US President Donald Trump’s trade war has put China under heavy pressure to liberalise its financial industry . In concessions made during trade talks, China agreed to allow foreign banks to take up to a 100 per cent stake in Chinese securities firms from April 1. The policy shift opens China’s US$21 trillion capital markets to foreign investment banks and hedge funds. Since the new rule, there are now five securities firms controlled by Goldman Sachs, Morgan Stanley , Nomura, JPMorgan and UBS putting domestic securities houses under intense pressure. While China’s commercial banks rank among the world’s largest, its securities houses are small compared to the global giants – China’s 130 securities firms put together cannot match JPMorgan Chase alone. To create national champions, the Chinese Securities Regulatory Commission recently announced that it would grant securities licences to commercial banks. Commercial banks take deposits and make loans to consumers and businesses whereas investment banks help large corporations to raise long-term capital by underwriting, issuing and distributing stocks, bonds and other securities. Previously, Chinese commercial banks were not licensed to offer investment banking services, but the country now wants to create “aircraft-carrier-size” investment banks to compete with powerful foreign players. To do this, it is allowing its biggest commercial banks – Industrial and Commercial Bank of China (ICBC), China Construction Bank, Agricultural Bank of China and the Bank of China – to enter the business. ICBC, the world’s largest bank, boasts total assets of US$4.3 trillion compared to JPMorgan Chase’s US$2.69 trillion, and appears on paper to be up to the task. In investment banking, size matters, but reach is important too. Although Chinese banks are among the world’s largest in total assets, they have a limited overseas presence. British bank HSBC, by contrast, employs over 235,000 staff worldwide. Investment banks underwrite initial public offering shares and make a profit by selling them on to institutional investors, but Chinese banks may lack the same distribution channels and, as with any knowledge-based industry, investment banking relies on talent. Chinese banks may face difficulty attracting and retaining the best talent. Top managers at Chinese financial institutions earn between 1 million yuan (US$143,000) and 2 million yuan a year – a tiny fraction of the pay on Wall Street. China Investment Corporation , China’s sovereign wealth fund, has lost some of its most experienced managers in recent years. Investment banks also depend on deep industry relationships around the world, but those links often consist of cosy old boy networks of mostly white men who share the same sociocultural background. More importantly, China must not forget the lessons of previous financial crises. In the 1920s, American banks took excessive risks with depositors’ money and created a stock market bubble. They issued unsound loans to companies in which the banks had invested, and encouraged clients to invest in those same stocks. When the crash came, millions around the world lost their jobs in the Great Depression. To prevent a recurrence of the disaster, US Congress enacted the Glass-Steagall Act in 1933 to separate commercial from investment banking. The act sought to encourage banks to lend their funds to businesses rather than invest in equity markets, to channel resources into the real as opposed to the virtual economy. As US mulls delisting Chinese companies, Wall Street looks to police itself Over the years, however, bankers lobbied persistently and succeeded in repealing the Glass-Steagall Act and removing barriers between commercial and investment banks. From 1999 onwards, US commercial banks, investment banks, securities firms and insurance companies were allowed to merge into giant firms paving the way for the subprime crisis. Bankers returned to risky bets, or what British economist Susan Strange called “casino capitalism”, while US Federal Reserve chairman Alan Greenspan preferred light-touch supervision, trusting banks to self-regulate. To ensure financial stability, oversight is crucial but difficult. Because of the potential for enormous gain, unethical practices creep in despite compliance departments set up to scrutinise deals. Bonus schemes encourage risk-taking and foster a culture of greed and ambition. Goldman Sachs’ role in the multibillion-dollar Malaysian 1MDB corruption scandal is only the latest exposure of money laundering and theft. Banks “too big to fail” are prone to make risky bets counting on governments fearful of systemic meltdown to bail them out when things go wrong. Bankers’ close ties to the political elite enable a culture of impunity, while those who invent complex derivatives are always a step ahead of the regulators. Opening the gates to full participation by global giants compels China to lift the barrier between commercial and investment banking, and exposes it to the same risk of systemic failure seen on Wall Street. Hopefully, Chinese regulators will have more power and tools at their disposal to curb banking excesses. Otherwise, it may only be a matter of time before the next financial crisis. Dr Michael Tai is a fellow of the Royal Asiatic Society and author of US-China Relations in the 21st Century: A Question of Trust