Chapter 18: Executive Summary
International Alignment of Financial Sector Regulation
Viral V. Acharya, Paul Wachtel and Ingo Walter
Many of the policy recommendations being put forward to repair national financial architectures will prove to be ineffective — or at least their edge blunted — if there is a lack of international coordination among central banks and financial stability regulators in implementing them. This issue is important; although cross-border banking and financial flows are extensive, much of bank and financial supervision remains national. There is some consensus on prudential aspects of regulation such as capital requirements and their calculation, but there is hardly any consensus on the core set of principles driving the regulatory stance to providing guarantees and intervening in markets and banking sector.
Complications that could arise from lack of coordination between national regulators are many. These complications are largely due to regulatory arbitrage across national jurisdictions: i.e. if institutions are more strictly regulated in one jurisdiction they may move (their base for) financial intermediation services to jurisdictions that are more lightly regulated. But given their inter-connected nature, such institutions nevertheless expose all jurisdictions to their risk-taking. Individually, jurisdictions may prefer to be regulation-lite in order to attract more institutions and thereby jobs. For example, they may adopt weak accounting standards to allow opacity of off-balance-sheet leverage, not require OTC derivatives to trade on centralized clearinghouse, allow systemically large institutions to grow without imposing a significant additional "tax", and grant generous bailout packages during a crisis.
We believe it is highly unlikely that an international financial sector regulator with power over markets and institutions will emerge in the foreseeable future; countries are simply not willing to surrender authority. It remains unrealistic to expect that an international central bank will be able to close down a large part of the financial sector of a country or determine monetary or fiscal policy for a country; or that international civil servants will supervise or inspect national financial institutions. Indeed, such centralization may not be necessary and may even be undesirable. The issue is one of externalities and coordination may suffice. If national regulators can agree upon a core set of sensible regulatory principles, then the constraints imposed by such alignment would reduce regulatory arbitrage through jurisdictional choice substantially, even if specific national implementations of the principles vary to some extent.
Our recommended steps to achieve such international coordination for designing the blueprint of global financial architecture are thus as follows:
Central banks of the largest financial markets should convene first, and agree on a broad set of principles for regulation of banks. These principles should cover the following themes:
A commitment to such a process will generate a willingness to take the outcome seriously and hopefully pave the way for international coordination on well-rounded policies that balance growth with financial stability as efforts get under way to repair national financial architectures.
© 2008 New York University Stern School of Business.