In an increasingly interconnected world, financial risks now spread like pandemics. One of the effective ways to prevent risk contagion is to set up firewalls between banking and capital markets.
Unfortunately, many people have forgotten this principle, or dispute it as “old-fashioned”. However, in China we have maintained such a firewall mechanism in our financial system reform. Only qualified commercial banks are allowed to participate in non-banking activities, and have strict firewalls separating them. We insist that the main funding source of banks should always come from deposits. On top of that, the China Banking Regulatory Commission (CBRC) is developing a regulation that would require firewalls to be established between commercial banks and their controlling shareholders and between commercial banks and their non-banking subsidiaries, in order to prevent risk contagion.
Sometimes the most effective way to address a complex issue is by using basic, simple but useful measures. Practice shows us that traditional tools work, especially considering that financial engineering can malfunction. In recent months we have noticed that many regulators in the rest of the world have also started to embrace this “back to basics” approach.