The Guest Blog

Working for the Chinese yuan: the next stage of global capital

Professor Moorad Choudhry
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Britain's Chancellor George Osborne shakes hands with Chinese Vice premier Ma Kai
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If punk music had burst on to the scene in 2013, instead of 1976, The Skids wouldn't have been singing "Working for the Yankee Dollar". Although perhaps "Working for the Chinese Renminbi" doesn't trip off the tongue so easily. The Scottish band's lyrics from their 1979 chart hit definitely needs updating to reflect U.K. Finance Minister George Osborne's trip to China this month.

Mainstream U.K. media concentrated on a deal that allowed Chinese companies to build nuclear power plants. The strategic, economic and security concerns around this are still being debated.

(Read more: Britain to build Europe's first nuclear plant since Fukushima)

This being a column on finance and macroeconomics however, we're more interested in the agreement that Osborne signed up to that allowed Chinese banks to set up their U.K. operations as branches, rather than subsidiaries. The difference is not one of mere legal technicality. Bank branches are not separately capitalised from their home parent, and crucially their ultimate supervisor is the parent supervisor. In other words, the primary regulator will be the Chinese regulator.

Is this significant? Well, it is when the entire thrust of regulation and compliance on both sides of the Atlantic is one of "safer" banks that are standalone robust for liquidity and funding. Allowing a branch to be reliant on its parent for funding goes against this principle.

(Read more: UK opens doorsto Chinese banks with special terms)

The Chancellor's office made clear that Chinese bank branches would not necessarily be in the business of accepting retail deposits, rather their business model would focus on corporate lending and trade finance. This observation brings to mind what happened when Bank of Cyprus imploded and the U.K. regulator moved to cover the U.K. branch customers with the U.K. deposit compensation scheme. But this is irrelevant. Certain people seem to think that there is only a problem if are tail bank goes bust, and that non-retail banks can wind down with no systemic impact. But financial systems are integrated to such an extent now that almost all banks are "systemically important".

The Economist painted a different picture. Applying an inarguable logic, it suggested that forcing foreign banks to set up subsidiaries risked creating pools of trapped capital and liquidity. Far better, in the interest of global economic development and integration, to let capital flow freely between a parent and its branches.

(Read more: China charm offensive may not bring back UK investment)

I don't disagree. Capital mobility is what economic development is all about. But to credit Mr Osborne's move as perhaps the last hurrah from a defender of true capitalist liberalism is to credit his department with perhaps a bit too much incisive thinking. As a number of other measures, such as easing visa restrictions for Chinese students or the nuclear power plant deal suggest, there is an almost unseemly scramble to get on board the Chinese economic powerhouse train. In principle that should reap dividends for open economies such as the U.K. But when one has oodles of regulation on banking coming out everywhere one looks, it's worth persevering with trying to inculcate conservative principles in banking. That means emphasizing, for now, the importance of self-sufficiency in capital and liquidity for all banks and their subsidiaries and branches.

But as The Skids could have told you, sometimes the force of politics and money is irresistible.

Professor Moorad Choudhry is at the Department of Mathematical Sciences, Brunel University and author of The Principles of Banking (John Wiley & Sons 2012).