The impact of the recession on the global economy, particularly in the developed countries, has been severe. At the same time as the developed world has lost tens of millions of jobs (an estimated 34 million since 2007),1 the developing world is struggling to harness expanding growth opportunities and cope with their growing populations.
Consider that more than 50 percent of India’s 1.2 billion people and 60 percent of Africa’s 1 billion population are 24 years of age or younger. Trust is critical to making the capital markets work. Investors won’t invest until they trust the capital markets system; consumers won’t buy until they have confidence; and businesses won’t deal with each other, borrow or lend money, or make deals until they have trust in the system. Global regulatory reform is also a critical part of restoring this trust, and financial and accounting regulation changes need to provide a solid foundation for growth. For business leaders, as well as governments, the current lack of confidence or trust in the capital markets and business in general is a major challenge.
Let’s face it, in many places around the world the system let a lot of people down, savings were wiped out, retirement plans altered. One of the obvious outcomes of this situation is the call for stricter regulations. And after what we have gone through, that’s understandable. Regulators around the world are defining the specifics on issues like capital requirements and much tighter liquidity requirements. They are mandating not only what to disclose but how to disclose it. They are taking positions as to what are acceptable business models or risks.
However, changes in financial regulation must be designed and applied thoughtfully. I believe we need a global regulatory framework for global, complex institutions. I am not saying we need a single global regulator, but there needs to be a framework so the world is moving in a similar direction even though they may take different paths. A clear destination would be very constructive. Countries also need to continue to come together in groups like the Group of 20 (G-20) to focus on the issues, to share best practices, to learn from each other. I believe we’ll get to a reasoned solution, with a global framework and consensus for moving forward on key items, provided we keep the following principles in mind:
- We do need global financial institutions with the resources to meet the highly complex needs of global companies: at the same time, we must reduce the systemic risk in the system.
- We shouldn’t take any actions that put the current fragile recovery in jeopardy.
- We must be thoughtful and not over react.
I am encouraged by the work that has been going on with the G20 and the Financial Stability Board (FSB). It could move regulators to focus not only on tactical country level views of compliance and regulation, but to also work across borders to a macroprudential view to assess and monitor the strengths and vulnerabilities of the global financial system.
By bringing together national regulators from different functions – banking/treasury, securities markets and insurance – the FSB can reduce risks of regulatory arbitrage, both between countries and across industries. I believe that we have not yet seen the possibilities of the FSB, and I am watching with interest to see how that group and its work develops.
Let me turn to one specific issue being debated across the globe: ‘too big to fail.’ There is no question this must be resolved. On one hand, there is a need for large, global financial institutions that can serve the needs of large, complex global companies. On the other hand, when an institution becomes integrated into every part of the global capital system, it presents a systemic risk when it pursues more risky initiatives.
And we need to protect the system. There are many approaches being tried and debated. The U.K. FSA announced that they are pursuing a path that says that banks operating in the U.K. will be required to produce ‘living wills’ to provide blueprints on how to wind them down in the event of financial difficulty. The documents would allow financial authorities to manage a bank’s demise quickly if there’s an issue.
At the end of 2009, a small number of major U.K. banking groups began to produce living wills as part of a pilot exercise intended to help the FSA develop policy in this area. In the U.S., a draft proposal to deal with ‘too big to fail’ firms unveiled by the Treasury Department requires companies that can affect large parts of the system to abide by ‘heightened prudential standards.’ These include leverage limits, liquidity rules and ‘living wills.’ And the Volker Plan addresses this topic as well. Of course, the caution here is to guard against requirements that compel institutions to keep so much capital on hand to hedge against excess leveraging that the industry becomes unattractive to new capital investors.
Regulatory bodies around the world are looking for a systemic and orderly answer to the ‘too big to fail’ issue and that will be the hot topic for the near future. This is a worthy conversation and highlights the need for a global regulatory framework.
Read more about Tim Flynn’s delivery of the Ken Spencer Memorial Lecture in the April 2010 edition of Across the board [PDF 343].
1 WEF International Business Council International Business Council Background Note prepared by the U.N.’s International Labour Organization, January 2010.