25 Feb

Jane Fuller on the new revised Ed. of Davies & Green’s Global Financial Regulation

Posted By Politybooks

Jane Fuller
With all the hand-wringing that goes on over financial regulation, you would think that books on the subject would be two a penny. Surprisingly, they are not. So, Howard Davies’s and David Green’s book, Global Financial Regulation, remains an essential guide.

This is despite the fact that, as they write in the Update, “Time seems to have speeded up in the world of financial regulation” since the first edition was published in spring 2008. That Update is, of course, a crucial part of the second edition, but the job is made easier by the fact that two important trends in reforming the system were recommended by the authors.

The first is that the Financial Stability Forum should be beefed up and fulfill its promise as a co-ordinating body for the world’s economic and financial regulators. Now dubbed a board, in April 2008 it set out tasks for bodies ranging from the Basel Committee on Banking Supervision to the IMF and national central banks. In many cases this remains a work in progress, but profound changes in such areas as bank capital and liquidity requirements have been initiated.

The second is the expansion of the membership of international bodies to reflect the changing balance of power in the world towards emerging nations such as China. This addresses the legitimacy issue raised in the book. An obvious example is the expansion of the political hub from the G7 to the G20.

Other trends are either less clear or less appealing to the authors. The US, with its bewildering array of financial regulators has realised the need for fundamental re-engineering. But while some consolidation of banking supervision has taken place, delivery of wholesale change has run into political resistance, not least because of scepticism about giving additional power to the Federal Reserve.  

In the EU, the Larosière proposals have tackled both the need for a systemic risk board and greater cross-border powers to ensure standards are applied. But, in the authors’ view dependence on co-operation between national regulators remains a second best solution in a single market.

Larosiere also left the sectoral bodies – covering banking, insurance and markets – intact. This is out of line with the book’s original theme that such divisions are out of date. The collapse of firms such as the insurer AIG through their dabbling in investment bank-style activities would seem to bear out the need for regulating according to what the institution actually does, rather than what it calls itself.

The authors’ background is at the Bank of England and the FSA, where they led the case for “one stop shop” regulation. But even though the crisis has shown little correlation between structure of regulation and good or bad outcomes, there preference for a unitary authority has been frustrated. In prudential supervision, the swing is back towards central bank authority, with new or separate bodies  focusing on consumer protection. If the Conservatives win the UK general election this spring, the FSA will be dismantled.

But none of this negates the value of the original book, which is descriptive rather than opinionated. The advantage is that it does what it says on the tin. It is indeed an essential guide to the teeming bodies that feed into the “simplified” chart on page 33.

The authors conduct a first-class bluffers’ tour of differing approaches to regulation and of the surprisingly short history of cross-border bodies. The Basel Committee only dates back to 1974 and the buzzphrase “financial stability” is a juvenile apparently coined in 1994. Charles Goodhart has since pointed out how hard it is to define it, let alone measure it.

[OPT PARS] [They also point out how difficult it is for grand international initiatives to be effective. The book describes the other FSAP – not the EU’s action plan but the Financial Sector Assessment Programme of the IMF and World Bank. Launched in 1999, it has cost more than $1bn and “most major countries” have been assessed.

Exceptions are China and the US – one of many instances where the latter is a whipping boy in this book. The former is of course to be welcomed into every international forum. Yet are these two countries wrong to resist when cost-benefit analyses of this FSAP have proved inconclusive and the inspectors could not even sniff the onset of an international crisis in the Dominican Republic.

In the end regulation is a political subject and the authors do portray their prejudices: they do not like sectoral regulation, fragmented and competitive regulation, or regulation pulled in different ways by politicians.

As one would expect from powerful intellectuals, the case for a rationalised and simplified way to manage the international world of finance is strongly made.
But the practical problem of how universal regulators can develop sufficient market knowledge is skipped over; and so too is the cultural divide between prudential supervision and consumer protection.

Jane Fuller is Co-director at the Centre for the Study of Financial Innovation.