G20 on banking regulation and leadership responsibility of EU

By Zdenek Kudrna

The G20 meeting this weekend was more important for the fact that major emerging economies were invited than for the substantive decisions. It all makes sense to get India and China at the same table with G8, but it does not make it easier for the US to swallow any kind of supranational financial regulation. I guess we need to wait for the new brand of Obama multilateralism to see any progress on this front.


The G20 statement is thick on good intentions, but thin on specific proposals: Increased transparency of financial sector, regulation of rating agencies, avoiding pro-cyclical regulation, increased information sharing between national authorities, expanding the FSF to include emerging economies and ensuring that IMF and other multilateral institutions to have sufficient resources to support emerging economies capital needs. It practically shifts the ball to the Financial Stability Forum that should develop substantive proposals for the next meeting of G20 in April 2009.

I doubt that FSF would be able to cut through the complexity of the global financial markets and formulate the future vision of the global financial architecture that could deal with all aspects listed by G20. Actually, I believe the EU 27 should be the leader in terms of substance of the new financial regulations. If EU cannot make progress towards supranational regulatory regime, than chances for global progress are slim.

Today EU is composed of both developed (EU15 + 2) and emerging economies (EU10) and its financial sectors cover the full spectrum from cutting edge of finance in the City of London, to rather sleepy backwaters in Prague or Bratislava (Today the 'advantage of backwardness' is worth billions of dollars as it means little exposure to 'innovative' financial products that proved 'toxic'. So Czech and Slovaks may still hope to get through the financial crisis without involvement of state finance). At the same time, EU financial markets are highly integrated, but the regulation is still based on home-country supervisors and its supranational dimension did not progress beyond vague memoranda of understanding and more or less informal consultation process.

EU is well aware of the discrepancy between the financial integration and fragmented regulation. A few years ago it even devised the so-called Lamfalussy procedure to be able to catch up on the regulatory side. However, even before the financial crises the regulatory integration hit the wall. Even the idea of regulatory colleges for major internationally active banks that now seems a nobrainer proved too politically contested to be passed.

As is often the case, lack of compromise boils down to interest-group politics. The political cleavages among vested interests in different countries proved too numerous. Brits, like Americans on the global scale, are suspicious of the supranational regulators. French push for centralized heavy-handed approach. Germans worry about their parastatal landes banks. The EU10 countries are not quite sure whether they should try somehow to adjust their regulatory regimes to the fact that all their banks are controlled from abroad (so they just hope for the best now). Moreover, the non-euro countries are not keen on letting ECB (which usurped the bank supervision responsibilities) to supervise their banks. Moreover, the retail banks are not keen on reducing regulatory barriers to competition, whereas wholesale banks support it. Moreover, parties on each side of these plentiful cleavages are shifting all the time. No wonder EU did not make much progress.

the other hand, times of crisis force some clarity of thinking and make clearer the relative costs and benefits of various arrangements. Some refined objections to supranational regime lose their persuasiveness as bad news keeps coming. Some political compromises (such as principles for agreements on burden-sharing of fiscal cost of bailout of banks active in many EU countries) that would be unthinkable in the normal times may be possible in extraordinary times. Economists call this benefit of crisis. If EU could seize on it, the rest of the globe would be more likely to follow.