­dimensional rating methodology). c) The supervisory authority develops a multi­year supervisory plan for the institution (usually covering up to five years). The plan will identify the risk areas for supervisory attention through off­site monitoring, on­site visits and inspections. Perceived high­risk areas will receive more frequent and intense attention than lower­risk areas. d) The supervisory authority initiates remedial action, which requires the financial institutions to scale back risky activities or to increase capital level. And such risk assessment would be updated annually. CONCLUSION AND IMPLICATIONS FOR A GRADUAL TRANSITION TO UNIFIED FINANCIAL SUPERVISION IN CHINA The changing financial landscape in China needs further reforms in financial supervision. With more and more cross sector businesses occurring, integrated financial supervision seems to be a possible solution for such innovations. Singapore’s success in implementing integrated supervision in the last forty years or so has set up a very good example. However, given the financial development level and current institutional arrangement for financial supervision, a “shock therapy” to change directly into integrated supervision would cause enormous friction to the financial system, and might not produce good results.
Therefore, in this paper we propose a gradual approach to establish the mechanism for integrated financial supervision. 5.1 Integrated Financial Supervision with Chinese Characteristics Unlike Singapore which has MAS as a supervisory body to carry out the function of integrated financial supervision, it is better to keep the separate supervisory bodies as they are in China. It is suggested in this paper that a Financial Supervision Coordination Committee (FSCC), be established under the direct leadership of the State Council (which directly reports to the Prime Minister), to coordinate the supervisory activates among CBRC, CSRC and CIRC. We thus plot a hypothetic organisational structure in Figure 4. The new integrated Financial Supervision Coordination Committee may organize its departments according to the type of financial supervisory bodies it co­ordinates. Essentially, this new institution merges the multiple supervisory functions and standardizes the rules and regulations on the supervisory activities. Initially, the purpose of this ministry level committee is to improve the strength of the pre­ existing supervisory agencies. Once the performance of different supervisory agencies has been improved, the next stage is the integration process of the agencies. It is pertinent for the unified supervisory body to have an in­depth understanding of the different objectives and practices associated with supervising different groups of financial institutions. Eventually, this new integrated Financial Supervision Coordination Committee will transform into the country’s unified financial supervisor. Going along with this agenda, a new law on the unified supervisory board should be prepared and eventually be passed by the People’s Congress to support the newly established Financial Supervision Coordination Committee under the direct leadership of State Council. 5.2 Implementation Stages Based on the gradual approach depicted above, we propose the institutional arrangement for establishing such a system in China. First, we believe that according to the reality in China, the financial institutions under the future integrated financial supervision should be classified into two big categories: the industry financial holding companies such as CITIC group and China Ever­bright Group, and the largest commercial banking groups such as Bank of China Group, China Construction Bank Group, and ICBC Group. For the industry financial holding companies, it is suggested that more freedom should be allowed for integration under current scope of supervision arrangement. For the largest commercial banking groups, universal banking is encouraged in addition to their cross­business practices, thus increasing their business scope and depth. Finally, these commercial banking groups would be reformed into real financial holding companies. In terms of time frame arrangement, we believe three phases will be involved. An estimate of such time line is: within the first phase (around two years) the government should maintain stability of the current supervision arrangement, while using the current legal and policy framework to allow financial institutions to cross industry lines in their business operations; for the next phase (four years) the government should start to reform current supervision system to allow financial business integration, and promote financial holding companies; finally in the third phase (final and long stage) the government should decide whether to adopt the integrated financial supervision based on the performance of the previous two stages. 5.3 Future Agenda The primary objective of this study is to highlight a number of primary challenges to the establishment of a unified supervisory agency in China in light of the Singapore model. The list of issues discussed in the paper is not meant to be exhaustive, and obviously more studies are needed in the future. The world financial markets are experiencing a special revolution. The emerging of new products, new risk management techniques and cross­border financing has changed the traditional financial structures. The emergence and fast growth of financial conglomerates, cross industry financial products
and their impacts on traditional supervision model have not only attracted academic researchers’ attention but also financial regulators into considering how they can supervise financial institutions, products and markets better. How to view the phenomenon of universal banking and financial holding business， how to evaluate its influence and make reasonable response, and how to address their regulation and crisis management are questions that need to be examined using multi­dimensional and comprehensive analysis based on modem economic theories. This paper provides a foundation to systematically examine the global trend of integration financial supervision and relevant business processes. The conclusion of this paper is that China’s separate control and financial supervision arrangement is only efficient for its current financial sector, and China needs to actively prepare for financial supervisory reform in the near future. From a realistic point of view, we should highly emphasize the preparation to deal with the far­reaching influence of financial innovations and the resulting transformation in the financial architecture, financial firms, financial supervision authorities and legal system. The future direction of financial regulation reform is integrated mega­function supervision, but a gradual approach is the best and most reasonable choice.
Figure 1 ­ Supervisory Framework of MAS Source: Objectives and Principles of Financial Supervision in Singapore, 2004, Monograph, Monetary Authority of Singapore, page 2.
Figure 2 ­ Organizational structure of MAS Source: Pei, Sai Fan, 2009, Integrated Financial Supervision & MAS’ Experience, Seminar Notes, MAS Academy.
Figure 3 ­ CRAFT Overall Framework Overall Risk Rating Institution Net Risk Capital Board of Directors, Senior Management Earning Parental Support Inherent Risks Control factors Business 1 Business 2 ….. Business n
Credit Risk Liquidity Risk Market Risk Operation Risk Technology Risk Legal Risk Insurance Risk Regulatory Risk Risk Management Operational Management Internal Audit Compliance Source: MAS’s Framework for Impact and Risk Assessment of Financial Institutions, Monograph, Monetary Authority of Singapore, page10. Figure 4 ­ Hypothetic Organizational Structure of a Unified Financial Supervision System in China STATE COUNCIL FSCC Other financial Businesses CBRC CSRC CIRC Banking Businesses Securities Businesses Insurance Businesses
Table 1 ­ Risk Assessment Matrix Business Net Risk Inherent Risk Low Strong Low Semi Strong Factors Semi Weak Weak Low Control Low / Medium Low Medium Low Medium Low Low Medium high High Medium Low Medium High Low / Medium Medium Low / Medium High / Low Medium High High Medium Low / Medium High / High Medium High High Medium High High High Source: Pei, Sai Fan, 2009, Integrated Financial Supervision & MAS’ Experience, Seminar Notes, MAS Academy.
FOOTNOTES 1. Taylor, M. and Fleming, A. 1999, Integrated Financial Supervision: Lessons of Scandinavian Experience, Finance and Development, Vol. 36, No. 4, IMF. 2. Herring, Richard J. and Jacopo Carmassi 2008, The Structure of Cross­Sector Financial Supervision. Financial Markets, Institutions & Instruments, Volume 17 (1). 3. Crane, Dwight B., Robert C. Merton，Kenneth A. Froot，and Zvi Bodie 1995, The global Financial System: A Functional Perspective, Harvard Business Press. 4. Objectives and Principles of Financial Supervision in Singapore 2004, Monograph, MAS. 5. Objectives and Principles of Financial Supervision in Singapore 2004, Monograph, Monetary Authority of Singapore. 6. MAS’s Framework for Impact and Risk Assessment of Financial Institutions 2007, Monograph, Monetary Authority of Singapore. 7. 2009 China Statistical Year Book and China Banking Regulatory Commission estimates. 8. Statistics Singapore website: http://www.singstat.gov.sg/stats/themes/economy/hist/gdp2.html
APPENDIX: LIST OF ABBREVIATIONS ABC Agricultural Bank of China BD Banking Supervision Department BOC Bank of China CBRC China Banking Regulatory Commission CCB China Construction Bank CI Complex Institutions Supervision Department CIRC China Insurance Regulatory Commission CRAFT Common Risk Assessment Framework and Techniques CSRC China Securities Regulatory Commission FSCC Financial Supervision Coordination Committee ICBC Industrial and Commercial Bank of China ID Insurance Supervision Department MAS Monetary Authority of Singapore PBC People’s Bank of China PICC People’s Insurance Company of China PPD Prudential Policy Department RBS Risk­Based Supervision SRD Specialist Risk Supervision Department
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