Friday, October 10, 2008

To enhance supervision and financial innovation

When the sub-prime mortgage crisis has been escalating, the governments of the United States and other related countries and personages from all social sectors globally are mulling over its causes and impact worldwide. These days, U.S. statesmen and economists reflect upon the divorce of banking business innovation from financial supervision, and review the practice of former Federal Reserve Chainman, Alan Greenspan, in which he strove sedulously to extend the boom-and-bust cycle when America's red-hot economy was already cooling.

In another development, French President Nicolas Sarkozy demands the overhaul of the world economic system. "We need to rebuild the whole world financial and monetary system from scratch," he said in a keynote speech in last September. He also called for working out drafting essential international norms for guiding economic and trade globalization. Meanwhile, some developing countries hope to draw lessons from the financial market upheavals in the U.S., which, up to date, has the most mature and developed banking system, and are thinking of what-type open strategy they should adopt to stabilize their financial market.

Despite a divergence of particular emphases, they focus on one question in common, that is, the relationship between government financial supervision and financial innovation. The business of banking has all along been regarded as the lifeblood of the performance of a modern economy and the core for the allocation of resources. The past experience shows that the market-oriented mechanism can give more play to the efficiency of the banking business and contribute more to the economic growth accordingly.

American economy is a typical case in point. In spite of some troubles or disorders it has encountered on its financial market, big or small, at an interval of a dozen years, the U.S. is certainly the most booming, thriving economy among the developed nations, and its renewed vigor comes from the optimized allocation of resources, and the outstanding contributions its banking sector has made are of course beyond any doubt.

Fully market-oriented banking industry brings in greater competition and innovation, which are not all necessarily beneficial or conducive to economic entities. Some innovations, such as the high-lever financial derivatives, chief culprit of the present financial turmoils, contain or herald immense risks, as operators of the relevant agencies expose investors' money to market risk. If a gambling is won, they would make windfall profits and, if it is lost, both investors and the government would incur huge, unmeasurable losses. Such "innovation" will definitely not help economic entities, but contrarily dampen investors' confidence, give rise to panic, and proceed to thwart economic entities due to the loss of financial games.

There poses a tough, thorny problem placed before investors: An excessive supervision can smother market competition and innovation, which are indispensable in keeping up the vitality of economic entities, whereas the lack of such supervision will end with a plunder of public property by a handful of individuals and naturally jeopardize the stability of the entire economy.

Although the current raging financial tsunami is not yet over, the international community has come to recognize that three ensuing points have to be underlined in the supervision of the banking sector. Firstly, increasing transparency, or to propose more transparency for the derivatives to be devised, so as to ensure that investors would not be hoodwinked. Secondly, stepping up social supervision, so that more stakeholders should be empowered to inquire about activities of banking institutions, which are in turn accountable to give detailed and earnest replies.

Thirdly, to ensure that financial innovation should not be detached from financial supervision, whose activities should also keep pace with new financial innovation promptly and ensure that supervision departments should have an ample, high degree of freedom in action so that these departments, too, would be likewise accountable once problems crop up.

With regard to developing nations, how to beef up financial supervision represents a conspicuous, protruding issue in the process of opening their financial markets to the outside world. The opening-up of banking sector poses a crucial, component part of the marketization of banking business and also a vital fresh impetus to uplifting the banking industry.

This constitutes a severe test for national economy, since both the shortage of experience and the lack of supervision could possibly spur financial competition to deviate further from the development objective of economic entities and become an instrument for speculation and plunder. Faced with vibrant global financial upheavals, therefore, developing nations need all the more to mull over carefully and learn painful lessons; they must never forget that they should retain transparency, and keep up the wide-ranging, rigid supervision, and prompt, effective control over the financial business while advancing the opening-up of the financial sectors prudently and with great caution.

By People's Daily Online, and its author is Zhang Bin, deputy researchers with the Institute of World Economics and Politics under the Chinese Academy of Social Sciences


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