Higher Authorities

If financial crises have a tendency to recur, then so, too, do official regulatory responses. After the Asian-centered crash of 1998, international governmental reactions, in broad outline, were much like those a decade later. The principal reactor, so to speak, was the G-20 group of economic powers that was organized in 1999 and immediately called for an international financial regulatory regime to be coordinated by a new arm of the Bank for International Settlements, the Financial Stability Forum (FSF).

Their intentions were sound, the results less so. As U.K. Financial Services Authority Chairman Adair Turner recalled in a speech in Mumbai early this year, “There was a determination to learn lessons, to improve the quality of regulation.” That “institutional response” was, he said, “ineffective.”

In September 2009 the leaders of G-20 – consisting of the major industrialized nations historically grouped as the G-7 or G-10, plus the European Union as a single unit and major Latin American and Asian economies – met at a summit meeting in Pittsburgh under far bleaker economic circumstances than those of 1999. This time, the G-20 gave the FSF “a broadened mandate” to put central banks and regulatory bodies on the same page, to tackle such thorny issues as bank capital requirements and executive compensation standards and, in the process, lessen the opportunities for “regulatory arbitrage,” whereby institutions played one jurisdiction off against another to obtain the most lenient treatment by supervisors. The Basel, Switzerland-based FSF was renamed the Financial Stability Board. Its chairman is the well regarded Bank of Italy governor Mario Draghi, and its secretary general is Svein Andresen, a BIS staff veteran.

Might things be different this time?

In recent months, critics have found plenty wrong with the FSB. Not so much in what it is trying to do, but rather for attempting what no international body has ever succeeded in doing: centrally directing financial regulatory policy. In one sense, that is a non-starter. As a product of international diplomatic cooperation, FSB lacks statutory authority and can at best cajole or jawbone the nation-states. The Nobel Prize-winning economist Joseph Stiglitz, among others, has argued that the U.S. and other major countries should take bold and necessary actions on their own, rather than waiting for multilateral recommendations that, even if ultimately considered, will only prolong the undesirable status quo.

In March, as philosophical rifts were becoming apparent among key G-20 members (differences over bank taxation and oversight approaches that U.S. Treasury Secretary Timothy Geithner was delicately addressing in visits to European capitals in late May), Richard Reid, research director of London’s International Centre for Financial Regulation, wrote: “It will be a major task for the FSB to demonstrate that the strategic G-20 objectives are on track.”

Still, the FSB has that mandate and has been taking it seriously. And with the G-20 reconvening June 26 in Toronto, followed by a Seoul, Korea summit in November, the board and its efforts are likely to get more moments in the sun, opportunities to reestablish momentum.

Draghi submitted a progress report to G-20 finance ministers and central bankers in April. He singled out such issues as capital, too-big-to-fail, over-the-counter derivatives and accounting standards, and noted that “2010 and 2011 are critical years for the reform process. The G-20’s support will be vital for the difficult decisions to be made and for timely implementation.”

Meanwhile, at least two other multilateral bodies of note have their sights on international regulatory coordination and are in a position to keep it in the limelight: the International Monetary Fund, whose leaders sit with the G-20 as ex-officio members; and the International Organization of Securities Commissions, which, like FSB, falls under the BIS administrative umbrella. The latter has a long history of information-sharing and standard-setting. IOSCO in May published “关于跨境监管限制原则eration,” including a sample “Memorandum of Understanding” between securities regulators overseeing investment managers, financial advisers, hedge funds and others that operate in multiple jurisdictions.

The IMF may have even bigger muscles to flex. Its voluntary Financial Sector Assessment Program, also of 1999 vintage, has shown its seriousness about keeping tabs on financial industry conditions, risks and stability. Most of the G-20 countries have participated in FSAP. Two important countries that had not, China and the U.S., entered this year.

In a May 20 Washington Post interview, IMF managing director Dominique Strauss-Kahn suggested that to avert future crises, the fund would have to step up data-gathering from and surveillance of individual, systemically important institutions. That was interpreted by Wayne Abernathy, executive vice president of the American Bankers Association, as a threat of an unnecessary new layer of regulation.

Regardless of its evolving role, the IMF will be a voice and force to be reckoned with. John Lipsky, first deputy managing director, surveyed systemic challenges and reform priorities in a May 18speechin Japan. He said, in part: “Ultimately, we shouldn’t lose sight of the overarching motivation driving global reform efforts – reducing the risk and costliness of future financial failures. In particular, we are stressing two themes. First, that initiatives regarding regulation, supervision, resolution mechanisms and possible charges or taxes must be set in a comprehensive and coherent fashion. And second, that we should be very careful not to repress the legitimate and beneficial functions of the financial sector by imposing too heavy burdens, thus stifling the innovation that is vital for economic growth.”

Lipsky also focused on the IMF’s role in reinforcing through its lending facilities “a multilayered, global financial safety net.” He added: “Increasingly the role of the IMF should encompass providing crisis resolution insurance-like facilities that offer contingent funding, where appropriate, that could be available on very short notice. In addition, the fund should continue to develop its more traditional countercyclical lending, that is, based on the fund’s large liquid resources, and its ability to catalyze private lending through agreed policy frameworks.”

Jeffrey Kutler is editor-in-chief of Risk Professional magazine, published by the Global Association of Risk Professionals.