From Rules-Based To Principles-Based Banking Regulation

The inevitable market failure would jeopardize the effectiveness of market and hinder the allocation of resources, therefore, appropriate regulation by government is regarded as important supplement for market mechanism. As an important component of regulation, the increasing concern has been given to banking regulation with the trend of financial globalization and innovation, particularly after the Global Financial Crisis since 2007.While both the market mechanism and competition in China’s banking sector is yet to be improved and need the intervention of regulation, the banking regulation in China is also in its initial stage. Therefore, the establishment of effective banking regulation in China is generally regarded as a critical concern for promoting further development of China’s banking sector and maintaining financial stability in China.In recent years, there is currently a large literature in regulation field arguing the principles-based regulation (PBR) is better in efficiency than the rules-based regulation (RBR), also many from the regulatory regimes are calling for financial regulation developing or even taking revolutionary change towards PBR. With the international implementation of the new Basel Accord (Basel II) which reflects the PRB concept in a significant extent, China is also ready for the implementation of Basel II, which would significantly change the form and practice of banking regulation in China. At this point, questions about the effect of the implementation of Basel II in China and whether it could push China’s banking regulatory regime to turn to PRB has been emerged for China’s banking authority.In the context of the urgent demand for the improvement of China’s banking regulation and the lesson given by the current financial crisis, this paper studied the effect of PRB from the perspective of Law and Economic and the feasibility of its implementation in China. This paper employed a wide spectrum of methodology including theoretical analysis, incentive and performance modeling, cost-benefit analysis and empirical study to reveal the inherent advantage of PRB and its positive effect in enhancing the effectiveness of banking market, as well as the impact of implementation of Basel II in China.Furthermore, this paper identified several crucial weaknesses in both China’s banking sector and regulatory regime by comparing the PRB system running in the UK, and provided suggestions for the improvement of these aspects respectively. Finally, this paper also gave several universal suggests for improving PRB regardless its environment.