Institutional Study Of Effective Financial Supervision In China

As the key features of the global economy, financial innovation, deregulation and globalization while escalating the competition and operating efficiency of the banking sector, also forges a closer tie within the multi-national financial institutions, financial instruments and markets. As a result, it is much easier and faster for financial risks and crises to pass around from one country to another, leaving the aftermaths of the modern financial crisis more devastating and long-lasting. The outbreak of the rampant global economic crisis in 2008 drew again world's attention to financial supervision and the choice of the supervisory system. Against this backdrop, the in-depth study of the financial supervisory theory and system bears huge significance for an effective supervisory framework, which shall greatly contribute to the steady operation of the financial sector and the soundness of the national economy by minimizing the occurrence and adverse impact of the financial crisis. Facing the financial sector severely stricken by the crisis, the supervisory authority of each country began to review its financial supervisory system, in the hope of facilitating the financial sector to better guard against the risks with the help of an effective supervisory framework. How to structure a sound supervisory framework to keep pace with the growing financial industry has already become a global concern and hot topic.Supervision is a kind of government intervention opposite to market behaviors. Financial supervision was born with the establishment of central banks and it originated from the functions of central banks. With a retrospect to the history of banking supervision, banking deregulation and regulation-strengthening took turns to play on the stage– strengthening the regulation after the failures of many banks and the outbreak of the financial crisis, while loosing the control after the recovery of the economic growth. From the free financial industry in the infant period of capitalism, the systemically regulated period from 1930s to 1970s, the deregulation era from late 1970s to early 1990s, to the current regulation-strengthening stage, the rule of the social history demonstrates itself in times that social development is a spiraling-up process achieved through twists and turns.Financial regulation is a form of regulation or supervision carried out by either a government department or a governmental agency, which subject financial institutions to requirements that mainly include restrictions on financial institution's market access, scope of business, market withdrawal, requirements on financial institution's organizational structure, risk management and control, and a range of relevant legal systems and processes.The concept of financial regulation could be understood in both a broad sense and a narrow one. In a narrow sense, financial regulation refers to regulation and supervision of financial industry, including financial institutions and their market conducts, which are carried out by the central bank or the financial regulator in accordance with relevant laws and regulations. In a broad sense, financial regulation also includes, apart from the above-mentioned aspects, internal control of financial institutions, supervision by self-regulatory organizations in the financial sector, and supervision by various intermediary organizations.The author would like to define financial regulation as a market-oriented mechanism that regulates activities in the financial market, including market entry, operations, and withdrawal of financial institutions. Financial regulation is directed by governmental financial regulator and complemented by internal risk control mechanism, industry self regulation system, and information disclosure system, with the aim of guarding against financial crisis, maintaining financial stability, protecting investor interests, and encouraging rightful competition. From an economic perspective, conclusions could be drawn that financial regulations are compulsory restrictions and requirements that governments, by virtue of their political power, use to constrain economic individuals in the market from free decisions and to determine the applicability of regulatory measures and allocation of resources in case of market failure, in order to protect public interest. Three different paradigms have been developed on theories of financial regulation: Capture Theory, Public Interest Theory, and Economic Theory of Regulation.The concept of financial regulatory system has been widely used in scholarly studies, however there is no unified definition on the term. In accordance with the basic logic of new institutional economics, this paper defines financial regulatory system as a set of rules that formed in the interplay of various forces in financial activities to influence behaviors in the financial market, and various economic, political, and social arrangements that are formed accordingly. These arrangements are mainly embodied by regulatory measures on information asymmetry, arrangements to prevent the spread of financial crisis, and daily management of financial institutions.The institutional structure of financial supervision is generally composed of four parts: laws and regulations, administrative supervision, self-disciplinary supervision and auxiliary supervision outside the system. These are four indispensable and integrated components of a complete supervision system where each part constrains and complements one another, together forming a game equilibrium of the financial market. Financial supervision theories like Capture Theory, Public Interest Theory, and Economic Theory of Regulation are all limited to some extent. Capture Theory represents a blending of political science and economics, because supervision concerns not only economics, but also political science, for which both economists and political scientists are trying to explicate from their own expertise and disciplines. Public Interest Theory starts from market failure, maintaining that government supervision could correct market failure to protect interests of consumers, while Economic Theory of Regulation starts from the costs and effects of government intervention, holding a negative attitude towards supervision. To address this issue, the paper attempts to establish a complete analyzing framework for effective financial supervision institutions from the institutional economics perspective by using game theory methods. The paper includes mainly the following four aspects: effective financial supervision institutions are the external demonstration of the homeostasis formed under various forces; these institutions should be in line with the incentive compatibility principle; should have self-disciplinary mechanisms and should include cost-effect analysis.Since the establishment of the CBRC, especially since the Law of the People's Republic of China on Banking Regulation and Supervision took effect, banking regulation system compatible to the actual situation of China has been set up in an all-round manner, in accordance with the institutional requirements raised by the"Core Principles for Effective Banking Supervision"of the Basel Committee and with the supervision practices since China's reform and opening-up.Amid the financial crisis, institutional innovation of China's effective financial supervision should start from the following respects: improve and strengthen financial supervision, consistently taking risk prevention as the top priority of supervision; promote supervision on financial innovation; raise the awareness of supervision costs and improve coordinating mechanisms of financial supervision; accelerate the establishment of financial risk emergency response mechanism as well as a comprehensive system of financial data and information; enhance the financial infrastructure of laws and regulations, tightening market discipline restraints. Current institutions, mechanisms, modes and means of international financial supervision are highly inadequate to deal with security problems arising from the financial service system. The present international financial system is facing increasingly severe challenges and the internationalization of financial supervision would be an inevitable trend in the development of the financial industry. International cooperation of financial supervision means that all countries, based upon domestic financial supervision targets, establish extensive multilateral cooperation agreements around the globe, identifying the responsibilities of regulatory bodies in both home country and host country, conducting full supervision and administration upon cross-border businesses and international financial corporations.