Li Gengnan, a bank regulator: The regulatory logic of dog walking

The Year of the Dog may be the "birth year" for the financial industry.

Various signs indicate that the intensity of financial supervision in 2018 may be unprecedented. Focusing on the battle to prevent and resolve financial risks proposed by the central government, the central bank and financial regulatory departments such as banks, securities, and insurance companies have made a series of moves, introduced regulatory regulations intensively, issued sky-high fines continuously, and coordinated the promotion of supervision within the system and supervision outside the system. At the same time, the accountability of regulatory performance will also be "from virtual to real", and "failure to discover risks in time is dereliction of duty, and failure to promptly warn and deal with risks after they are discovered is malfeasance" has become a curse for regulators. This means that both financial institutions and regulators will face "hurdles" ahead.

The complex financial ecosystem is full of thorns and hidden traps. How can we safely and smoothly navigate the gap between dereliction of duty and malfeasance? What regulators will face is not only the challenge of regulatory capacity, but also the baptism of regulatory concepts. Finding the right position, exerting precise efforts, and not doing something in order to be able to do something, may be the way of supervision.

People are used to describing the relationship between regulators and the regulated as the relationship between cats and mice. Recently, there is a saying that “cats and mice are one family” to refer to regulatory corruption. I think this description is obviously out of date.

According to the previous "cat and mouse" regulatory logic, the regulator (regulatory regulations) is the cat, and the regulated (financial innovation) is the mouse. Innovation - regulation - re-innovation - re-regulation... repeating over and over again, this is what we often call the cat-and-mouse regulatory and regulated relationship. Driven by interests, the regulated always try to circumvent the current regulatory regulations, obtain advanced returns (or "head saliva") through innovation of financial service models and products, and realize regulatory arbitrage; while the regulator should follow up and monitor the emerging financial innovations in a timely manner, judge their compliance and risks, and take targeted regulatory measures in a timely manner to make up for the defects and loopholes of regulatory regulations.

Logically, the establishment of regulatory regulations lags behind the pace of regulatory innovation, which is almost an immutable law in the financial market. Innovation precedes regulation. Only in this way can innovation be dynamic and regulation have the motivation to continuously improve. The problem is that if financial regulation lags behind financial innovation too far and too long, it is obviously abnormal, and the absence, dislocation and gap of supervision will arise from this.

In fact, in the cat-and-mouse game, cats often fall into the embarrassment of the inherent paradigm. When the mouse appears, the cat with a keen sense of smell may catch the mouse directly; or chase it fiercely on the street. However, when the mouse gets into the mouse hole, the cat can do nothing no matter how ferocious it is! ——This may be the confusion faced by the current financial supervision of the financial business and varieties. Penetrating supervision is easier said than done. What is more embarrassing is that the cat may lack or lose its keen sense of smell. Maybe when the mouse jumps out and swaggers through the street, the cat is still napping!

As the financial ecology becomes increasingly rich and complex, this almost antagonistic relationship should be replaced by a long-term, benign interactive relationship. The more complex the financial situation and environment, the higher the requirements for supervision, and the more urgent the call for improved supervision. Good supervision is first and foremost efficient supervision, and the improvement of supervision efficiency is inseparable from the benign interaction between supervision and the regulated.

The so-called regulatory efficiency refers to the speed and smoothness of the entire process of regulatory objectives and regulations being transmitted from regulators to the regulated and forming positive feedback, as well as the comparison between the regulatory benefits obtained (such as effective governance of financial order, prevention and mitigation of financial risks, etc.) and the corresponding regulatory costs (such as regulatory enforcement costs). Short time, fast speed, low cost and obvious effect are signs of high efficiency, while the opposite is inefficient.

There are many factors that affect the efficiency of supervision, including the behavior patterns and characteristics of the actors at each node of the formation, transmission, and feedback of regulatory regulations. The sensitivity of the regulator's response to risk issues (including the internal time lag of the introduction of regulatory regulations), the appropriateness of regulatory methods and means, and the seriousness of regulatory enforcement will undoubtedly have a greater impact on regulatory efficiency, while the understanding, acceptance, and implementation of regulatory regulations by the regulated are even more critical. In short, in the process of regulatory transmission, the direction of the force generated by each link and each actor is different, either deviating from or deviating from the direction of supervision. Therefore, reducing the negative force of supervision and maximizing the positive force of supervision are the inherent requirements for improving regulatory efficiency, and seeking a benign interaction between supervision and the regulated is naturally what the topic should mean.

Undoubtedly, increasing the cost of violations is an effective way to improve regulatory efficiency, but it is by no means the best policy. Truly effective supervision should be based on the joint force formed by consensus among all parties in the process of regulatory transmission, the so-called "the best strategy is to attack the enemy's strategy".

Therefore, the relationship between cats and mice obviously cannot explain the positive interaction of incentives, tolerance, and cooperation between regulators and the regulated in modern financial supervision (logically, there is no tolerance of cats to mice); using humans raising dogs and walking dogs to define the relationship between regulators and the regulated, as well as the operation of the regulatory mechanism, may be more vivid and appropriate. This is not only a reflection on the past "cat-and-mouse" regulatory relationship, but also the most appropriate interpretation of the new regulatory concepts and requirements.

Supervision should be like dog breeding, strictly controlling market access. Dogs are the most loyal friends of human beings, and dog breeding is becoming a hobby for many residents; however, careless dog breeding may lead to risk events such as dog bites and the spread of rabies, and also pollute environmental hygiene. Therefore, most major cities have issued specific regulations for the management of family dog ​​breeding. Although the regulations vary from place to place, they all include entry requirements such as dog "holding" licenses and registration, and epidemic prevention. This is exactly the tone of the current regulatory authorities on finance: all financial businesses must be included in supervision, and all financial businesses must be licensed.

The basic attitude of the regulatory authorities towards finance has undoubtedly clarified the thinking, direction and principles for the governance of the current social disorderly financial system. However, the key to the problem is that the institutional regulatory model that relies on licenses has become increasingly embarrassing in the face of the surging wave of financial innovation. How can we truly bring all financial activities under supervision and ensure that all financial activities are licensed? The key is to clarify the basic attributes, classification and identification standards of various financial behaviors, and clarify the responsible departments and regulatory responsibilities of various financial behaviors, so that each financial innovation can be suitable for the corresponding attribute classification in terms of characteristics, and can find the corresponding regulatory destination; so as to avoid regulatory gaps and absences, and avoid the emergence of "wild dogs" wandering unrestrained on the streets of finance. This is the behavioral regulatory system that we urgently need to build.

Supervision should be like walking a dog. We should always hold the reins of supervision and regulation in our hands and grasp the appropriateness of supervision. First of all, we must have laws to follow. For each financial activity, there should be a corresponding regulatory system to regulate and constrain it. This requires regulatory authorities to accelerate the innovation of regulatory systems, make up for institutional shortcomings in a timely manner, shorten the time lag in the introduction of regulatory policies, and keep up with the pace of innovation of financial institutions. Secondly, we must grasp the degree and boundaries of supervision and insist on doing what we should do and not doing what we should not do. Excessive and insufficient supervision are undoubtedly not conducive to improving regulatory efficiency. In the context of increasingly clear accountability for the performance of regulatory duties, we need to pay special attention to the problem of excessive supervision.

But at the same time, the reins should be kept loose and moderate, and it is not ruled out to let go in certain situations. Just like walking a dog, sometimes we want our beloved dog to enjoy the joy of not having a rein for a while, letting it run and play happily. However, even without a rein, you should keep it within your sight and within your voice control range. The key is to let it get familiar with your voice and distinguish the affection and majesty in your voice. Otherwise, you may get into trouble!

The same should be said of financial innovation. When faced with innovations such as Fintech based on big data, the Internet and blockchain technology, how can regulatory authorities balance the relationship between preventing risks and encouraging innovation, and be inclusive but not permissive? This requires us to actively learn from the introduction of the "regulatory sandbox" and, through a special license, allow some financial innovation institutions to test their new products and services within a small range that regulators can control. On the one hand, it reflects the moderate tolerance of supervision for innovation and provides a basis for regulatory correction for the regulators themselves; on the other hand, it controls the risks and negativity that may be brought about by financial innovation within a certain range, so as to achieve the purpose of protecting consumers to the greatest extent possible.

No matter how the regulatory approach is innovated, the most important thing for regulators is to establish and maintain (recover, reshape) regulatory authority. Do not let the arbitrariness, blindness and inertia of regulation destroy the authority of regulation! This is also the basis for implementing the "regulatory sandbox".

If the Year of the Dog is indeed the Zodiac Year of Finance, regulators and the regulated should remember their respective precepts: regulators should perform their duties diligently, strictly enforce the law, be impartial and not corrupt; the regulated should abide by the law, operate prudently, stick to the bottom line, and never forget their original intentions. All we can do is pray, may the Year of the Dog bring financial peace!

(About the author: Li Gengnan has worked for the Industrial and Commercial Bank of China and the People's Bank of China. He is currently a member of the banking regulatory department. He has been responsible for the promotion of small business financial services for a long time and has devoted himself to studying small business financial services issues.)