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Wang Yanhang: Heavy engagement in derivatives a risk to economy

2015-10-15

By Wang Yanhang    Source: Global Times    Published: 2015-10-14

 

China’s banking system should learn from Deutsche Bank’s mistakes

 

Deutsche Bank, the largest bank in Germany, recently said it will probably post a third-quarter loss of 6.2 billion euros ($7.1 billion), causing wide concern among the international banking community. One reason for the huge loss lies in the bank`s risk management strategy. For instance, by the end of 2013, the bank`s derivative exposure was more than 54.6 trillion euros ($75 trillion at the time), which was 100 times larger than its 522 billion euros in deposits, 20 times larger than Germany`s GDP, five times larger than Europe`s GDP, and almost as high as global GDP.


Financial derivative instruments are a double-edged sword, making banks` means of risk control in the face of huge amounts of financial derivatives more fatalistic. Banks` huge amounts of financial derivatives will bring in profits comparatively more easily, but it is at the cost of both their integrity and the disorder of the financial system, the economy and society as a whole. In fact, not a single major bank that is heavily engaged in financial derivatives has gained decent profits and remained immune to crises so far.


On a global scale, banks that suffer huge losses like Deutsche Bank are rare, but in the vast and murky depths of the international banking sector, Deutsche Bank might not be the only institution facing such problems. As many regional and systemic risks persist in the current international financial system, banks around the world, including China, should take decisive measures to deal with risks.


First, the banking sector should strictly keep risks within the banking system so that reckless banks must admit defeat and contain losses within an acceptable range. In other words, the banking system must have the courage to accept the consequences of its own actions.


Second, regulatory authorities should stick to their principles when it comes to the rescue of troubled banks, because it is impossible, unnecessary and thankless to try to save all of them. When banks suffer huge losses, their decision-makers often lack the ability to understand the overall situation or become involved in dirty dealings that cross ethical lines behind closed doors. Regulators` unprincipled and limitless rescue efforts can only perpetuate unlawful practices.  


Third, reform, innovation and standardized management should drive banking development. The deposit insurance system launched in China is a good thing, because it could create a regulated and efficient business environment for banks. But since the system is by nature an insurance, it is based on the future and contingencies, not on the past and the inevitable. The banking industry as a whole believes in self-salvation, but some banks have developed a sort of insurance dependence, in which they come to see the deposit insurance system as a universal cure for all banking ills. Consequently, banks and regulators should give more thought to deepening banking industry reform and strengthening supervision of the banking system.


Lastly, regulators should spare no effort in protecting the legitimate rights and interests of the public and consumers. Public stability is the foundation of social stability. In the past when some Western countries gambled with the public interest and used public interest as an excuse for seeking profit, the negative effects were significant, and those countries were doomed to lose the public`s trust. The greatest test of a bank`s integrity comes when it falls upon hard times and must follow up on its claim to make customers the top priority.


The Deutsche Bank incident has set off alarms about the prevention of financial risks in China`s banking sector. These warnings should be heeded all the more because China`s banking industry still has the opportunity to take preventive measures. Due to the international financial crisis and the global economic slowdown, the banking sector is no longer able to apply financial instruments at will, as it did when the economy was doing better. In light of these challenges, banks should be cautious about risks and resolve risks only through realistic means, instead of relying solely on the authorities or on the books. They should also deeply reflect on the old Chinese saying about having the phoenix-like ability to rebound. Opportunity will certainly favor those banks who are forward-looking and who strictly abide by principles of good faith, but it is difficult to predict the future for discredited banks.


The author is a senior fellow at the Chongyang Institute for Financial Studies at Renmin University of China.

 

 

Key Words: economy   risk   RDCY  

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