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Special Report: Can this committee save the world from bankers?
November 10, 2010 / 12:43 PM / 7 years ago

Special Report: Can this committee save the world from bankers?

LONDON (Reuters) - Was the creation of the Financial Stability Board last year a bloodless coup by the world’s central bankers? A repeal of the U.S. Declaration of Independence? That’s certainly how some in America view the new body which is supposed to plug the holes in the world’s financial regulations.

<p>Italy's central bank president Mario Draghi speaks at a news conference after the G-20 finance ministers and central bank governors meeting during the spring IMF-World Bank meeting in Washington April 23, 2010. REUTERS/Yuri Gripas</p>

Here’s a taster from Ellen Brown, author of “Web of Debt: The Shocking Truth about our Money System”, on huffingtonpost.com in June 2009. Pointing to the fact that the FSB’s secretariat is based at the Bank for International Settlements’ headquarters in Basel, Switzerland, Brown warned that “to the wary, this is not a comforting sign. The BIS has a dark and controversial history”, and was, according to one professor she quotes, created as the apex of “a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole.”

The “coup”, she argued, quoting blogger Marilyn Barnewall, lies in the fact that the United States has only one vote of 20 in the FSB. “In other words, the group will be largely controlled by European central bankers. My guess is, they will represent themselves, not you and not me and certainly not America.”

That such extreme theories can be provoked by a body with just 20 staff, housed in a round brown tower in Switzerland’s third biggest city, probably says more about American bloggers than it does about the FSB. But that’s not to say that the FSB, set up in April 2009 by the world’s top 20 economies in response to the financial crisis, is not already a very influential institution.

In its first year, its small, unelected group of officials, little known outside financial markets, has wielded tremendous power in reshaping how banks work. U.S. Treasury secretary Timothy Geithner describes it as “in effect, a fourth pillar of the architecture” of international cooperation alongside the IMF, the World Bank, and the WTO.

It’s still a work in progress. The FSB’s broad license to roam across long established regulatory fiefdoms has sparked inevitable power struggles with other regulators. Emerging states in Asia could clash with older forces, Europe and the United States. It’s not even clear that the FSB will have the backing to push reforms through in the future. So far, it doesn’t even have its own budget or office, let alone any binding powers.

Despite all that, its reach is remarkable. “The FSB is now like a roof over all the global standard setters,” says a European member of the FSB, making no effort to hide a broad smile.

THE ROOF

Officially, the FSB’s role is to keep an eye on potential weaknesses in the financial system, and to encourage the world’s regulatory bodies to share information about how they address those problems.

One early achievement has been to speed up agreement on tough new rules about the amount of capital that banks must hold. Basel III, as the rules are known, will force some banks to raise extra capital in the markets as a buffer against the kind of liabilities the crisis has foisted on taxpayers. Unveiled in draft version last December and set to be formally approved by G20 leaders gathering in Seoul later this week, the new rules replace an accord known as Basel II, which took a decade of haggling.

“Without the apparatus of the FSB, the Basel reform would never have gone through at the speed it has,” says David Green, a former Bank of England and Financial Services Authority official.

But the FSB has its sights set on much, much more. Its charter says it can undertake “any other task agreed by its members in the course of its activities and within the framework of its charter”. Though it was set up by, and continues to be beholden to the G20 group of countries, the FSB has a degree of independence that to some extent enables it to escape their control and become an actor in its own right.

“It’s still a coordinating body but a much more active and assertive coordinator because the G20 governments have decided it is effectively their secretariat in financial regulation,” Green says.

BIG AMBITIONS

How does it work? As blogger Marilyn Barnewall complained, the official at the head of the FSB is a European central banker: Mario Draghi, the 63-year old head of the Bank of Italy. A former vice-president at Goldman Sachs, Draghi’s a banker through and through, widely admired by his fellow officials and known in Italian media as SuperMario for the frenetic pace of his work in the run-up to the creation of the single currency.

Draghi chairs quarterly meetings of G20 central bankers, financial supervisors and treasury officials. Countries can send ministry representatives but not politicians. The idea is that while the FSB’s main actions may be directed by politics, the rules of the global financial system should be above them. “On the one hand the FSB provides a shield for the independent standard setting process from political influence, but also provides a membrane for political imperatives to get expressed,” says one supporter of the body, speaking - like most of those in the industry whom Reuters interviewed for this article - on condition of anonymity.

As well as pushing along Basel III, the FSB has started working on a list of “systemically important financial institutions” or SIFIs - the 30 or so biggest banks in the world whose failure could destabilize the broader financial system. It hopes to force even tougher capital requirements on those institutions deemed “too big to fail”. It’s also devised global principles to rein in excessive banker pay, though the EU has introduced even tougher rules, raising doubts about the FSB’s ability to avoid a patchwork of global rules.

There’s more. The FSB has set out ideas for ways to account for the risks inherent in derivatives positions: the trades which nearly blew up the likes of U.S. insurer AIG and are typically carried out on a bank-to-bank basis, so can remain hidden from regulators. It has made recommendations to reduce markets’ blind reliance on the credit rating agencies, which were blamed in the subprime crisis for stamping AAA on products that were cocktails of toxic debt.

It’s also examining ways to coordinate the supervision of financial institutions internationally - so banks can’t arbitrage the rules between countries. It’s working on what to do about the risk of collapse by a globalised bank blowing a hole in the economies of countries where it has subsidiaries. And, perhaps most ambitiously of all, it’s examining ways to prevent risk-taking players from evading regulation by presenting themselves as being active in some other segment of the financial services sector -- a problem known as “shadow banking”.

BRICS ON THE BOARD

Success in even one or two of these areas would be a revolution in global finance, but many obstacles remain. To start with, the body Draghi heads has an incredibly diverse membership. Built on its predecessor, the Financial Stability Forum (FSF), a loose-knit group of officials from the world’s seven leading economies, the FSB also includes such countries as Brazil, Russia, India and China - the ”BRIC“ economies” - which are racing up the global economic league tables and becoming more important players in global finance.

The FSB represents over 80 percent of the world’s financial activities, which gives its new rules a better chance of global success. But its powers are actually quite limited: it can make recommendations, but these must be endorsed by the G20. It cannot approve rules that are binding on G20 countries, and instead relies on “peer reviews” that “name and shame” laggards who don’t implement them. Regulators say that even though this process hints at the FSB’s weaknesses, it amounts to something of a revolution in financial regulation. “It can’t roll out the tanks across the lawn. It works on peer pressure. There is the possibility of disciplining countries -- that is very new,” says one European regulator.

So far, Draghi’s board has not been afraid of stepping on a few regulatory toes. Some of the areas it’s working in were hitherto the exclusive purview of three global standard setters: the International Organization of Securities Commissions (IOSCO); the International Association of Insurance Supervisors (IAIS); and the Basel Committee on Banking Supervision, which authored Basel III. The reputations of all three took a battering in the crisis, making it easier for the FSB to muscle in.

There has even been talk that the FSB should be given oversight of the International Accounting Standards Board, whose rules the G20 wants as the global benchmark for accounting. Regulators have voiced concern that the FSB’s “peer reviews” may clash with and confuse similar exercises that the IMF and IOSCO already carry out. “The FSB is coming in and trying to capture that market as well,” one regulator quips.

IOSCO says it would be concerned if political involvement goes beyond pushing for speedier rulemaking to dictating the standards themselves. “I think the FSB has been a very positive force. It provides energy and momentum for our plans. The idea there is a political will to improve global standards is fantastic, it’s a plus,” says IOSCO Chairperson Jane Diplock.

NEW ORDER

Some officials have complained that the FSB’s political masters in the G20 will curtail its independence, enabling it to be hijacked to serve the interests of the G20’s most influential states. But people close to the FSB counter with the fact that countries such as China and Brazil are increasingly powerful, which means it’s becoming harder for traditional powers such as the U.S. to dominate.

“The idea that India, China and the other emerging markets are going to accept everything the western world dreams up is finished,” says a Europe official with knowledge of the FSB.

One Asian regulator says the United States and European Union are still the main shapers of new rules - for now. “What the Asian countries now have is a veto say. The newer entrants are not shaping the rules until they find something they don’t like and just block it,” the Asia-based regulator said, referring to China’s move early on in the crisis to stop richer countries from publishing a blacklist of tax jurisdictions that won’t share information on tax dodgers. Says a Europe-based supervisor: “Now China is giving longer speeches about the Chinese view of the world, asking questions about weaknesses here and there and giving the impression they are strong and their role will be bigger and bigger.”

As the G20 finalizes fixes like Basel III, regulators expect emerging markets to push for a greater focus on their concerns, including, for example, the risk of failure of a U.S. bank with substantial activities in Asia. “The emerging markets are saying now we have been through a phase of significant focus on problems in advanced economies, we should now pay attention to the problems in our systems such as rapid capital inflows and responses linked to that, and concerns as hosts to large foreign financial institutions,” says one G20 source.

RACE FOR LEGITIMACY

Another problem - and a reason for the frantic pace - is that the FSB is in a race. Past crises have often been followed by a frenzy of rulemaking activity. Over time, though, momentum can slow. “The FSB is a work in progress but it’s not entirely clear a work in progress to what,” says Nicolas Veron of Brussels-based think tank Bruegel.

Agreeing on Basel III in such a short time was a major feat, but it will be harder to secure global agreement on steps to make safe the world’s “too big to fail” financial institutions. The Seoul summit was at one stage meant to agree a package of measures to beef up Basel III for the SIFI institutions, but has failed to get beyond broad principles. There is no consensus on whether such big lenders should face capital surcharges, because emerging markets say their banks don’t need extra safeguards. Even if the list is agreed, keeping it secret and away from speculators - as seems to be the plan - would prove almost impossible.

“The credibility of the FSB and G20 rests on implementing those difficult agreements. The jury is out,” says David Wright, who was until October a top official representing the European Commission on the FSB.

The FSB’s independence from its political masters will be tested next year, when it may publish names of countries that won’t cooperate in sharing supervisory information according to standards set by the IMF and IOSCO. If it pushes ahead with that plan, the move would extend the FSB’s influence even further - to more than 100 countries from its current base of 20, including offshore havens. Some G20 countries will also be on the “blacklist” unless they change their ways in time.

The FSB’s fate will also hinge on keeping U.S. backing for the broader G20 process, whose summits provide the detailed conclusions that map out its work and lend it authority. A G20 process mired in spats between China and the United States over currencies, coupled with Congressional gridlock in the wake of U.S. mid-term elections, could leave the FSB sidelined once its current work winds down, regulators say.

If that happens, what once seemed to some Americans like a threat to democracy would boil down to little more than a political PR stunt, leaving taxpayers the world over exposed to the risks run by the banks to which they entrust their wages. The bloggers would not be happy. (Editing by Sara Ledwith and Simon Robinson)

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