LONDON ― A little more than three years ago, just as the financial crisis was getting into full swing, I published a guide to the international system of financial regulation, “Global Financial Regulation: The Essential Guide.” It described an elaborate spider’s web of committees, councils, and agencies with overlapping responsibilities, unrepresentative memberships, and inadequate enforcement powers ― a system built up incrementally over decades, with no guiding architectural hand or central authority to promote coherent global regulatory standards.
After all that has happened in the intervening years to demonstrate the dangers inherent in these flaws, and a plethora of summits and conferences, a 2008 guide to financial regulation ought now to be hopelessly out of date. Unfortunately, it is not.
True, some things have changed for the better. At the apex of the pyramid, the G7 was obliged to give way to the broader G20, bringing countries like China and India into the decision-making nexus as full partners. G20 summits are more cumbersome as a result, but that simply reflects the reality of the ongoing shift in economic power from West to East.
There is no point in pretending that this shift is not happening, or that standards set in New York and London will be slavishly followed in Mumbai and Beijing if China and India are not involved in the process. So the increased importance of the G20 should be welcomed.
There has been one other important change, too. The Financial Stability Forum, created after the Asian financial crisis as an informal coordinating body ― the United States resisted anything stronger ― was renamed the Financial Stability Board. A “board” sounds more impressive, authoritative and permanent than a mere “forum.” In the arcane world of international financial diplomacy, these subtle shifts in terminology matter.
But the change in name should not blind us to the fact that the FSB has no more power than the FSF had. Successive G20 summits have asked its chairman, Mario Draghi (now a favorite to succeed Jean-Claude Trichet as president of the European Central Bank), for updates on progress in reforming regulation, but the FSB has no authority over the Basel Committee on Banking Supervision, or any of the other standard setters. It cannot instruct them to change their rules. Nor can it achieve consistency between different standard setters’ approaches, or, indeed, consistency of implementation by different national regulators.
Yet consistent implementation is crucial to avoiding another regulatory “race to the bottom.” There are already dangerous signs that global firms are moving activities into more congenial jurisdictions in order to avoid tighter regulation in the major financial centers.
The G20 should fill that gap urgently. President Nicolas Sarkozy of France, which chairs the G20 this year, has asked for a review of the governance of the financial system. In response, the existing bodies are vigorously defending their autonomy, resisting any attempts to impose on them a modicum of coordination and discipline.
The International Monetary Fund, for example, has always resented the FSB, arguing that the fund itself should be the monitor of systemic risk ― and thus serve as the de facto global financial regulator. But the IMF’s arguments have been weakened by a recently published report by its own evaluation office, highlighting the fund’s failure to identify emerging risks in the run-up to the crisis. The IMF is too political a body to act as the systemic-risk watchdog.
The next G20 summit should implement a fundamental reform of the FSB. It should give the FSB a legal personality, enshrined in an international treaty. Currently, the board has no formal status and only a small, though high-quality, permanent staff, hosted by the Bank for International Settlements in Basel. Draghi’s successor as chairman should be a full-time appointee, and the FSB should be given powers to direct the other standard setters, review the implementation of standards by individual countries, and publish the results.
It would be unrealistic to think that the FSB could direct countries to strengthen their regulation, but it should have some form of arbitration power analogous to that held by the World Trade Organization. So, if a country is thought to be operating a lax regime to attract mobile international business, the FSB could expose that behavior and publish its conclusions. The anomaly that countries have decided to endow an international body with powers to regulate disputes in trading goods, but not in financial transactions, should be corrected.
There is a strong argument for going further, and subsuming the standard setters ― the Basel Committee, the International Organization of Securities Commissions, the International Association of Insurance Supervisors, etc. ― in a single body. They could be co-located in a regulatory Tower of Babel in Basel.
That might happen one day, as the borderlines between different sub-sectors of the financial system become more blurred. But, for now, however logical such an objective may be, it is probably too much to hope for.
Even so, as the saying goes, it is important not to waste a good crisis. Sarkozy has a golden opportunity to put his mark on the global financial system. Surely a French president, eager for global success with a domestic election looming, will not pass up his chance.
Indeed, Sarkozy has an additional incentive, given that he would be scoring a point against the IMF, led by Dominique Strauss-Kahn, his likely Socialist opponent in the next presidential election. So, for once, logic and personal political motivation are pushing in the same direction. That ought to be a winning combination.
By Howard Davies
Howard Davies, a former chairman of Britain’s Financial Services Authority and a former deputy governor of the Bank of England, is currently director of the London School of Economics. His latest book is “Banking on the Future: The Fall and Rise of Central Banking.” ― Ed.