The Way Forward
The global financial crisis has been a truly an international crisis. The crisis had its genesis in the US sub-prime mortgage market and quickly spread to other financial markets, leading to dislocation in international credit, debt and equity markets. The market volatility that emerged in the summer of 2007 continued to undermine investor confidence well into 2011.
Following Lehman’s collapse in late 2008, the financial crisis transformed itself into a crisis in the real economy. Credit markets froze, banks stopped lending and some financial institutions collapsed as investor panic set in. All of the ingredients were now in place for a full-blown economic catastrophe not witnessed since the Great Depression of the 1930s. The GFC led to significant declines in industrial production, described by the International Monetary Fund as the “Great Recession,” with millions of workers losing their jobs worldwide.1
Although the international economy staged a recovery at the end of 2010, by the beginning of 2011 cracks began to emerge in Europe. The sovereign debt crisis, which initially started in Greece and Ireland, soon spread to other debt-laden countries, including Portugal, Spain and Italy. This euro debt crisis sparked fresh fears that the recovery would stall and a new crisis would emerge to engulf international currency and financial markets.
International Council for Financial Stability
The United States and the United Kingdom have led the way towards reform and enhanced regulatory oversight with the creation of a Council for Financial Stability which has its primary focus on examining, analysing and making recommendations for addressing systemic risk concerns. Systemic risk is now a core objective in financial markets regulation in the US and the UK. The European Union has also expressed a desire to achieve greater cooperation and coordination among national supervisors, central banks and governments in its member states.2 With the sovereign debt crisis in Greece continuing to undermine investor and market confidence, the EU has pledged to develop more robust crisis prevention and management procedures in order to promote financial stability throughout Europe.3
With this objective in mind, it is appropriate and timely to propose that a new Council for Financial Stability be established at the international level. The proposed International Council for Financial Stability (ICFS) will have financial stability of international financial markets as its core objective. The ICFS will have a similar regulatory objective to the Council for Financial Stability in the US and the UK, but will be international in its regulatory focus.
The need to develop an international council has been established by recent events, which revealed structural shortcomings in the ability of national regulators and governments to coordinate a rapid response to the onset of the crisis. The ICFS would be an association of financial stability councils, central banks and national treasuries, whose aim would be to promote financial stability and to provide an integrated approach to crisis prevention and the resolution of bank and large entity collapses. Further, the IFCS should not only provide a forum to discuss significant economic events but it would also include policy development and provide up-to-date risk assessments that accurately quantify the probability of systemic risk confronting the global economy.
The ICFS would be tasked with developing a comprehensive and international framework for the purposes of formulating clear policy guidelines to achieve the global policy objective of financial stability. Unlike current arrangements of the G84 and the G205 finance and leaders’ summits, the ICFS would be expanded beyond the richest nations of the world to include developing and emerging nations, in order to be a truly international organization.
The ICFS should have representation from all countries, as developed and emerging nations are interconnected through the phenomenon of globalization. As is discussed in Chapter 1, serious ramifications can flow even from relatively small economies, as the world witnessed in the Asian currency crisis of the 1990s, which was sparked by Thailand. As the more recent example of Greece has shown, in a global and interconnected world, problems with small nations can lead to more significant reverberations across the international economy.
The ICFS should also develop a set of core objectives to achieve the overall stated aim of promoting financial stability in the international economy. These core principles should ordinarily include the following:
1. To monitor, assess and anlayse the probability of systemic risk confronting the global economy.
2. To provide up-to-date risk assessments and risk mapping of significant economic events, including the collapse or imminent collapse of large interconnected entities.
3. To provide leadership in the coordination of government, central bank and treasury responses.
4. To manage and resolve economically significant events, including bank runs, collapses of large interconnected entities and excessive market volatility on international securities exchanges.
5. To exchange information with member state organizations, including central banks, treasuries and governments, with the aim of promoting financial stability and market integrity.
6. To make recommendations for policy reform designed to improve market transparency and overcome deficiencies in the regulatory and supervisory framework of the financial markets of the member states.
7. To collaborate with other international agencies, including the International Monetary Fund, the International Organization of Securities Commissions and The Council for Financial Stability in the United States, the Council for Financial Stability in the United Kingdom, the European Commission, the World Bank and the Bank for International Settlements.
Consistent with the overall aim of promoting financial stability in the international economy, the ICFS should also take a leadership role in developing a set of core principles that will minimize systemic risk in international financial markets. The core principles will provide guidelines for member states to choose to adopt as part of their legislative agenda, and could include:
1. To develop a set of core principles for central banks, treasuries and governments to adopt to promote financial stability and minimize systemic risk within their nations’ financial markets and domestic economies.
2. To develop a set of principles to ensure that market transparency and corporate, banking and financial disclosures are promoted in financial markets regulation.
3. To develop a set of regulatory principles that are designed to minimize systemic, regulatory and legal risk and to provide for a robust regulatory regime.
4. To develop core principles designed to provide effective prudential oversight of banking activities consistent with Basel III guidelines and pronouncements.6
5. To design appropriate regulatory principles to minimize excessive risk-taking and speculation capable of causing damage to financial markets and the real economy.
6. To develop a set of regulatory principles for the use of credit ratings within the banking sector and financial products with special emphasis on product issuers, promoters and underwriters of securities, derivatives and structured financial products.
7. To design a set of principles in conjunction with the International Organization of Securities Commissions for good practice for derivatives clearing organizations;7
8. To develop a common set of standards for financial reporting requirements which will aid comparability and the understanding of financial reports, and allow meaningful analysis of potential weaknesses and structural vulnerabilities in the international banking and financial system.8
9. To develop a common set of principles for good banking practices which emphasizes consumer protection and minimizes the instances of abusive or misleading practices.
Policy and Research Development
The ICFS would also be responsible for making recommendations for regulatory reform designed to promote financial stability and minimize systemic risk with international financial markets. The recommendations for reform would be made to member states that can adopt the recommendations as part of their legislative agenda. The ICFS could coordinate policy development and provide an effective international forum to debate proposals for regulatory and supervisory reform of financial markets with the aim of promoting financial stability at the international level.
To aid the proper and effective assessment of systemic risk, the ICFS should also establish an international systemic research office capable of providing timely research and up-to-date data. Like the Office of Financial Research, which was created under the Dodd-Frank Act 2010 and serves the Financial Stability Oversight Council in the United States, an International Stability Research Office should be created for the ICFS.10 The International Stability Research Office would provide for the ICFS up-to-date and timely data and analysis which would be focused on promoting financial stability and minimizing the incidence of systemic risk in global financial markets.
Providing timely, relevant and up-to-date data and analysis to the ICFS would also support the Council in anticipating and responding to future crises. The assessment of systemic risk concerns and risk mapping of structural vulnerabilities can be supported with the provision and use of timely data and information. The provision of reliable data will, in turn, allow the ICFS to better anlayse, examine and monitor structural weaknesses with international banks and global financial markets.
Ongoing Monitoring and Reporting Requirements
Like the Financial Stability Oversight Council in the United States, the ICFS would also provide ongoing monitoring and reporting to its member state representatives. The reports by the ICFS would provide relevant and reliable information to central banks, treasuries and governments regarding any potential systemic threats to financial markets, banks and non-bank financial institutions.
The reports prepared by the ICFS would also contain information regarding risk analysis and structural weaknesses in regulatory and supervisory frameworks of member states. In the lead-up to the GFC, many national and international regulators were caught unaware of the build-up in risk in the shadow banking system that later spilled over and contaminated the conventional banking sector.