This page is a work in progress summarizing the existence of Glass-Steagall type regulations in the PRC banking system. As this is a work in progress, there are certainly inaccuracies, please let me know what inaccuracies exist so that I can correct them.

Why my original interest?

My original and continuing interest in this subject was because of the question "who do I send my resume to"? My interest is in quantitative financial calculation of PRC securities and the question that I had was to what extent foreign entities were subject to the Glass-Steagall type restrictions in the PRC.

Rationale behind Glass-Steagall type restrictions

The rationale behind Glass-Steagall was to address the problem in which banks would find themselves in financial trouble because of money which they loaned out to buy stock.

Summary of US restrictions

Glass-Steagall is the separation between commercial banking and investment banking that was enacted in the United States in 1933 in response to the Great Depression. In addition the Banking Act of 1933 prevented banks from holding shares. The Holding Company Act of the 1956 separated banking from insurance.

The Glass-Steagall Act was significantly modified in 1998 by the Gramm-Leach-Biley Act. Although this is commonly cited as the repeal of Glass-Steagall Act, this is an oversimplification. The sections of Glass-Steagall which prevent the same company from performing insurance, commercial banking, and securities regulation remain in effect as does a provision prohibiting non-banking entities from owning banks. What did change was an end to the prohibition on affilations between financial institutions. Commercial banks are now allowed to own securities firms and vice versa. A new entity known as a financial holding company (FHC) is now allowed to own commercial banks, investment banks, insurance and other financial service entities.

Summary of PRC restrictions

The PRC currently has separated commercial banking, securities firms, and insurance companies. Although these regulations resemble Glass-Steagall and have similar goals, the legal framework for the rules are quite different.

• Article 43 of the Commericial Banking Law (1995)

Commercial banks are not allowed to make trust investment, trade in shares or make investment in fixed assets of non-self use within the People's Republic of China,

Commercial banks are not allowed to make investment in non-banking institutions and enterprises within the People's Republic of China. For investments in the kind made before the promulgation of this law the State Council will work out rules to deal with them.

• Chapter IV of the Securities Law (1998) defines the scope of securities companies.

Article 117

The establishment of a securities company shall be subject to examination and approval by the securities regulatory authority under the State Council. No one may engage in securities business without approval of the said authority.

Article 131

No securities company may engage in securities business or other business beyond the scope of business verified.

No Glass-Steagall restrictions appear to exist in the Insurance Law.

There are some interesting differences between US and PRC regulations. One of the more interesting is that the core of US law is focused at preventing cross-ownership while there appears to be no explicit prohibition against third parties or non-financial institutions owning banks, securities companies, or insurance companies.

In practice this has not been an issue due to the economic structure of the PRC. Over ninety percent of deposits are in commercial banks, most of which are largely owned by the State. The "big four banks" for example are owned by the state through a holding company known as Central Huijin.

A much larger loophole is that there appears to be no prohibition against interlocking directorships. (Personally I have a strong suspicion that there are instances in the PRC financial service industry which are exist through interlocking directorships, but this is personal speculation.)

Another difference is that PRC securities companies are not analogous to investment banks under Glass-Steagall. At the time of the passage of Glass-Steagall, the major investment banks had been well established and were well capitalized. By contrast, PRC securities companies were only formed in the 1990's and are not well established or well capitalized. In contrast to IB's, PRC securities companies tend to be small, make their many from trading, and do not have a good reputation either in the financial community and the general public.

PRC rationale

There are some specific reasons for the commercial bank/securities company dichotomy which are unique to the PRC. One of the is the fact that as we have seen, CB and securities companies within the PRC have very different institutional histories and roles within the PRC economy. One notable difference is the "implied guarantee" that the PRC has given on commercial bank deposits. The PRC has no explicit insurance against commercial bank failure, but the major commercial banks seem "too big to fail" and the government has been recapitalizing them. This implicit guarantee does not appear to extend to non-commercial banking institutions.

• Rejection of the German and Japanese model of bank owned enterprises
• United States was a model. Most laws passed pre-Enron/Worldcomm.
• Allow for focused regulation
• Separate the mess in the stock market from mess in the banking system
• Prevent flow of money from banks to stock markets.

Differences between the PRC and US

• Regulation of all three entities is at the national level in the PRC with three separate regulators. By contrast regulation in the US includes both national and state entities.

• Securities firms in the PRC seem to be very different from investment banks in the US in that securities firms are much less well capitalized and a very minor part of the PRC financial system.

• Commercial banking makes up 90+% of all savings in the PRC.

• Commercial banks can loan money to securities firm. This has caused problems due to non-performing loans and security company collapses.

• Also Glass-Stegall and GLBA prevent non-financial institutions from owning banks. There is nothing I can see in the PRC commercial banking law that explicitly prohibits this, but this has not been an issue because of the general rules of state ownership of listed companies. As these rules are lifted spelling this out is in important issue.

Ownership matrix

Horizontal rows are owners Vertical columns are owned

Foreign entities

• Two subsidaries of the same foreign company can engage in both commercial banking and securities operations provided that the subsidaries are separate from each other.

• Foreign investments in PRC financial institutions appear to be approved by a case-by-case basis by CSRC, CBRC, CIRC. Ministry of Commerce appears to have authority to reject investments but is not likely to use it.

A bizarre coincidence

• The regulatory environment in the United States for banking, insurance, and securities trading is fragmented between state and federal agencies. Securities trading is mainly a federal responsibility. Insurance is mainly a state responsibility. Commercial banking is somewhere in between.

• In order to deal with this fragmented environment Gramm-Leach-Bliley authorizes the creation of financial holding companies with subsidaries each in banking, insurance, and securites trading. GLB also allows commercial banks to undertake securities operations provided they do so under a subsidary.

• By a bizarre and unintended coincidence, the regulation scheme envisoned by GLB works perfectly with PRC law. In forming a joint venture you have an American partner which is either regulated by the SEC, the banking regulators, or the insurance regulators. This partner can then be regulated by the appropriate PRC regulator.

• Foreign entities operating in the United States must structure themselves to fit into a system of holding companies. This structure can be used to initiate joint ventures with PRC partners.

Prospects

• General agreement that the economic factors which pushed US into repealing Glass-Steagall are also operative in the PRC.

• Glass-Steagall type restrictions between commercial and investment banking likely to be repealed at some point once the both the banking and security sectors are healthy.

• No interest in allowing banks to engage in active management of companies.

Conclusion

• Division between commercial and investment banking is as much a function of the national financial structure as the legal framework.
• The legal framework of the PRC and of the post-Glass Steagall US system is surprisingly compatible.
• I can send my resume to US commercial banks which are part of holding companies

See also

http://www.shearman.com/documents/Corp_1199.pdf

On fitting trusts into civil law jurisdictions