My Blog

December 16, 2007

SUN 16 DEC 2007

More on cross-border banking

In the “Comment” section Brad Setser raises and interesting and important point about one of my December 14 entries (“Foreign companies can now raise money in China”), and I thought it would be more interesting to respond in an actual entry rather than in the “Comment” section.  I haven’t asked his permission to do so, but I am pretty sure he won’t mind.  Brad asks:

 

Why is allowing Chinese state banks (or the Chinese state) to own US banks necessarily a good thing? China very clearly uses its state banks to achieve policy as well as commercial goal – most obviously right now China uses the banks as a took for below market sterilization.  Now in practice the US may not be conceding much, as the promise to treat Chinese banks like other banks is effectively the United States current policy, and I rather doubt a controlling Chinese state bank stake (or a CIC stake) in a large US institution would pass regulatory muster – the USG[overnment] is probably less impressed with the health of Chinese banks than the equity market.  But it does seem to me that allowing a government that uses its own state banks to achieve its domestic policy goals to own banks abroad raises a host of difficult issues.

 

Of course Brad is right in that this does create a complex of issues, but as a general rule I assume that financial openness is a good thing for the US and that allowing foreign banks to bring capital into the US market and add their mix of strategies and interests to the vast pool in the US can only help the process of specialization and differentiation.  It also helps diversify risk by creating an additional (non-correlated) pool of banking capital from which to draw – although given the size of the US market the impact of Chinese entry is likely to be small.  This assumption may be unreasonable, but I think not because it seems to me that developed countries with more open financial systems tend to be better at allocating capital and at withstanding the economic impact of financial crises.

 

If this assumption is correct, and I suspect that Brad will broadly agree, the question then becomes whether a Chinese branch, subsidiary or minority stake in a US bank can cause damage to the US economy or to US national interests in a way that is different from other forms of foreign participation – even if it is being constrained or propelled by domestic policy considerations.  It is true that Chinese banks are forced to assist in domestic sterilization, and may even be “encouraged” to provide cheap capital to Chinese firms operating in the US, but I don’t see how the former would affect the US at all and I think that while the latter may raise cries of unfair competition by the Chinese companies’ competitors, it is always a good thing for the US economy if foreigners give us cheap capital..  This might be a more serious issue if it were possible that cheap capital to Chinese companies in the US might one day propel them to a position of such dominance that they could manipulate US policy, but I find the likelihood of this happening to very low.  

 

One of the things that I teach my students at Peking University is that fear of foreign “control” of domestic assets (which is an obsessive fear here in China) is usually irrational because a foreigner who invests a lot of money in another country is much more of a “hostage” to the local government than the local government is to him – unless, perhaps, he is a relatively large company investing in a relatively small economy, something which can never be the case in the US, or if the local government is in a state of near-collapse and easily manipulable, as was the case in Republican China.

 

If the Bank of China, for example, were to invest a sizable amount of money into a US bank, it would suddenly be forced to comply with the Fed and other US banking regulators in a way that it never before had to.  Fear of undermining the value of its large investment in the US might even force it at least to consider the interests of US regulators in areas outside their direct jurisdiction – for example in offshore banking activity with entities deemed national enemies.

 

In addition its actions would probably be scrutinized much more carefully than its US equivalent.  But if its presence helped in any way at all to provide capital to US-based businesses (Chinese-owned or otherwise), the net impact would be an increase in total US investment and a strengthening of US domestic competition (which is, in my opinion, almost always a good thing), and that would be good for the US economy.  On the other hand if it ever began behaving in a disruptive way, there would almost immediately be a domestic outcry that would cripple its activity.  This is just the flip side of the common Chinese (mistaken) belief that if Citibank opens more branches in China, Chinese sovereignty would be eroded.  Actually China’s sovereignty would probably be strengthened because its economy would be better served (much better served, in this case).

 

I remember that in the 1980s many of the same fears were expressed about Japanese financial institutions (and in the 1970s it was OPEC control of banking deposits), with some people worrying that the tremendous power of Japan’s MoF and the tendency of Japanese banks to herd and/or to form the core of major industrial groups made them akin to being state-controlled, or at least controlled by interests that were not purely banking profit-oriented.  In the end, however, it seems to me that the Japanese banks did little more than transfer a lot of cheap capital to the US.  They were neither formidable banking competitors nor formidable tools of state intervention.  They were largely just cosseted banks that had a brutal time surviving in the US markets even with their lower cast of capital.

 

At any rate if for no other reason than to protect one of the great US strengths – its openness – I would want the burden of proof to fall on those who would constrain the Chinese banking presence in the US.