Strengthening the Stabilizers

The G-20 summit in Cannes in early November is a major opportunity to address the mandate, governance, and institutional capacity of the Financial Stability Board, the international body that monitors, and makes recommendations about enhancing, the international financial system. The meeting is particularly timely, because the FSB will soon be under new leadership, as its current chairman, Mario Draghi, takes over in November as President of the European Central Bank.

In the midst of the financial meltdown in 2008-2009, the G-20 established the FSB, building on its predecessor, the Financial Stability Forum, and charged it with coordinating urgent international regulatory-reform efforts to ensure greater financial stability and global consistency of rules. Even as the G-20 wrestles with the challenges of the global economic slowdown and the euro crisis, the mandate to the FSB remains central to a substantial financial-reform agenda – and to avoiding national and regional divergence in areas critical to the global financial system’s stability.

The FSB has been criticized for lacking enforcement capability. But, in today’s world of sovereign states, treaties creating new international institutions with supranational powers are not realistic alternatives. Moreover, the FSB’s achievements are significant. Its agenda is rapidly expanding, and it is becoming an influential and permanent component of the international economic and financial architecture, even as challenging questions surround its future.

Pragmatic steps to clarify the FSB’s mandate and enhance its operational effectiveness can and should be taken. Today, the FSB is without legal standing (it is only the product of a political statement). Institutionally, it is simply an extension of the Bank for International Settlements in Basel. It is funded through the BIS, which also seconds its small staff. Its internal governance processes are underdeveloped and lack transparency.

As the only entity that integrates central banks, supervisors, treasuries of major economies, and international standard-setting bodies, the FSB is uniquely positioned to set priorities on financial regulation, provide regulatory coherence across the financial sector, oversee consistent implementation, and, in conjunction with the International Monetary Fund, to assess systemic vulnerabilities. But, while it should identify regulatory gaps and encourage more proactive work by the various standard-setting bodies, it should not take on daily operational responsibilities. It should, however, foster a culture of consultation with industry as a necessary dimension of legitimacy, which implies more transparent approaches to considering the market impact of proposed standards.

Effective execution of such an ambitious mandate is particularly important in view of two emerging G-20 priorities for the FSB: regulatory initiatives with respect to the functioning of markets, including so-called “shadow banking” (the less regulated forms of private financing), and new mechanisms to foster consistent implementation of standards.

Expectations of a greater FSB focus on shadow banking stem not only from non-bank financial institutions’ role in fueling the 2008-2009 crisis, but also from the concern that stiffer capital and liquidity requirements for banks might shift risk away from the financial sector’s regulated core. This will require carefully balancing the need to mitigate risks in the unregulated sector with the benefits that its efficiency and innovation provide to the financial system.

The FSB, along with the Basel Committee on Banking Supervision, has been quietly considering new mechanisms for monitoring implementation of standards, particularly in the context of Basel III rules. FSB membership should imply accountability in implementation of standards. In the absence of formal enforcement powers, the pragmatic alternative is to develop mechanisms for monitoring implementation of standards on an ongoing basis, and to incorporate systematic, impartial peer reviews.

The Cannes Summit should articulate a renewed commitment to consistent implementation of agreed regulatory reforms, and to minimizing divergence in national regulation that could create systemic risks or significant competitive advantage. The G-20 should provide the political support to develop a framework that relies on monitoring, consultation, mutual oversight, reporting, and publication. It is in the financial industry’s interest to support the development of these mechanisms as a means to address the competitive implications of divergent national regulation.

Finally, the G-20 should provide the FSB with adequate institutional capacity to address its tasks, but without creating a bureaucracy. The first order of business is to endorse a capable and dedicated new FSB chairman. Beyond that, the FSB should be given legal capacity through proper incorporation – an institutionally intermediate point between its purely political status now and the extreme of a treaty organization. This would enable to FSB to hire the best possible talent, receive funding from governments, and enter into more formal arrangements with other international bodies in order to carry out its responsibilities more effectively.

Olin Wethington, a former US assistant secretary of the Treasury, is a member and director of the Council on Global Financial Regulation (http://www.c-gfr.org).

Copyright: Project Syndicate, 2011.
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