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G20-IMF-FSB Update - March 5, 2010

By Adam S. Hersh

FSB Chair Under Fire

Revelations that investment bank Goldman Sachs helped Greece hide the size of its fiscal deficit through creative financial derivatives transactions have cast a spotlight on an unlikely place: Financial Stability Board Chair Mario Draghi. In between a long run as Director General of the Italian Treasury (1991-2001) and becoming Governor of the Banca d Italia and Chair of the Financial Stability Forum (since 2006), Draghi was a vice chairman and managing director of Goldman Sachs International where his job was to leverage his political connections to develop business with European governments and government agencies. Banca d'Italia issued a statement denying that Draghi played any role in the Goldman-Greece affair, but questions remain about what Draghi might have known about such dealings and whether he might have been brokering similar services to other governments. The allegations are spilling over into the race for the next European Central Bank presidency and also call into question the integrity of international financial reform coordination under Draghi's stewardship.

G-20 Deputy Ministers Meet

On February 27-28 the G-20 Finance Ministry and Central Bank Deputies met in Songdo, Incheon, Korea with 150 representatives from the G20 countries, the IMF, the World Bank, and the OECD. Although the meeting was closed to press and the deputy ministers issued no communiqué, reports indicate that issues under discussion included: US current account deficits and Chinese surpluses, voting share reform at the IMF and World Bank, and international coordination of ‘exit strategies’ from the exceptional fiscal and monetary policies adopted by many countries in response to the financial crisis and global recession. The deputy ministers were laying the groundwork for higher level discussions at the G-20 Finance Ministers and Central Bank Governors meeting to be held April 23, 2010 in Washington, DC.

Substantial Representation Gains for China

While voting share reforms at the IMF and World Bank are still being hashed out, on February 24, the IMF appointed Zhu Min, deputy governor of China’s central bank, Special Advisor to IMF Managing Director Dominique Strauss-Kahn. It is unclear what role Mr. Zhu will play or what authority he will wield. Part of his role will be to help rebuild relations with Asian countries that have been leery of the IMF since the 1997-98 Asian Financial Crisis and the IMF's heavy-handed treatment of crisis-stricken countries. But Mr. Zhu's appointment perhaps indicates that the locus of the politics of global imbalances will shift within the IMF. For years, the IMF--at the behest of the US and Europe--has admonished China's ‘hard pegged’ exchange rate regime, a policy that Mr. Zhu strongly supports. Mr. Zhu appears in line for a top position within the IMF. Although talk of forming an Asian Monetary Fund following the 1997-98 crisis have ebbed, a number of Asian countries including China and Hong Kong SAR have created a less institutionalized mechanism in the Chiang Mai Initiative to supplant the IMF as lender of last resort in the Asia region.

China has also been gaining representation at the international standard setting bodies. Alongside four other developing countries, Australia and Russia, China gained membership at the Basel Committee on Banking Supervision in early 2009. And the international finance rumor mill also suggests that China or another Asian country national may be a leading contender to replace International Accounting Standards Board Chairman David Tweedie (British) when he steps down in summer 2011.

Yet More IMF Mission Creep

In a speech in Washington, DC, Managing Director Dominique Strauss-Kahn called for an updated and expanded mandate for the IMF with new authority to supervise the global financial system. The IMF’s mandate as laid out in its Articles of Agreement in 1944 is to promote exchange rate stability, to provide temporary assistance for balance of payments adjustments, and to promote high levels of employment and real income for member countries. In the years sense its founding, the IMF has pushed the limits of its mandate into activities monitoring countries' governance structures, fiscal and social priorities, poverty reduction strategies, and more.

Financial Reform: International Coordination vs. National Efforts

While IMF chief Dominique Strauss-Kahn continues sounding caution that co-ordination works better than unilateralism for international financial reforms, a number of high profile economists including Nobel laureate Joseph Stiglitz (registration required), former IMF Chief Economist Simon Johnson, and Harvard professor Dani Rodrik have been vocal against internationally coordinated financial reform in favor of national efforts.

On paper, internationally coordinated financial reform makes a lot of sense. A common international regime could help eliminate opportunities for banks to exploit regulatory arbitrage (that can push down standards everywhere) and make it clear how to resolve bankruptcies with large cross-border asset and liability holdings. But in practice international coordination also carries several serious problems. For starters, international coordination is ‘painstakingly slow.’ Efforts that began at the November 2008 G-20 meeting are targeting a July 2010 deadline for a comprehensive proposal of reforms to prudential regulation and supervision of banks. Then proposals will be debated some more as they begin wending their way through disparate domestic political processes on the path to actual implementation. Every day that financial regulatory reform is delayed is another day that the same financial risks and abuses that got us into this financial mess continue. The G-20 is aiming for implementation by the end of 2012.

Next, the process of international coordination is egregiously undemocratic. Yes, the club of participating countries has expanded notably since the last global financial crisis. But most countries remain excluded from the process, although they will be entreated to conform with new standards and will be subject to the economic fallout spilling over from those advanced economy countries. What's more, the coordination process is ceded to a clique of global regulators---many of whom, no doubt, have spun through the revolving doors between private sector and public governance---working behind closed doors in places far removed from institutions of democratic accountability in their home governments. This would be less troublesome if regulators were merely nailing down the ‘best’ technocratic fix to ensure a stable, fair, and efficient international financial system. Rather, a lot of the hold-up is because governments are bargaining over how costs and benefits of new regulations will be distributed to secure relative privileges for their home country institutions.

All of this spells good news for business as usual at private financial institutions: regulation deferred is regulation evaded. And the longer reform is deferred, the more initial political will erodes and the greater is the opportunity for financial interests to influence the process. Laura Kodres, a division chief in the IMF’s monetary and capital markets department, cautions that even ‘incentive compatible’ regulations will be met with resistance from the private financial sector. Lobbying efforts from the financial sector are already in full force at the national and international levels (registration required).

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