The Challenge to G-7 Regulators

CIAO DATE: 2/00

The Challenge to G-7 Regulators

Conference on Crisis & Credit: Restructuring Asia’s Financial Sector
October 1, 1999, New York

Speeches and Transcripts: 1999

I will offer three controversial propositions. These propositions that point towards novel policy conclusions—novel in the sense that they differ from those emanating from conventional discussions of “new financial architecture”.

First, the IMF is incapable of fundamentally reinventing itself in a way that would lay the groundwork for it to become the world central bank of the 21st century. The IMF bureaucracy cannot redesign its mission, and the IMF members will permit, at most, incremental changes.

As a consequence of mistakes made in handling the crises of 1997/99, the IMF has run very short of political capital, not only in the United States but also in other capitals.
Neither the Federal Reserve, nor the European Central Bank, nor the Bank of Japan are going to “step aside” and allow the IMF more latitude to run world monetary affairs.
Moreover, the United States will not surrender its dominant voice to the IMF in times of crisis management (a role symbolized by the appointment of Stanley Fischer as First Deputy Managing Director).
In turn, Europe and Japan will continue to limit the IMF’s scope, and emerging countries will continue to ignore intrusive IMF policy advice.

Second, the Bank for International Settlements (BIS), the International Organization of Securities Commissions (IOSCO) and kindred international bodies will continue to be run as consensus clubs. They may succeed at setting higher standards for financial intermediaries (banks, securities markets, accountancy, etc.). But they will do no better at enforcing tougher standards than the BIS was at calling Japanese banks to acknowledge their mountains of non-performing loans. What gentleman’s club criticizes its own members?

Third, there is little likelihood of creating a brand new international institution with significant financial powers. Harrison Young, in this Conference, has recommended a World Deposit Insurance Corporation. The generic problem with such proposals is that they threaten to intrude on the bureaucratic space already occupied by national regulators, the IMF, the BIS, IOSCO and others. As the 1997/99 crisis recedes into history, the political enthusiasm for pushing old bureaucracies aside and creating new institutions correspondingly diminishes.

From these propositions, I leap to two conclusions, one on the “demand side” of international financial markets, the other on the “supply side”.

On the demand side, the IMF, the BIS, IOSCO and other international institutions can help to bring better regulation and stronger surveillance to financial markets in emerging countries. But countries themselves will do most of the work, as they compete in the international “beauty contest” for bank credit and portfolio capital. Countries that do well in the beauty contest will dramatically enhance the internal efficiency of their capital markets and boost rates of return on investment and rates of growth in GDP. Countries that do poorly will falter.

On the supply side, the bank and security market regulators in the G-7 countries must do a much better job regulating and reporting on the provision of financial capital to developing countries. The G-7 regulators, such as the Federal Reserve and the Securities and Exchange Commission, have tremendous latent powers owing to the global reach of financial firms based in the G-7 countries. Broadly, they should use their powers both to expand the non-bank segment of financial capital invested in emerging markets, and to enhance the rating and surveillance of those financial markets. Here is a short action agenda:

Banks should not be allowed to make short-term “commercial loans” to countries or firms that do not have the capacity to repay on a timely basis, as determined by independent ratings.
Banks should be encouraged to establish non-bank subsidiaries to extend credit to borrowers below investment grade. These subsidiaries should be funded by liabilities that are not insured by public deposit insurance systems, and the subsidiaries should not be eligible for lender-of-last-resort support.
Large portfolio and hedge fund investors in emerging markets should be required to disclose their positions on a timely basis for the benefit of the financial market at large.
When a country is struck by a financial crisis, as certified by the IMF, all G-7 banks should be required to form a collective action committee for the purpose of restructuring commercial loans to that country. Moreover, banks, large portfolio managers and hedge funds should be required to disclose their investment intentions at least 24 hours before they initiate purchases or sales.