试听180秒038：Why Banks are Tempted to Take Excessive Risks

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Hello, Himalaya’s subscribers. My name is Timothy Taylor. 

Today we're going to discuss why banks are tempted to take excessive risks. There's an old saying in English, which is “heads I win tails you lose”. It refers to a situation where a decision is going to be made by flipping a coin. Many coins in the US and some other currencies have the head or face of a famous person on one side, that's called the head, and then a different pattern on the other side of the coin, which is called a tail. So this expression means if we flip a coin and it comes up heads, then I win. But if we flip the coin and it comes up tails, then you lose. Now, this is clearly a very good deal for one party who wins, no matter what, and a terrible deal for the other party who loses, no matter what. 

As this lecture will explain. A key to understanding how financial regulation works is that banks and other financial institutions can make loans and investments in a way that creates a “heads I win tails you lose” situation for them.Or more specifically, a bank can make loans in a way that what happens is either the bank wins by making a lot of money, or the government loses by having to pay for the losses. 

Let's break up our discussion into three parts. First, we'll talk about this“heads I win tails you lose” financial scenario. Second we’ll talk about banks and also about shadow banks or non bank banks. Third, we'll talk about China's new structure for financial regulation and how it's addressing these issues. Our first point is the“heads I win tails you lose”  financial scenario. And let's look at each part of this one step at a time. 

First “heads I win”. How does the bank get the highest possible return? Well, the obvious answer is it should lend money out at the highest possible interest rate. In a few years ago, China's government removed the controls on the interest rates that banks could charged borrowers, so a bank could potentially ask for a really high interest rate. Now here's the problem. Imagine you or a company wants to borrow some money. So you go around to several different banks, and you ask what interest rate they would charge you. Well, if you are a relatively safe borrower who's extremely likely to repay the loan on time, at least one of the banks you visit should offer you a relatively low interest rate. 

But if you're a very risky borrowers, and much less likely to repay the loan on time, some banks might refuse to lend to you at all. Or if they do lend to you, they might request a much higher interest rate. Thus, when a bank decides it wants to charge very high interest rates, It's going to end up attracting and lending to some very high risk borrowers who were less likely to repay. Now the “heads I win”scenario should be clear, lend to a high risk borrower. And if the high risk borrower does repay the loan, the bank gets a nice high interest rate and makes high profits. 

But what if the bank decides to charge high interest rates and gets a bunch of high risk borrowers, and a lot of those loans do not get repaid? Who loses? Well, you know from the earlier lecture that regular bank depositors are not going to suffer, because with deposit insurance in place, their deposits are safe. But one loser could be the deposit insurance fund. And what if the high risk borrowers can't repay? In part because the overall economy has a problem, or because there's a financial crisis in that situation, the central bank might feel it needs to step in as a lender of last resort, as we talked about in the previous lecture, and loan this bank a lot of money. Later on when it turns out the bank really can't, we can't function because the loans are not getting repaid. 

The costs of giving that bank money would fall on the central bank. Now, this is the basic problem of financial regulation. There's always going to be risk in financial markets, because lending and investing involve risk. But you want to make sure that those who get the gains from the risk should also have to face the losses. If the risks don't work out, you never want to set up a “heads I win tails you lose” situation in any financial market where the rewards of high risk behaviour go to one group. But the potential costs all end up going to the government or a government fund. And this is true, not just about banks, but it's true across all elements of the financial system. Those in the financial sector need to know if gains are possible. Losses are possible, too. 

So let's move to our second main point about banks,shadow banks and non bank banks. China's financial regulators are, of course, aware of this problem. And when it comes to regulating bank loans, they have, by all accounts, done a pretty good job of making, to be sure, making sure that banks are behaving in a way that involves only a moderate and acceptable level of risk. 

The problem is China's financial system has been expanding very rapidly in all different kinds of directions. Companies called non bank financial institutions have started everywhere. These are companies that are not banks. What I have in mind are some insurance companies of various kinds of asset managers who offer different kinds of investment products and wealth management products. These companies are often willing to make loans to others. They're sometimes called non bank banks because they are financial intermediaries. They take money from people and they often make loans and investments, but they're not officially banks. 

The money that is placed with them is not covered by deposit insurance. And the banking regulators who look at bank loans to make sure those loans aren't too risky are not looking at these companies because they are not banks, not officially. They're sometimes called shadow banks. Now, these shadow banks, of course, can be financially connected to banks. They might have the same owners, er, they might be receiving loans from a bank, they might be investing in the stock of a bank. If shadow banks have a bad time, these interconnections can actually cause real problems for the banking system, too. 

So the activities of shadow banks and how to deal with them have been a problem in the United States and in Europe. They could be a problem in China as well. Let me give you one recent example. In China, it would be the Anbang Insurance Company. Over time, China's insurance companies have been given a lot more freedom to invest in different kinds of assets and sell different kinds of products. Well, Anbang was setting up all different kinds of funds and making all different kinds of investments. Many of these were tied to banks, for example, Anbang often sold insurance through banks, but it also owned stock in lots of different Chinese firms including part ownership of banks and different real estate developers which borrow money from banks, but Anbang was doing all kinds of other investments,too.It had bought life insurance companies in Korea and various European countries. 

It had borrowed a lot of money to buy overseas properties like luxury hotels and resorts in the United States. It owned a chain of retirement homes for elderly people in western part of Canada, and it was mixing together money from the insurance company part to all of these different kinds of investments. Well, mixing this money together, moving money from one place to another is against the rules. It's not safe. And in May 2018, the head of Anbang was actually sentenced to prison. According to one court report, his defense was at least at first that he was ignorant of the rules, and he didn't really know whether the activities Anbang had violated the law or not. 

Now, by one count Anbang was the 139 largest company in the entire world at that time. It's clearly not a good sign when someone who is running a huge company really doesn't know if they're following the law or not. China's financial regulators have ended up taking ownership of the company. And over about a year, the plan is defined. Private sector investors who were willing to buy the stock of the company move forward and operate. But in the meantime, the China insurance security fund, which is a fund like a bank deposit insurance fund, except it is aimed at insurance companies rather than bank deposits. 

It needed to give Anbang about sixty billion yuan to make sure that the company would have enough money to pay those who held insurance policies with the company. Clearly, this is a situation where a company was going for a  “heads I win tails you lose”  scenario, in this case, the insurance deposit fund lost. 

Let's move to our third point, China's new framework for financial regulation. Up until late 2017, China's financial framework was sometimes called one bank and three commissions. The one bank was the People's Bank of China. And there were three commissions focused on different parts of the financial market. There were the China Banking Regulatory Commission for Banks, the China Insurance Regulatory Commission for Insurance Companies, and the China Securities Regulatory Commission for financial markets like stocks and bonds in more complex financial securities. 

But there were two problems emerging in this framework. One was that because things were divided up in this way, it was kind of unclear who should regulate and what some areas were being regulated by two separate entities, both the People's Bank of China and a commission, and also some areas were setting and enforcing different rules in some areas, while other financial areas, like certain kinds of investment funds, didn't seem to be being regulated very well at all. The other problem was what economists call regulatory capture, and the problem of regulatory capture sounds like this. Imagine you are a financial regulator， you're supposed to be looking out for the public and making sure there's no excessive risk. 

But think about this. Who do you talk to everyday? Well, people from the financial companies you're regulating. When you need information about the industry, who do you get it from? People from the financial companies you're regulating. When you ask for opinions about new rules or regulations, who do you hear from? Well, people from the financial companies you're regulating. You put all these things together and you can see a common pattern emerging. This has happened with regulators in the US and Europe. It's happened with regulators in lots of different industries, not just banking and finance, but airlines, electricity and others. 

In 2017. There was a high level financial stability and development committee which was set up directly under China's State Council. It's going to set overall policy including all areas of the financial sector. Underneath that, the People’s Bank of China will take on the role of enforcing these rules for the banking and insurance industries, not setting policy, just enforcing the rules, while the securities commission will continue to operate. 

The idea is that policy will be set by the high level committee, and then these other agencies will focus on just enforcing the rules. Now, notice this way of dividing up the problem of financial regulation should address the difficulties that were coming up before.There's less overlap and less gaps in financial industry, regulation and responsibilities. Also, those who deal with industry every day and the ones most likely to be captured by the industry are separated from those setting the rules. And they have to be accountable to those who are setting the rules. 

But the ultimate test for financial regulators is every now and then they need to shut down a financial firm. In a very large economy like China, there should be some new banks starting every year, but also every year there should be a few banks that go broke and go out of business. It might be just bad luck or bad management, but it should happen. In fact, maybe once every five or ten years, there should be a big financial firm like Anbang that needs to go out of business again through some combination of bad luck or bad management. 

When this happens, It's a very clear signal to other banks and financial firms. Pay attention to the rules, moderate your risk. The government, financial regulators are on the job and they're not going to play a  “heads the bank wins tails the government lose” kind of game.

In the next lecture, we’ll return to issues of exchange rates following up on our more general discussion. And look at how the yuan US dollar exchange rate has moved over time. And this will let us put some of the controversies over the yuan exchange rate in perspective. 

I'm Timothy Taylor. Thank you for listening to Himalaya.