Ma Hongman

 

As the debate on liquidity-caused bubbles on the domestic stock market intensified, the regulators remained silent until late last month, when the China Banking Regulatory Commission (CBRC) ordered commercial banks to stop making loans used to trade stocks.

 

The CBRC said if any violation of the rules occurred, the banks will be held responsible.

 

The CBRC move aims to curb financial risks as an increasing amount of money is rushing into the stock market. But the policy may not work as effectively as expected.

 

As the stock market remained bullish for most of January, investors remained optimistic. Some took out bank loans to buy stocks.

 

This caused market risks to rise and the bubbles to keep swelling.

 

Once the market tumbles, as it did recently, the index will drop and much of the capitalization will evaporate. Those who used bank loans to invest will face extreme pressure from both investment losses and their debts to the banks.

 

For this reason, the CBRC move is in the right direction, but it will be hard to implement the policy.

 

What the new CBRC rules forbid has long been stipulated in the securities law and other relevant regulations. In reality, however, the practice of bank loans for stock investment has never been rooted out, because both investors who borrow from the banks and the banks want to continue the practice.

 

As the market remains bullish, the rising stock index ushers in more investors and capital, which in turn further pushes up the market.

 

Many investors want to make quick profits as the market continues to rise.

 

The commercial banks are also faced with pressure to make profits. Due to their lack of skill in providing competitive financial services, they have largely relied on the interest rate gap between the loans and deposits to make money.

 

As a result, many want to make more individual loans to increase profits, although they know the borrowers may use the money to invest in the stock market.

 

Bankers believe that the current stock market will continue to rise despite occasional corrections. Their thinking is that the risks for the investors will not be very high.

 

Not entirely at risk, the banks are covered by the borrowers' mortgages. If the borrowers suffer severe losses on stock investments, the banks can sell the collateral to retrieve part of the loans, limiting their overall risk.

 

Therefore, the commercial banks may not be adequately motivated to follow the CBRC orders to stop such lending.

 

Moreover, those who want to borrow from the banks to invest in the stock market may resort to some financial maneuvers to circumvent the banks' tracking the loans.

 

As a result, although the regulators have taken a harsh stance, it is hard for them to stop bank loans from flowing into the stock market simply by pressuring the banks.

 

The stock regulators have repeatedly reminded investors of the potential risks of the market. Although risks are intrinsic to the stock market, as long as investors expect to profit, they will find ways to obtain funds to invest.

 

Even if the regulators can plug the commercial bank loopholes, investors can secure money from other sources. This would make regulating such money flows even more difficult.

 

Other countries' experience shows that it may be better for regulators to take a more liberal stance toward such investment zest rather than trying to control the barely controllable flow of capital.

 

In developed countries, banking regulators generally stipulate a series of strict bottom-line rules for commercial banks to issue loans.

 

For example, in the United States, where the bad loan ratio is quite low compared with other countries, the banks cannot issue loans worth more than 90 percent of the mortgaged property, such as buildings.

 

With those requirements met, the lending risks are under control and the banks are allowed to make loans without keeping track of how the money is used. The borrowers can use the money to buy stocks so long as they meet the loan requirements.

 

Such a policy is obviously more in line with the development of a modern market economy. The banks are commercial entities that aim to make profits. In their own interest, they will assess the risks of making the loans and will determine whether the collateral can cover possible losses.

 

It will not work if regulators require the banks to shoulder the responsibility of solving the macroeconomic problem of excessive liquidity.

 

It is the regulators' duty to help the commercial banks to establish their own risk assessment system. They should also provide timely information for the financial institutions to make the right decisions and reduce risk.

 

For example, they can establish a nationwide individual credit network and a unified statistical database. This way the banks can have more information on loan applicants.

 

The author holds a doctorate in economics from the Shanghai Academy of Social Sciences

 

(China Daily February 12, 2007)