Financial Regulators Also Need Performance Salary
The article titled Discussion on Bailout Problem under Financial Crisis published in the Economic Research Journal by ZHOU Xiaochuan, governor of China Central Bank, has sparked a hot debate, most of which focused on the profit of China banking sector. By contrast, I have paid more attention to the problem “with high income on one hand, desire for government bailout on the other hand” of large financial institutions illustrated in this article.
After the financial crisis, the high income of finance industry has become the target of public criticism. It is generally believed in the society that there is a need to restrict the financial employees, especially the income of financial executives. It needs emphasizing that as pointed out by the governor ZHOU Xiaochuan, the high income of finance industry is related to the change of financial system in recent one or two decades just seeing from the international perspective, including the financial transaction frequency, financial innovation and derivative product, etc. Therefore, the artificial constraint of income of financial employees runs counter to the market economy principle. However, one fact that has been neglected by Governor ZHOU Xiaochuan is that the current international finance sector generally adopts market performance to determine the salary system, so is the Chinese finance sector to some degree. The consequence is a bet between finance sector and whole society. To cater to the interests of shareholders and profit maximization itself, the finance sector is generally engaged in the financial activities with large risk and even speculation to enjoy the high profit brought by high risk. But once the economic situation and asset price go into reverse, the Large Complex Financial Institutions/LCFIs can receive the government bailout because of the morality risk “too big to fail”. As a result, the whole people (whole taxpayers) will pay the bill for the consequence of financial crisis. The paradox in it is that when the financial crisis and huge risk event take place, the government publicizes that this LCFIs is such important to the whole economic system as to rescue them, rather than talks about the responsibility it shall undertake, that is, the so-called “regulatory failure” problem.
To be specific, the regulatory failure embodies in two aspects. First, fail to forecast the potential risk and take prevention measures when the economic situation is good. Second, fail to take active measures to deal with when the bad sign occurs. To a large extent, the regulatory failure of financial regulators is due to lax regulation. Take the biggest bank bankruptcy case in American History of Washington Mutual (WaMu) as an example. The bank regulators have long recognized the defect of bank. In general, the financial regulators like other public servants earn only fixed salary. Of course, the Chinese financial regulators actually have higher salary because of their countless relations with the industry. But basically their salary does not decide on such index as performance of financial institution under their regulation or whether they have effectively avoided the failure of financial institutions. If the salary of regulators does not link to their regulation performance, the rational choice of them will surely ignore the potential problems of their regulatory institution.
As early as in 1974, two winners of Noble Prize in Economics, Gary Becker and George Stigler, have published a groundbreaking article in the Journal of Legal Studies talking about the problem existed in the standard salary structure of public servants. Hence, it seems that the government public servants have adopted performance salary earlier than the private department. But it is surprising that after 20 years since the issue of above article, the performance salary in allusion to the company executives has first become universal, whereas to link the salary of financial regulators as the public servant with the performance has just been discussed and put into practical operation recently.
Recently, two American scholars, Todd Henderson from the University of Chicago and Frederick Tung from the Boston University, have analyzed the performance salary of financial regulators. They have pointed out that although the FDIC, OTS and OCC start to pay performance bonus to regulators of banking sector, but this afterward performance bonus system is not satisfactory enough to inspire the regulators to do their own work well. In light of this, they have pointed out implementing the advance payment and indicator related to external performance indicator for regulators.
At present, the regulatory way of Chinese Financial Sector is a kind of extensive regulation, which, in specific, is policy regulation and access regulation. With the deepening of future economic reform in China, the financial regulation will surely meet profound change and transfer to fine regulation. In this case, it is necessary for government to take precautions, consider carefully and design the salary arrangement of regulators so as to effectively respond to future change.
Originally published on Time Weekly | 2012-10-18
