By Max Clarke
Overhauls of global financial rules typically take years to put into action and rapidly lose relevance. The Basel I and II accords succeeded one another, and took roughly a decade each to implement. The global financial crisis abruptly ended implementation of the latter. Basel III may be no different. The risk is that today’s proposed fixes address the problems of yesterday. If these fixes look outdated now, then they will look even more irrelevant by 2018 — the deadline for full implementation.
To succeed, reform must recognise the growing importance of developing countries. The Group of 20 leading economies and the Financial Stability Board have driven regulatory reforms in response to the near-financial melt-down of 2008; and, understandably, these aim to repair the financial system of advanced economies. Both the G20 and FSB have given greater representation to developing countries. But regulation could go further in recognising the implications for developing countries, which today account for nearly half of global growth and where one in every three banks is located. While developing economies have grown, their financial markets have not kept pace. So solutions for advanced economies are not necessarily a good fit for developing countries.
There are four concerns with today’s “one-size-fits-all” approach: Basel III’s implementation; credit rating agencies; “too big to fail” institutions; and international accounting and auditing standards.
Basel III’s implementation could have unintended consequences that disadvantage banks in the developing world. Tightening of capitalisation and liquidity requirements could pose a stark choice: raise new capital or cut back business. But developing economy markets may not be deep enough to support the capital-raising. Borrowing internationally may not be an option: local banks must compete with heavy borrowing by advanced country banks and governments.
Basel III also discriminates against developing countries by depressing trade finance, which is more important to growth than in advanced countries. It will force higher margin requirements on this traditionally low-margin and low risk business. Unless banks raise more capital, this could depress trade finance, an important source of working capital — and so of jobs.
In discouraging advanced economies from excessive reliance on external credit rating agencies, regulators should be careful not to inhibit the emergence of new agencies in the developing world, which might create more locally-informed risk assessments and a diversity of points of view.
Regulators’ approach to “too big to fail” institutions also misses the impact on developing countries and the global economy. Regulators focus on risks for the “home jurisdiction”, often a big bank in an advanced economy, caused by failure in a “host jurisdiction”, often a big subsidiary of the same body. They need to pay more attention to the broader risks. The big subsidiary in a developing country may not seem that important within its global group. But its failure could be devastating for the local economy and could spark global contagion.
Developing countries have little say in efforts to improve global accounting and auditing standards. They are observers as European and US standard-setters struggle to agree a single set of standards. This transatlantic debate needs to open up to include economies within and outside the G20 so that new standards are truly global. If developing countries’ concerns are not taken into account, they will have little incentive to adopt them. This could provide opportunities for regulatory arbitrage, with riskier financial transactions moving to the least-regulated markets.
Failing to take the developing world seriously enough, ignoring unintended consequences, and imposing one-size-fits-all solutions could undermine efforts to establish a more stable global financial system. Financial reform must be continuous, taking the concerns of the developing world into account and listening to feedback so that new rules fit our changing world. The alternative is standards that ignore shifting realities, threatening the world with more uncertainty.