On 29 September 2011, the Lee Kuan Yew School of Public Policy hosted Professor Howard Davies from the French School of Political Science (Science Po) for its Master Class Lecture Series. Prof. Davies, a former director of the London School of Economics, gave a talk entitled "Global Financial Regulation Post-Crisis: Is the World a Safer Place?", and analysed the effects of change in the architecture of global financial regulation, especially in the context of the G-20 taking over from the G-7 as the key global political body.
Before starting his lecture, Davies pointed to the anomaly in the word ‘post-crisis’ in the title of the lecture, saying that the world seems to be “going back into it”. He reminded the audience of the flaws in the old global regulatory framework which did not pick up the signals of an extraordinary explosion of credit, particularly in the U.S. in 2008. The old regulatory framework, led by the G-7 was fraught with problems like the lack of early warning systems; an acknowledgement of vulnerabilities, but lack of action; an overly complex system with minimum autonomy; an excessively dominant U.S. paired with a multi-voiced EU; and finally too much scope for regulatory competition and arbitrage. He explained how the framework was being overhauled and discussed both the progress and challenges on this front. He also emphasised that global financial regulation was more an issue of political economy than straightforward financial regulation.
Replacing the G-7 with the G-20 reflects the first key change in the new regulatory regime. It is representative of the world economy and potentially enhances the legitimacy of standard-setters and eventually may also improve compliance. Second, the Basel III regulatory standard proposes additional capital buffers to strengthen bank capital requirements and introduces new regulatory necessities on bank liquidity and leverage. Third, on the issue of “shadow-banking”, which grew more rapidly than the conventional banking system in the U.S. till 2008, recommendations by the Financial Stability Board are underway. In the United States, the Dodd-Frank Act, amongst other things, recommended the creation of the Financial Stability Oversight Council, regulatory capital requirements, regulation of credit rating agencies, incorporation of the Volcker rule and other significant changes in the securitization market. Fifth, while there was yet no consensus on “too big to fail” -- where some argued that since banking was not broken there was no need to fix it -- in the US, Congress agreed to the Volcker rule and in the UK, the Banking Commission wanted a “firewall” around retail banking. Sixth, on the issue of over-the-counter (OTC) derivatives, it was still difficult to harmonise regulations. With regard to the credit rating agencies, which came in for strong criticism after 2008, new regulations were enacted both in the United States and EU. Finally, the lexicon of regulation in itself has changed and the tone and manner of regulators has become more demanding and pushy.
Considerable progress has been made to strengthen regulation, but not yet implemented. The political consensus seems to be fraying at the edges. There are still open issues with regard to “too big to fail”. Furthermore, the EU and the United States have divergent views on OTC derivatives as well as credit rating agencies. Shadow banking has barely been addressed from a regulatory perspective. And with regard to capital adequacy, “who is to decide on the imposition of a counter-cyclical buffer?” Davies asked.
Davies said implementing a new set of financial regulations in itself was a mix of financial theory and brutal politics. Every new accident swung the pendulum towards action. He questioned “why the financial world can’t be like the WTO?” If a country did not comply with the Basel norms, there was no way to enforce it because governments are generally more protective of their financial markets than trade.
Sidhartha Vermani is a Master of Public Administration student at the LKY School..