China’s Banking System Ruled by Glass-Steagall, Few Derivatives

Li Gang, former deputy chairman of the People’s Bank of China, wrote a chapter in 2010 a book, Transforming the Chinese Economy, (edited by Cai Fang) on China’s financial and economic policy which includes a section on the Glass-Steagall Act in China. The fourth chapter, by Li Gang, was entitled, “The Intrinsic Logic of China’s Banking Reform.”

China’s banks have been governed by the Glass-Steagall principle, adopted as such, for nearly 25 years. Li writes that “at the initial [1991-92] stage of reform and opening, China adopted the mixed operation [“universal banking”] model under which a commercial bank (China Communications Bank) was allowed to operate brokerage insurance business. [but] In the midst of economic overheating and financial chaos at the end of June 1993, …. policymakers held mixed operation partly to blame and decided to draw on the U.S. experience of separating commercial banking from investment banking.” Li describes the banking and securities laws passed then to do this, and writes, “China officially embarked on the path of separating commercial banking from investment banking, and told commercial banks to disconnect from their securities firms and investment companies.”

In the same chapter, Li describes how the issue became debated again a decade later, with economists (himself included!) arguing in favor of “universal banking.” But the trans-Atlantic financial blowout of 2007-08 settled the issue again, and until now, for the Glass-Steagall principle.

Moreover, a BIS report on derivatives at Chinese banks, makes this point: Financial derivatives transactions in China’s commercial banks still represent only a small proportion of the overall business. (“Development and Utilization of Financial Derivatives in China” by Jinan Yan) Interest-and exchange-rate derivatives posted a volume of almost 6.8 trillion yuan in 2008 and 2009. By the end of June 2014, the total of interest-rate and exchange-rate derivatives had reached 9.7 trillion yuan, or about $1.42 trillion in nominal U.S. dollar value. Thus the derivatives market in China accounts for only 0.33% of the global market, according to the BIS. Compared with China’s share of global GDP, China’s banking sector is obviously very cautious in its use of derivatives. This means, of course, Chinese banks can handle the default of bad debts and failures of delinquent companies they have loaned to, without spreading financial crisis.