Money, banks, and the commercial banking law: a framework for law and economics analysis

In this chapter we look at the regulation of the commercial banking sector in China, which has been heavily relied on to meet the needs of domestic firms. Due to significant government ownership of banks, the role of the market is still rather limited as far as domestic banking is concerned. Against the background of a recent attempt of the central government to liberalize its banking sector, we analyse and propose a systematic reform plan to solve the incompatibility between the current regulatory framework and ‘normal’ business practices. First, the comprehensive management of commercial banks raises new challenges and no longer fits with the separate regulation of different financial sectors. In addition, there are significant conflicts between market incentives and national industrial policy when commercial banks extend their loans to companies with a high share of state ownership. Public regulators often make business decisions for commercial banks, and this should be restrained. Finally, the implicit governmental guarantee for deposits in banks generates a moral hazard problem for domestic banks. We recommend that commercial deposit insurance should be established.