Will China Fall Apart When Their Banks Fail?

Simon Johnson: China's Banks on Road to Financial Disaster

Thursday, 31 Oct 2013 07:48 PM

By Michael Kling

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China's big banks, bent on global expansion and enabled by light regulation, are on the road to financial disaster much like the crisis experienced in the West, predicts Simon Johnson, MIT Sloan professor and former IMF chief economist, in an article for Project Syndicate.

Chinese leaders are enamored with the idea of building a worldwide banking sector.

"There is nothing wrong with this ambition, as long as it is handled with great caution," Johnson warns. "Unfortunately, it is now becoming clear that the hard lessons of recent financial crises have been lost on China."



Bankers, Johnson notes, are eternally crying for lower capital requirements. They want to be able to borrow more and to be able to hold less equity relative to debt in both good times and bad.

Many nations have learned the hard way about the risks of large banking sectors: expensive bailouts, damaged domestic credit, and wounded confidence that can depress the economy for years.

Johnson quotes former Bank of England Governor Mervyn King, who reportedly said, "Banks live globally and die locally." That means people don't think about where an international bank lends and where it obtains its equity during good times. But when times turn sour and panic ensues, people certainly care if it's an insured bank in the U.S. or an unregulated offshore subsidiary.

Ironically, the British are enabling the expansion of China's banks and their move to possible disaster, Johnson charges.

By offering to treat Chinese banks as branches subject to Chinese regulation rather than subsidiaries subject to British rules, the U.K. has loosened the regulatory screws and opened the door to China's banks. But it's a trap door, Johnson warns.

"By encouraging China to build global financial institutions with light regulation, the United Kingdom is not just inviting irresponsible behavior; it could help to pull an entire economy toward ultimately unproductive and even self-destructive activities."

Johnson questions if the U.K. will be able to handle a financial crisis when banks' assets again become huge relative to the country's GDP, which is quite likely.

"China is like Cinderella – finally allowed to attend the ball and given a chance to become a prominent player," he says. "But midnight could come very quickly, and financial crises do not have fairytale endings."

Other banking experts are also criticizing Britain's move to allow Chinese banks to open branches in the U.K.

"Do we really want banks that are going to operate on very low capital, because they are not going to put much capital into the branch, and then start spinning a big wheel here," Bob Lyddon, general secretary of IBOS Association, a London-based alliance of large international banks, told Reuters.

"Isn't that what we were meant to be getting away from?"



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