Nicolas Véron

Global Financial Authorities Must Adapt to a Changed World

This column was published by Bruegel and PIIE as well as De Tijd (Belgium), The Globe and Mail (Canada), La Presse (Canada), Caixin (China), El Economista (Spain), La Tribune (France), Kathimerini (Greece), Il Sole 24 Ore (Italy), Radikal (Turkey), Dziennik Gazeta Prawna (Poland), and RBC Daily (Russia). 

The first G20 summits in 2008 and 2009 were dedicated to overhauling global financial regulation, empowering international financial authorities, and combating the economic downturn. Since then, progress has been uneven and priorities have shifted. The next summit in Cannes is set to be dominated by discussion of the policy chaos in Europe; financial regulatory matters will be little more than an afterthought. The world still needs a functioning international financial regulatory framework, however, if the vision of a globally integrated financial system is to be sustained – and there would be large economic costs from jettisoning that vision. The crisis has demonstrated the perils of unregulated or poorly regulated financial activities. Coordination among different jurisdictions does not happen spontaneously, and the technical nature of financial policy calls for specialized institutions.

This is why global financial authorities are so important. These include the Financial Stability Board (FSB), an umbrella group of national and international organizations, and the ten FSB member organizations not attached to a country or region. These include the Bank for International Settlements (BIS) in Basel; four bodies hosted by the BIS, respectively the Basel Committee on Banking Supervision (BCBS), the Committee on the Global Financial System, the Committee on Payment and Settlement Systems, and the International Association of Insurance Supervisors; the International Accounting Standards Board (IASB) in London; the International Organization of Securities Commissions (IOSCO) in Madrid; the Organization for Economic Co-operation and Development (OECD) in Paris; and the International Monetary Fund (IMF) and World Bank, in Washington DC.

They are not a homogeneous group, and additional international bodies may be needed in the future to tackle specific worldwide financial challenges. But a more immediate challenge is whether the eleven above listed institutions have kept pace with changes in the geography of global finance. All were created in the 20^th century, when Europe and the US (and for a brief period, Japan) dominated the scene. We are in a different financial world now. Based on the Financial Times Global 500 rankings, emerging economies now weigh more than Europe in terms of large listed companies’ aggregate value. Three of the world’s top five banks by market capitalization are Chinese, including the top two. Hong Kong and Singapore get closer to London and New York in financial centers’ league tables. The crisis has accelerated this shift, as the West enters a long cycle of deleveraging and slow growth, while emerging economies continue to catch up. At a less tangible level, the West’s model of financial development has lost much of its aura of superiority.

The new landscape has produced a growing discrepancy between the reality of global finance and the authorities intended to oversee it. True, most of these authorities have expanded their membership to include large emerging economies. But in only one does the chief executive come from the emerging world (OECD Secretary-General Angel Gurria, a Mexican). Among the seven that have a permanent non-executive chair, only at IOSCO is the position is held by a non-Westerner. They are all located in either Europe or the US, making it more difficult for non-Westerners to attend meetings or even conference calls.

As the succession of Dominique Strauss-Kahn at the IMF has illustrated, emerging countries remain unwilling to seize the initiative and force a readjustment. But time is on their side. Westerners should acknowledge that it is in their enlightened self-interest to give up some positions unilaterally, instead of defensively claiming incumbency rights. This requires a monumental change in their mental map, especially for Europeans, who are more overrepresented in this system than Americans, and who still often feel entitled to being at the center of world affairs.

Concrete changes could include the relocation to Asia of, at least, the secretariats of some of the Basel-based committees, including the FSB, and of the IFRS Foundation, which hosts the IASB. This would be logistically easy to achieve. A more ambitious plan could include the move of the headquarters of either the World Bank or the IMF away from the US. At least for some transition time, non-Western candidates should be given priority as heads and chairs of global financial authorities. Certainly, France’s Christine Lagarde and Sweden’s Stefan Ingves, recently appointed at the IMF and BCBS respectively, are highly qualified. But a lot of talent lies elsewhere. The next prominent appointments – at the FSB next month, the IFRS Foundation in the next few weeks, and the World Bank in 2012 – should go to non-Westerners.

Even so, there will be no guarantee of success for global financial authorities. But without some serious such rebalancing, they are assured of fading into irrelevance, even as the world needs them more than ever.

More PIIE Interviews by Steve Weisman

The following interviews were conducted by Steve Weisman for the Peterson Perspectives series: 

- on 10 August, on financial contagion after the US was downgraded by Standard & Poor's;

- on 23 September, on the outlook for European banking reform; 

- and on 13 October, on plans for bank recapitalization in the Eurozone. 

Euro Area Banks Must Be Freed from National Capitals

This column was published in September by Bruegel and PIIE, and also by Vox, the Globe and Mail, De Tijd, Caixin, El Economista, La Tribune, FT Deutschland, Kathimerini, Nikkei Veritas, Radikal, Publico, and the Australian Financial Review. 

Most of Europe has been engulfed by a systemic banking crisis for more than four years, even as policymakers and bankers themselves have strived to deny it. Even worse, the continuing banking system’s fragility is increasingly intertwined with the euro area’s sovereign debt crisis, as illustrated by successive patterns of contagion, from sovereigns to banks or conversely, from Greece to Ireland, Portugal, Spain, and more recently to Italy and France.

It is now plain that the crisis will not be resolved by a muddling-through approach that would allow a return to the status quo ante. If the euro is to survive, euro area citizens will have to accept pooling economic policy decision-making in unprecedented forms, a redefinition of the political pact that underlies European integration, and significant treaty changes.

An intense policy debate focuses on the options for euro area fiscal federalism, expansion of the role of the European Financial Stabilisation Facility (EFSF), eurobonds, or what European Central Bank President Jean-Claude Trichet, in a landmark speech in Aachen in June, called a ministry of finance for the European Union. But the banking side of the crisis also calls for far-reaching innovation. For it to be resolved, Europeans must define a model of banking federalism that would complement the existing monetary federalism and the objective of fiscal federalism. All are needed as components of European financial and economic policy.

The strong and multifaceted links that remain between national banking systems and member states are at the core of the contagion dynamics. These linkages also prevent the emergence of a true single European market for banking services. Economic and monetary union requires that these links be severed and replaced by a credible supranational framework for banking policy, building on the recently created European Banking Authority (EBA) and on the financial resources of the EFSF (or whatever replaces it). Some member states have already gone a long way toward decoupling themselves from their banking systems: Central and Eastern European countries have sold most of their banks to foreign groups, and such “older” member states as Belgium and Finland are moving along a similar path. But most large Western European countries remain largely closed to foreign-bank entry and protective of their domestic financial institutions, often in apparent denial of the moral hazard this protection creates.

The current rapid deterioration in the euro area calls for a radical approach to bank/state decoupling. For Europe’s ailing banking sector, a major shakeout and consolidation wave looms anyway. This must be anticipated with the right instruments and institutions. Any banking policy framework should include components of regulation, supervision, resolution, deposit insurance, and competition policy. For the crisis to be resolved, all must be credible at the European level. First, the EBA should be granted supervisory and resolution authority on all credit institutions, part of which it could in turn delegate to national supervisors as regards banks with a local scope and the local operations of pan-European banks. Second, the EBA’s own governance should be gradually reformed, in parallel with institutional change in the EU, to better align its decision-making with the European public interest. Third, the EFSF should explicitly guarantee the euro zone’s national deposit insurance schemes, in order to prevent sovereign crises from triggering catastrophic retail bank runs. Fourth, member states should agree to dismantle all mechanisms that prevent cross-border mergers, so that regional consolidation can proceed. Among other consequences, these measures would put an end to the “financial repression” strategies by which member states persuade local banks to overinvest in their sovereign debt, with now-obvious negative impact as their own sovereign credit deteriorates.

In parallel with these structural changes, euro zone countries should pass emergency legislation to create a temporary instrument to help crisis resolution, following the successful examples of the US in 1989 and Sweden in 1993. This “European resolution trust corporation” (or Banking Treuhand, to borrow from the German) should, in close liaison with the EBA, take over those banks that cannot meet their capital needs through market mechanisms, restructure their operations, and resell the resulting entities as soon as market conditions allow.

Admittedly, this program would involve huge challenges. One would be the growing tension between the euro zone and EU perimeters, underlined by recent controversies over the Vickers Commission’s recommendations and the ECB’s approach to clearing houses. More broadly, the political obstacles are massive. Calls for a European resolution fund or “euro-TARP” tend to downplay the need for a comprehensive underpinning of the entire institutional edifice of European banking policy.

These measures would not be sufficient to solve the current crisis. But they are necessary. Public awareness of the requirements of European banking federalism is still largely missing. The clamor by special interests tends to obscure this debate even more than on fiscal federalism. In the meantime, Europe is fast running out of alternative options.

 

US Senate Testimony: the European Debt and Financial Crisis

On 22 September, I was a witness at a hearing of the Subcommittee on Security and International Trade and Finance of the US Senate Committee on Banking, Housing, and Urban Affairs. My written statement is accessible here, and a webcast of the entire hearing including my oral testimony and questions is here. 

Click here for the publication in Bruegel's Policy Contribution series. 

Click here for the publication on the Peterson Institute's website. 

An Accounting Perspective on Financial Globalization

Again, this is published late due to technical problems I had with TypePad this summer. This column was published in July by Bruegel, PIIE, Vox, the Globe and Mail, De Tijd, Caixin, La Voce, Nikkei Veritas, Radikal, and Dziennik Gazeta Prawna. 

Sometimes it takes a narrow lens to distinguish the true features of big objects. The future of financial globalization, whatever one’s perspective on its dangers or merits, is one of the biggest questions of our times. By contrast, accounting is often perceived as a boring technique. But the policy debate on accounting and especially on International Financial Reporting Standards (IFRS), which are replacing local accounting standards in an increasing number of countries, entails large stakes and important lessons for global financial integration.

Many observers have recently awakened to the importance of accounting because of the controversy over the mark-to-market principle (or fair value accounting, as accountants prefer to say) and its impact during the financial crisis. In late 2007 and early 2008, several prominent financiers and analysts protested that the rapid decreases in the market prices of US mortgage-based securities and other assets were meaningless and caused by liquidity shortfalls. According to them, marking these assets to reduced amounts in balance sheets would precipitate an unnecessary crisis. With hindsight, we know this analysis was wrong. The reason for the reduced market prices was not temporary illiquidity but permanent loss of value, and transparency was a better option than delaying the necessary recognition of losses. Regulatory capital ratios (set by banking supervisors) may be adapted to filter the short-term volatility of market prices and avoid pro-cyclical effects, but financial accounting should provide investors with a reliable reflection of market conditions at the time of measurement.

However, financial-industry executives and their lobbyists were able to obscure the debate to the extent that many people in Europe, and some in America, remain sincerely convinced that fair value accounting was a major aggravating factor in the crisis. A similar sequence had happened a few years earlier in the US, when corporate advocates managed to delay the accounting recognition of the cost of stock options for nearly a decade. This highlights a feature of accounting that extends to most other areas of financial regulation: because the issues are so technical and jargon-ridden, and the potential financial consequences are so large, public debates and policy decisions are often captured by special interests. Therefore, governance arrangements are crucial, and do not easily fit a clear-cut division of roles between the public and private worlds.

The governance of accounting standard-setting has widely varied over time and across countries. The general trend of the past few decades has been toward standard-setters that are more independent vis-à-vis governments and special industry interests. But the challenges related to IFRS are unprecedented because these standards are set at the global level. There is no global government to oversee the IFRS Foundation, the organization that sets IFRS standards, or to enforce consistent IFRS implementation across countries. Nor is there any coherent global representation of investors, whose information needs IFRS are primarily meant to serve.

Answers may lie in the IFRS Foundation making more efforts to organize the global investor community, and setting incentives for individual jurisdictions to adopt and enforce IFRS to foster genuine cross-border comparability of financial statements. At this point, it is still too early to judge whether the attempt to make IFRS the dominant global accounting language can succeed on an enduring basis. But there are already important lessons that have wide significance beyond the community of accounting professionals.

First, global financial rules are not a Utopian vision but a reality. The initial success of IFRS has been remarkable. Their adoption has been smooth and has generally improved financial reporting quality, starting in the European Union in 2005 but increasingly now in other countries as well. Given the right conditions, financial regulatory harmonization can work across continents.

Second, the crisis has increased the need for public oversight of financial rules, but it is not yet clear how this can be done effectively and consistently. A so-called monitoring board of public entities has been created in 2009 to control the IFRS Foundation, but its construction is awkward and raises concerns about its legitimacy and future effectiveness. For the foreseeable future we will have to rely on trial-and-error experimentation for international financial regulatory bodies, which in most cases cannot take existing national arrangements as a direct model.

Third, those global bodies that exist have yet to adapt to the ongoing rebalancing of the financial world. The IFRS Foundation is registered in America, its staff is in London, and it still caters largely to audiences in the US, European Union and Japan even as large emerging economies represent a rapidly increasing share of global finance. We don’t know whether or how China, India and others will take responsibility at a global level for transparency and integrity in financial reporting. But if efforts to empower them in formal global institutions are not accelerated, it is hard to see how such institutions can fulfill their potential.

 

The Dodd-Frank Act, One Year On: e-book

In July, Vox published this e-book based on a conference in which I participated in Washington DC, at the initiative of the Pew Charitable Trusts and NYU Stern School of Business. I contributed the (short) last chapter on financial reform outside of the US and global financial authorities, and how they connect with the reforms undertaken in the US. 

Click here to download the PDF version directly. 

Eurozone Crisis Resolution Requires a Single Banking Market

The Financial Times on 15 July published this column, in which I emphasize the importance of EU-wide integration of the banking system for both short-term crisis resolution and long-term sustainability of the Eurozone. 

It is also accessible on the websites of Bruegel and PIIE. 

Keeping the Promise of Global Accounting Standards

This is published with much delay, due to technical problems I had with TypePad. In July Bruegel and the Peterson Institute published my policy brief on the future of International Financial Reporting Standards (IFRS), in which I make policy recommendations as regards both the governance of the IFRS Foundation and the implementation of the standards in individual jurisdictions. 

Click here for the Bruegel version; 

Click here for the PIIE version.