the problem with china’s finance sector is too much regulation, not a lack of it

Recently， China’s central bank issued a warning against the risk involved in Internet finance， suggesting that it would step up its regulation of the booming industry， which it said “often enters a legal gray area.”

But despite the existence of fraud in the online finance sector， the problem with China’s financial market is not a lack of regulation， but too much of it. China’s financial sector， one of the most regulated markets in the world， is also home to some of the world’s biggest banks. Most Chinese banks are State-owned， and enjoy comfortable profit margins thanks to their monopoly status.

However， in the past a couple of years， the rise of Internet banking has presented an increasingly serious challenge to conventional banks. Offering interest rates up to 10 times higher than those allowed at regular banks， online funds have attracted large sums of money from private individuals.

Recent moves from the central bank indicate that the industry regulator also considers the rise of Internet banking a challenge to its ability to control the financial sector. But what the regulator should really be concerned with is its own hijacking by vested interests within the financial sector.

For many years， the government has been talking about reforming the financial sector with the use of innovation. But it is pointless to rely on China’s big banks to conduct meaningful innovation. The rise of online funds， which have forced conventional banks to offer more competitive interest rates， is beneficial to the health of China’s banking system in the long term. The regulator should adopt a new way of thinking regarding the reform of the financial sector， and take a more liberal view towards Internet finance. After all， no innovation is risk-free.

While discussing the risks posed by Internet finance， the central bank must also be aware that many of the problems are caused by over-regulation. For example， China’s cap on deposit rates at banks has been causing money to flood into a shadow banking system， masquerading as a collection of trust funds.

Some of the central bank’s concerns also stem from its efforts to minimize default risk associated with financial products offered by banks. Out of a consideration to prevent a financial crisis， the central bank chooses to strengthen its monitoring， and sometimes bails out individual banks when there is a default， rather than allowing the market to take its full effect. The result is a distorted assessment of the risks involved in a financial product， a problem that can influence people’s decisions in the Internet finance market.

To create a healthy financial market， China’s financial regulator should scale back， rather than escalate， their regulation. For China’s financial market， the enemy is not a lack of regulation， but a lack of marketization.