A round of banking crises has shaken the United States and Europe. Silicon Valley Bank (SVB) in the U.S. has collapsed after a run, making it the most significant bank failure since the global financial crisis of 2008 and 2009. After that, Silvergate Bank and Signature Bank also failed, while Credit Suisse Group has had to invest 3 billion Swiss francs ($3.3 billion) into the crisis-stricken Credit Suisse. Although the pace of bank failures has slowed and their impact has been limited, it remains unknown whether the SVB incident is just one episode in the fight against inflation or the first sign of more widespread financial crisis. Chinese financial institutions and regulators should seriously consider what lessons can be learned from these bank collapses.
Finance is an industry that manages and controls risks, both domestically and abroad. Monetary and fiscal policies change with macroeconomic conditions, which can squeeze the financial industry. Risks always break through at the weakest point. Just like weak spots in the earth’s crust, where magma can easily erupt, it is no surprise that banks that are poorly managed or lack effective risk control systems are more likely to fall. To resolve this issue, the key is how to prevent and mitigate risks, particularly systemic financial risks.
The danger of easing supervision of small and midsize banks is the biggest lesson of this crisis. After the global financial crisis, the U.S. enacted the Dodd-Frank Act to strengthen financial regulation. However, the Trump administration relaxed the regulations again, raising the threshold for “systemically important banks” from those with $50 billion in assets to $250 billion, leaving banks like SVB in something akin to a blind spot in regulation. The current crisis is the bitter fruit of this change. Federal Reserve Chairman Jerome Powell recently mentioned the need to strengthen regulation and reform supervision.
Of course, financial institutions are not without blame. Risk prevention and control at a bank are the first line of defense against crises. After a long period of low interest rates coupled with lax regulation, SVB ended up with a severe mismatch in assets and liabilities. Over the years, it has provided effective financial services to venture capital and startups, but collapsed due to risk control errors, which is regrettable.
The most notable characteristic of this most recent banking crisis has been its speed. In just 48 hours, Silicon Valley Bank, which had been operating for 40 years, collapsed, with the regulators implementing a disposal plan to stabilize financial market expectations within almost the same amount of time. So far, the response from the Federal Reserve, the U.S. Treasury Department, the Federal Deposit Insurance Corporation (FDIC), and the California government has been commendable. Perhaps learning from the 2008 financial crisis, the FDIC has not overstepped. Some people in China have still criticized the U.S. for not acting fast enough, which is a bit excessive.
When rescuing financial institutions in crisis, moral hazard must be considered. U.S. Treasury Secretary Yellen told Congress that the FDIC did not consider providing “comprehensive insurance” for bank deposits. This statement, which led to a sharp drop in the U.S. stock market, was necessary to strengthen financial regulatory discipline.
This crisis raises the question of how to coordinate macroeconomic policies and financial risk prevention. There is no simple answer to this important problem. When the storm hit, there were widespread calls for the Federal Reserve to slow the pace of its hikes. But the Fed stuck to its guns and raised interest rates by 25 basis points. Powell called the collapse of SVB as an “isolated event” that does not represent systemic flaws in the U.S. banking system. Paul Volcker’s experience of aggressively fighting inflation in the 1980s as the Fed chairman may be one source of the current Fed’s rate hike experience. However, adhering to the central bank’s independence and resolutely pursuing monetary policy objectives should not be done without considering the accompanying risks. In fact, the Federal Reserve is trying to balance both, but whether it succeeds will have to be judged by future generations.
The factors leading to this crisis exist to varying degrees in the financial systems of countries worldwide. Undoubtedly, this event also serves as a warning to the development and regulation of China’s financial sector.
Over the past 45 years of reform and opening-up, China’s financial market has grown rapidly, and the financial regulatory framework has been established, resulting in a relatively stable financial system. In recent years, China has made significant progress in preventing and defusing major financial risks. From 2017 to 2021, more than 12 trillion yuan in non-performing assets were disposed of in the banking sector, and large-scale group risks such as Tomorrow Holdings, Anbang, HNA Group, and Founder Group were addressed, resolving risks in a number of high-risk small and midsize financial institutions. A series of major corruption cases in the financial sector, such as Xiang Junbo, Lai Xiaomin, Hu Huaibang, and Cai Esheng, have been investigated, with the perpetrators punished severely.
However, we cannot take the risks in China’s financial system lightly. In addition to the increased pressure on China’s economy, making financial risks more prone to erupt and more difficult to control, Chinese regulators face some unique challenges. The most prominent are the financial and fiscal risks brought by the large amounts of local debt and the financial risks caused by the recent downturn in the real estate industry. Local debt risks, despite ongoing management efforts, continue to accumulate. Unlike developed economies with relatively sound corporate governance, many bank failures in China are characterized by actual controllers treating banks as ATMs and hollowing them out. Furthermore, the ongoing issue of corruption in the financial sector increases financial risks.
Preventing and defusing financial risks requires a high level of professional competence. Chinese regulatory authorities have gathered a group of professionals with a global perspective, and their practical experience has become increasingly rich after years of focusing on risk management. Recently, China’s financial regulation has undergone significant reforms, including the establishment of the Central Financial Committee, the National Financial Supervision and Administration Bureau, and the deepening of local financial regulatory system reform. We look forward to the further demonstration of professionalism in financial regulation.
In today’s highly interconnected global financial system, the systemic and contagious nature of financial crises is unprecedented, and panic can easily cross borders. During this latest of U.S.-European banking crises, some extreme voices have appeared on the Chinese internet, which is ill-advised. Treating every crisis suffered by others can help minimize our own crises. In October 2022, when reporting to the Standing Committee of the National People’s Congress on behalf of the State Council, People’s Bank of China Governor Yi Gang stated that we should further strengthen the prevention and resolution of financial risks with a constant sense of responsibility. We couldn’t agree more.
