Draft 2 ostrava_presentation

The Need for Consolidating International Financial

Regulatory Architecture: Case for a Global Supervisor

 Uzma Ashraf, Douglas W. Arner

Abstract

• There is need for harmonization of regulations and rules and for coherence in the functioning and the performance of the governing bodies

• And the activities of the regulatory and supervisory forums including BCBS, G-20, IMF/ WB, OECD, FSB

• stability of international law and international legal system itself is being threatened due to this ‘fragmented’ responses

• Result: multifarious platforms; sporadic responses to crisis; patch work of regulatory response

Why the need?• The severity and duration of crisis has brought us new

developments, we may call:– “globalization of crises”, (requires globalized

solutions/ responses, eg G-SIFI– Global financial system and global economy are

interlinked closely– National crisis may turn into international or global

quickly

• International institutions like IMF, ECB, FSB, G-20 etc emerged as indispensable particularly in recent European sovereign debt crisis

Options

• Leaving it as it is i.e, on the market forces• Empowering the existing structures • a set of common minimum standards for universal

adoption and implementation (e.g., to start with, depositor insurance), these coordinated efforts may bring stability to the IF architecture and thereby strengthen IFL itself

• Possibility for a brand new Global Supervisor under the changed circumstances, to reconcile the domain of the regulated with that of the regulator (Eatwell, et.al,)

contd..• Exploring the case for IMF, if takes over the role of a

global supervisor to set forth consolidated policy measures for adoption, ensuring its implementation (Alexander, Dhumale, & Eatwell, 2006)

• What IMF for: analytical input/reports; the supply of international liquidity (for global financial safety nets); exchange rate and capital flow regimes (for capital flow management); option to issue SDR on cap markets to raise funds; SDR bond; LoLR role; Global Umpire…

• To find an appropriate balance between the free market paradigm and regulation

Findings

• The world needs a regulated financial market environment as the markets and products have become essentially global whereas the regulators & supervisors have restricted scope

• the response from the policy makers remained tepid World Economic Outlook (WEO): Slowing Growth, Rising Risks, September 2011)

• the most important challenge that our economy is facing today is not the recession itself but the absence of suitable “tools” to deal with it

• a well concerted action can only make a difference

Historical overview- IFIs and IFRs

• 1945-1970: years of peace & stability(Bretton Woods; centralized system of payments and exchange rates;

Uniformity of system)

• 1980’s: Industrialization & free market(complex financial products & transactions; financial intermediation)

• 1990’s: Globalization (innovative financial products; market driven forces, led to a ‘gap’

between the regulated and regulator)

• 2000’s: further intensification, liberalization

(GLBA ,Financial Services Modernization Act) leading to crisis

What purpose financial regulation & supervision serve

• Contextualizing the objective• Regulations are defined as a set of rules and standards

that govern financial institutions• Main objective is to foster financial stability and to

protect the customers of financial services (Larosiere 2009).

• supervision, is “the process designed to oversee financial institutions in order to ensure that the rules and standards are properly applied”..

• If the above is true. Then why not to have a consensus and move ahead for a global overseer?

Nature of IFR: Structural deficiencies

• Soft law based on laissez-faire (GLBA)• Internationally agreed standards• Implementation through voluntary adoption• Force of sanction only through moral pressure

(Do we have morals in finance/ business?)

• the rating agencies & the argument for moral peer/pressure, however the balloon of RA pricked in 2008 (retrospectively a black swan cf Taleb’s Black Swan)

Structural deficiencies-FSA

• FSA proposals:– College of supervisors for complex, cross border

financial institutions– Establishment of European Cross border Bank- an

independent body to replace Lamfalussy committee, with:• regulatory powers• overseer & standard setter• macro-prudential analysis

• The initiative is partial in scope but a step forward in right direction, calling for further consolidation

Structural deficiencies-Basel Capital Accords

• G-10 Governors set up BCBS, membership gradually increased, almost universal

• First Concordat 1975: first time in the history of IFR, the principle of joint responsibility between home and host supervisors was established for the supervision of foreign banking establishments

• Revised Concordat 1983: the principle of consolidated supervision to be adopted by the authorities.

• Information supplement 1990 established the process of regulation through based on consolidation principle

Basel I- assessment• Minimum standards 1992• Market charge introduced through Market Risk Amendment

1996 (compromising capital requirements & quality in 1996 proved a major mistake)

• Core principles of effective banking supervision 1997 but

• Basel remained inflexible and could not grow as the financial markets were growing both in intensity and complexity

• Basel recommendations provided a blue print/ concept of harmonization.

• But it was essentially the first baby step not the whole process; and this led to Basel II

Basel II 1992• three pillar structure; (i) capital adequacy, (ii) supervisory

review, and (iii) market discipline through necessary disclosures.

• But Basel II remained inherently weaker in its contents (Larosiere) and,

• Asian Financial crisis despite having Basel II

• Amendments to the Basel Accord• ‘Contents’ critique/ ‘were Basel II regulations sufficient’?– harmonization missing in:– regulatory bodies; regulatory content; authority; line of

action/ a well concerted response to crisis situation

Pre and Post- crisis International financial architecture

• Structural weaknesses / counter developments:– Voluntary & sporadic adoption– Reversing GSA of 1930’s to repeal New Deal’s

strict system of ‘regulatory capitalism’ derived from Keynesian ‘command & control’

– GLBA: Gramm-Leach-Bliley Act, 1999 (cf European FSMA), free market ideology (Wood; Randall; Kroszner; Santos)

Pre and Post- crisis International financial architecture

• Trend: Increasing gap btw the regulated & regulator’s respective domains– Universal banking and originate-to-distribute

business models (including securitization)– Race for ‘technological innovations’(products) and

‘innovative strategies’ (eg SIVs)

• First trigger: Lehman’s fall & absence of contingency plan; fragmented approach; delay in response (same with Northern Rock)

Regulatory Response

• Fragmented responses:– US: Volcker’s Package of legal reforms through Dodd-

Frank - proprietary trading & consumer protection (the need is for more here e.g. depositor insurance)

– UK

• G- 20, FSB & BCBS– G-7’ comprehensive statement: Oct 2008; biggest move-

endorsement by full membership of IMF, WB, EU, FSF)– G-20 Action Plan: November 2008– FSF Consultation report by G-7 governors: IMF, BCBS,

IOSCO, IAIS, IASB, CPSS, CHFS, BIS including national authorities.

Regulatory Response contd..

• IMFC’ emphasis for a full scale regulatory reforms both for domestic and cross border regulations in a medium to long term agenda

• IMF governance reforms: lagging far behind (20 countries with 19% voting power for quota reforms 2010 ; the scheduled date is October 2012)

• Basel III

Challenges & Need

• One of the underlying causes of 2008 crisis: Divergence btw domestic regulatory structures & that of global finance

• IFIs: international in life & national in death and this necessitates more coherence (FSB’s report (April 2008) prescribes establishment of a college of supervisors for such crisis management)

Challenges & Need contd..

• For example the higher ratio requirements under Basel III may push high risk products from regulated banking sector to unregulated non-banking sector of economy (hedge funds, trading houses, private equity, energy firms etc etc)

Recommendations

• Macro-economic measure e.g. Deposit guarantee (in late 1990’s after Asian crisis, it was emphasized, but never implemented)

• Unrealistic growth projections out of a failure to admit flawed policies (Fischer 2001)

• Grand over haul vs interior decorations (e.g. Volcker vs Fischer)?

• For International Trade Law and International Monetary Law, WTO and IMF & WB sole e authorities respectively

Recommendations contd..

• Global financial regulator for global financial markets (Alexander in Ferran and Goodhart 2001).

• an absolute need to reform the existing regulatory forums to make them effective and meaningful in their universal role around the globe through harmonization and consolidation.