Why bailouts can do more harm than good
Beijing can afford to let some small lenders fail, to avert bigger problems and serve as a lesson to others, says former SFC chief Andrew Sheng
Beijing should not bail out all domestic financial institutions that get into trouble, particularly the smaller ones that might face a squeeze as the risk of credit default rises in the world's No 2 economy.
That is the view of Andrew Sheng, the former chairman of the Securities and Futures Commission in Hong Kong.
Chinese banks generally had a stronger capital base than their Western peers following the 2008 financial crisis, said Sheng, and Beijing could afford to allow some small banks to make mistakes, which other players could then learn from.
"Chinese banks largely have sufficient capital. But this doesn't mean small banks might not get into trouble, because if you are a local bank lending to a local industry, and the local area gets into trouble, you will be in trouble, too," said Sheng, a Chinese Malaysian who is now the chief adviser to the China Banking Regulatory Commission, the mainland's banking industry watchdog.
"In a large system of banks, some will get into trouble. There will not be zero failure just because there is prevention. If you prevent failure, what happens in the system is that it will become fragile and as a whole will become unstable. So allowing small mistakes actually prevents big mistakes," Sheng said in an exclusive interview with the South China Morning Post.
Amid the worsening economic slowdown on the mainland, concerns are growing about how strong the domestic banking system is. In late June, the mainland's interbank market was hit by a liquidity crisis for about one week, which was its worst cash crunch for decades. Some bankers privately complained about the central bank's slow reaction to the hike in interbank lending rates.
Zhou Xiaochuan, the governor of the People's Bank of China, has warned of potential credit risks. Early last month, while attending a forum in Shanghai, he told local media that he believed the market understood how the central bank had handled the interbank liquidity situation. The volatility in the domestic interbank market "highlights the demand for banks to adjust their asset structures", Zhou said at the time, without elaborating.
Sheng said Chinese banks should be more aware of asset quality and be more selective about who they lend to.
"The lesson we learned from the Asian financial crisis (in 1997) and later in the 2008 crisis is, If I owe the bank US$1,000, I'm in trouble. But if I owe the bank a billion, the bank is in trouble. So those are the relativity and scale issues."
Sheng, who is now also the president of the Fung Global Institute, an independent think tank founded by Hong Kong tycoons and brothers Victor and William Fung, said that, about five years after the 2008 global financial crisis that originated on Wall Street, some central banks had apparently not yet learned lessons from the crisis. He did not name any specific country.
"Life is all about experience and learning. Some people learn from mistakes; others tend to repeat them. I think the whole issue is that this  crisis has taught us that certain things are not sustainable.
"Basically, if you have a fiscal deficit, it's getting larger and larger. If you allow the banking system to continue printing money, it's not going to be sustainable."
There was no such thing as a free lunch. "You'll have to pay for it sooner or later," said Sheng, whose comments about highly paid bankers featured in an award-winning 2010 documentary film Inside Job about the 2008 global financial crisis.
In the movie, Sheng said: "Why should a financial engineer be paid four to a hundred times more than a real engineer? A real engineer builds bridges. A financial engineer builds dreams and, when those dreams turn out to be nightmares, other people pay for it."
His comments on bankers' payrolls in the 2010 film quickly drew criticism from some industry players.
In a recent interview with the Post, Sheng, when asked to comment on the latest regulatory efforts in the euro zone to limit bankers' bonuses, said: "I'm still a great believer in the market in exercising this [bonuses]. It's important for the board of directors because they are the judges of this area. It's not easy for a regulator to come in and say it's too much.
"The key question is - does the bank know where it is making the money, and is the remuneration justified on that basis? That's the real issue."
Additional reporting by Rachel Butt