Global Bank Regulation’s Second Best Solution
On the eve of the IMF-World Bank annual gathering a Brookings Institute working group issued a report advocating a “second-best” approach to cross-border capital flow rules in the absence of full self-correcting mechanisms and multilateral oversight. It assumes that unbridled banking and debt movements will bring distortions that must be managed while extracting savings, investment and technology benefits from financial integration. Selective controls may be imposed, although they are prohibited under the EU’s two-decade old single market regime. The euro area has seen fund reversal within a monetary union given banks’ home bias, and the lack of central resolution authority and fiscal oversight. The study emphasizes reference to gross rather than net and credit versus portfolio and direct equity flows as instability indicators. Pro-cyclical bank lending in particular magnifies asset price swings with regular resort to wholesale borrowing beyond the retail deposit base. Institutional leverage can be high even where local units must be capitalized and organized as subsidiaries as in Central and Eastern Europe. Parent lines are now shrinking despite the EBRD’s Vienna Initiative which was effective in the immediate post-2008 crisis period. In Latin America domestic operations were not as geared and have proven more resilient, although both credit demand and supply have fallen. Emerging Europe has net foreign currency liabilities with negative balance sheet valuations while other regions are “long.” Exchange rate fluctuations have not caused developing country financial crashes as in previous episodes with their better sovereign standing and prudential focus on potential mismatches. Flexibility alone did not bring relief as evidenced by forint fallout in Hungary, where weakness aided the trade account but elevated the burden of euro and Swiss franc obligations.
Basic international regulation should include data sharing, common enforcement practice, and loss division. In Europe the separate Systemic Risk Board and Banking Authority have no powers other than warning. The ECB may take primary responsibility under “union” plans but the responsibility split with national regulators must still be set. At the worldwide level the Basel Committee and Financial Stability Board have assumed these mandates but “momentum has dissipated” according to the expert panel of academics and former government officials. Capital adequacy and liquidity proposals were “watered down” with adjustment spans extended to end-decade. Shadow banking and OTC derivatives markets have seen even less regulatory progress. Administrative measures such as introduction of loan-to-value and debt-to-income ratios can be helpful and eliminating tax deductions for debt could contribute to safety. Liability restrictions such as special taxes have been tried in places like Korea but the low-interest environment abroad may offset its impact. The related web of inward capital curbs most prominent currently in Brazil may mitigate the boom tendency but they are an experiment still without “firm findings” the observers conclude.
