Guest post from Oxford Anaytica.
While a lack of international regulatory coordination is not key to explaining the global financial crisis, the collapse of a few financial systems had important international repercussions. The case of Icelandic banks probably is the best example of ‘light’ regulation in a small country having a significant impact domestically and abroad. Moreover, the effect of the US financial crisis on the international system was enormous and greatly increased pressure to act globally.
Cross-border objective. The G20 Leaders’ Summit in April agreed that sound and sustainable financial regulation requires strong local oversight and better cross-border communication and regulation. One decision was to enlarge and transform the Financial Stability Forum (FSF), which the G7 established in 1999, renaming it the Financial Stability Board (FSB).
Stronger mandate. The FSB has a stronger mandate, being charged with:
- assessing vulnerabilities affecting the international financial system;
- conducting early warning exercises (EWEs) (in collaboration with the IMF);
- advising on and monitoring best practice in meeting regulatory standards;
- undertaking joint strategic reviews of international standard setting bodies;
- setting guidelines and supporting establishment of supervisory colleges; and
- managing contingency planning for cross-border crisis management.
Legitimacy vs. efficiency? As part of its transformation, the FSB greatly expanded its membership to include all G20 countries, Spain and the European Commission. However, this may create problems. While expansion gives the body’s actions greater legitimacy, at times it may hinder deliberations. As with the G20, member commitment will be crucial for success. A potential problem is that while most members favour market-oriented policies, membership includes Argentina and Turkey — countries with strained relationships with the IMF in recent years.
A problem the FSB may face is the view that the global financial crisis is ending, reducing pressure to develop and implement actions.
Much will depend on the Obama administration and G20 Leaders’ Summit in Pittsburgh on September 25-26. In the economic arena, the Obama administration has been more internationalist that its predecessor, notably supporting increased IMF resources. However, the perception that the US financial sector is recovering may lessen incentives for the US Treasury to work enthusiastically with the FSB.
Exercise challenge. A significant test for the FSB will be the first EWE that it will conduct in coordination with the IMF:
- Uncovering global financial vulnerabilities, and putting forward proposals to address them, would boost FSB credibility — and make it better known among the general public.
- The IMF is investing heavily in the EWE. If the exercise — supposed to be presented during IMF-World Bank Annual Meetings in October — fails to make a significant contribution, both organisations will suffer.
- Nonetheless, the FSB has most to lose. Future EWEs are supposed to occur twice a year.
Future powers? If the FSB gains significant credibility, eventually it may achieve powers it now lacks, including mechanisms to enforce decisions or share the burden when financial institutions fail. For example, economist Barry Eichengreen has proposed creating a World Financial Organisation (WFO). The WTO establishes trade policy principles, and the WFO would do the same for prudential supervision, leaving regulatory details to national authorities. Crucially, the WFO would have power to authorise sanctions against countries that fail to comply. However, such an organisation remains a distant aspiration.
