(Under the introduction of translation)
1. Promote strong supervision of financial enterprises.
In the years leading to the current financial crisis, the risks in our financial system have intensified. The rise in asset prices, especially real estate prices, masked the serious deterioration of loan standards. The country's largest financial enterprises have been highly leveraged, and they have become dependent on unstable short-term financing. In many cases, the fragility of enterprise risk management system makes them unaware of the increase of risk exposure inside and outside the balance sheet. The credit explosion followed the real estate bubble. Due to the free access to short-term loan credit, enterprises did not make any plans for the required liquidity during the crisis. When asset prices begin to fall and market liquidity freezes, enterprises are forced to repay loans and are restricted in credit for families and enterprises.
Our regulatory framework cannot cope with such a large-scale crisis. It is true that most of the largest, most connected and most leveraged financial enterprises in China are indeed under the supervision of the federal government. However, these forms of supervision are insufficient and inconsistent.
First, the capital requirements and liquidity requirements are too low. The regulatory authorities did not require enterprises to hold enough capital to cover trading assets, high-risk loans and off-balance-sheet commitments, nor did they require enterprises to increase capital in good economic conditions to cope with poor economic conditions. Regulators did not require companies to make plans to deal with the serious decline in liquidity.
Secondly, from a systematic point of view, the regulatory authorities do not believe that the bankruptcy of large, interconnected and highly leveraged institutions will damage the financial system and economy.
Third, many federal departments have separated their supervisory responsibilities for the consolidated operation of large financial enterprises. The compartmentalization of supervision responsibility and the loopholes in the legal definition of "bank" enable bank owners and other insurance deposit institutions to choose their own supervisors.
Finally, the operation of investment banks lacks adequate government supervision. Money market mutual funds are fragile. Hedge funds and other private futures funds are completely outside the regulatory framework.
In order to establish a new foundation for financial supervision, we will promote the establishment of stronger and more consistent supervision standards for all financial institutions. Similar financial institutions should apply the same regulatory standards, and there should be no simple differences, loopholes or opportunities.
We propose to set up a financial services regulatory committee chaired by an official from the Ministry of Finance to fill regulatory loopholes, promote cooperation in policy and dispute resolution, and identify risks arising from corporate and market behaviors. The Committee will include the heads of major federal regulatory agencies, and the Treasury Department will serve as a permanent staff member.
We propose to strengthen the current supervision power of the Federal Reserve over bank holding companies, so as to establish a comprehensive supervision and accountability system for bank holding companies. Specifically, those interconnected enterprises whose bankruptcy will lead to system stability should be fully supervised by the Federal Reserve, regardless of whether they have insurance depository institutions or not. These enterprises should not change their legal structure to avoid the supervision of their risk activities.
In our proposal, the largest, most relevant and most leveraged institutions will face stricter prudential supervision than other enterprises, including higher capital requirements and stronger comprehensive supervision. In fact, our proposal will force these enterprises to internalize the expenses that will be transferred to society when they lose money as their own costs.
2. Establish a sound capital market supervision system.
The current financial crisis occurred after our financial market experienced long-term remarkable development and innovation. The new financial instruments allow credit risk to expand widely, which enables investors to diversify their portfolios in new ways and enables banks to cover up the risks they initially reflected in their balance sheets. Through securitization, mortgages and other loans can be aggregated with similar loans and sold to a large number of scattered investors with different risk preferences. Through credit derivatives, banks can transfer a lot of their credit risks to third parties without selling basic loans. This kind of risk sharing is considered to reduce systemic risks widely, improve efficiency and help to allocate resources better.
However, the above procedures do not allocate risks reasonably, but often concentrate risks in opaque and complicated forms. As far as the market base consisting of payment, clearing and settlement is concerned, as far as national financial supervision is concerned, as far as the risk management system of most financial institutions is concerned, innovation has developed too fast.
Securitization has cut off the traditional relationship between borrowers and lenders, resulting in conflicts of interest that cannot be corrected by market rules. The original owner of the loan failed to require sufficient documents to prove income and ability to pay. Securitization institutions failed to set high enough standards for the loans they planned to buy, which prompted the loan standards to drop. Investors are totally dependent on credit rating. Credit rating often cannot accurately describe the risk of rated products. In all cases, the lack of transparency leads market participants to fail to understand the full risk nature of their actions.
The increase in the risk of OTC derivatives market is considered to spread the risk to its tolerable limit, and it has become the main reason for the spread through the financial sector in this crisis.
We suggest that all OTC derivatives and asset-backed securities markets should be brought into a coordinated and cooperative regulatory framework to require transparency and strengthen market discipline. Our proposal is to implement document preservation and reporting requirements for all OTC derivatives. We also suggest strengthening the prudent supervision of OTC derivatives market traders, that is, requiring all standardized OTC derivatives transactions to be conducted in designated and transparent places and cleared through designated central counterparties.
We suggest strengthening the power of the Federal Reserve in the market base to reduce the potential spread between financial enterprises and the market.
Finally, we propose to coordinate the statutory supervision and regulatory authority of futures and securities. Although there are differences between the securities market and the futures market, the inconsistency of the rules of the two markets may no longer be appropriate. In particular, the development of derivatives market and the introduction of new derivatives make it more urgent to solve the loopholes and inconsistencies in the application rules of products supervised by CFTC and SEC respectively.
3. Protect consumers and investors from financial abuse.
Before the financial crisis, the federal government and state governments had made many laws and regulations to protect investors from fraud and promote their understanding of financial products such as credit cards and mortgages. However, due to the spread of abuse, especially in the subprime and non-traditional mortgage market, our regulatory framework has been proved to be lacking in important aspects. Many departments have the responsibility to protect investors in financial products, but due to historical reasons, there are serious loopholes and defects in the regulatory framework for implementing these regulations. There are potential conflicts between state and federal banking supervision departments in ensuring bank safety and promoting good bank operation, while other departments have clear responsibilities, but limited management tools and jurisdiction. In the process of gathering this financial crisis, the most crucial thing is that mortgage companies and other enterprises that are outside the banking supervision rules take advantage of their lack of responsibility to sell extremely complicated and inappropriate mortgage products and other products that are not suitable for investors' financial situation. Banks and savings institutions have followed suit, which has brought disastrous consequences to consumers and the financial system.
This year, Congress, the Obama administration and financial regulators have taken important measures to solve the most obvious deficiencies in our consumer protection framework. Although these measures are very important, they only focus on two aspects, namely, the product market-credit cards and mortgages. We need more comprehensive reform.
Based on the above reasons, we propose to set up an independent regulatory agency, namely the Consumer Financial Protection Bureau, and give it the power and responsibility to ensure the formulation of fair and effective consumer protection laws and regulations. Consumer Financial Protection Bureau should reduce loopholes in federal supervision and law enforcement, promote cooperation with states, set higher supervision standards for financial intermediaries, and promote the consistency of supervision rules for similar products.
Consumer protection is the key foundation of our financial system. It gives public confidence, and even if the public believes that the financial market is fair, it can keep policy makers and regulators stable in terms of regulatory requirements. Stable rules will in turn promote development, efficiency and innovation in the long run. We propose legislative, regulatory and administrative reforms to promote transparency, simplification, fairness, accountability and convenience in the consumer financial products and services market.
We also suggest giving the FTC new authority and resources to protect investors on a larger scale.
Finally, we propose to provide new authorization to the Securities and Exchange Commission to protect investors, promote information disclosure, raise standards and strengthen law enforcement.
4. Provide the government with the necessary financial management tools.
In the past two years, the financial system has been destroyed by the failure of the largest and most related enterprises. Our current system has complete procedures and technologies to deal with bank failures, but when a bank holding company or other non-bank financial enterprises are under severe pressure, there are only two options at present: obtaining external financing or filing for bankruptcy. In most economic climates, the above options are appropriate and will not seriously affect financial stability.
However, under the pressure of the economy, it may be difficult for these financial institutions under pressure to raise enough private capital. Therefore, if a large, interrelated bank holding company or other non-bank financial enterprise is close to bankruptcy in the financial crisis, there are only two unstable options: to obtain emergency rescue funds from the federal government like AIG, or to file for bankruptcy like Lehman Brothers. However, these two schemes are not suitable for enterprises to make plans at the lowest cost of taxpayers and effectively limit systemic crises.
We suggest following the example of the Federal Deposit Insurance Corporation of the United States and setting up an institution to let the government handle the potential losses of bank holding companies or other non-bank financial enterprises when the stability of the financial system is at risk.
In order to promote the responsibility of using other crisis tools, we also suggest that the Federal Reserve Board should obtain the written consent of the Ministry of Finance before providing emergency assistance according to its "extraordinary and urgent" authorization.
5. Improve international regulatory standards and promote international cooperation.
As this crisis has witnessed, financial pressure can spread to the whole country easily and quickly. Although most of the regulations are set against the background of the country. Due to the lack of consistent supervision, financial institutions tend to put their activities under the jurisdiction of lower regulatory standards, which leads to a race to the bottom and aggravates the systemic risks of the global financial system.
The United States plays an important leading role in the process of international financial policy cooperation through G20, Financial Stability Board and Basel Committee on Banking Supervision. We will take advantage of our leading position in the international community to promote compatibility with the domestic regulatory reform described in this report.
We will reach an international consensus around four core issues: regulatory capital standards, international financial market supervision, active international financial enterprise supervision and crisis prevention and management.
At the London Summit in April 2009, the G20 signed an eight-part declaration outlining a comprehensive plan for financial regulatory reform.
The preliminary actions of domestic regulatory reform described in this report are consistent with the international consensus reached by the United States and other G20 members, and we suggest strengthening supervision in some aspects.