The go-go years on Wall Street and in the City of London are over – and won’t return for a long time. Even when the global economy rebounds, the tighter regulatory noose set out in a blueprint drawn up for the G20 summit next month will stop finance bouncing back. This will be good for most people – except financiers.
The ability of 20 nations to achieve consensus on this 24-point programme, a copy of which has been obtained by breakingviews.com, is a significant achievement in international collaboration. The consensus covers not just Anglo-Saxon economies such as the US and UK, but continental European countries such as Germany and France, and the big emerging markets such as China, India and Russia. Similar proposals have already appeared in the European Union’s de Larosière report and the UK’s Turner review. A global crisis has produced a global response.
The G20 blueprint programme is largely a statement of principles. The scheme will have to be blessed when the leaders meet in April. Detailed numbers and regulatory mechanisms will then need to be worked through in the coming months.
That said, the overall scheme looks pretty robust. First, the authorities are determined to pay proper attention to credit and asset bubbles. Second, they have assembled new tools to prick the bubbles before they get too big. Third, they want banks to have fatter capital and liquidity cushions so there’s less chance of them going bust or needing bailouts when they do fall on hard times. Fourth, they want banks to manage risk much better and will force them to change the way they pay their staff in order to reduce the incentive to behave like high-rollers in a casino. Finally, they want more intrusive regulation.
This package of changes falls short of a total revolution. There is, for example, no call to bring back some version of the Glass-Steagall Act, which forcibly separated commercial and investment banks in the US during the Great Depression. But these measures will still cause dramatic changes in the world of finance. The requirement to hold more capital, for example, means banks will be less profitable. They won’t just be able to gear themselves up to the gills and hope for the best. The same goes for telling banks to have more liquid assets. It won’t be so easy to play the game of borrowing cheap short-term money and stuffing it into illiquid long-term assets. Measures to crack down on excessive risk-taking will also cut profits — at least in the good times.
With lower profitability, finance will no longer be the money-pot which sucks in talent from all across the world. Add that to restrictions designed to align compensation with long-term achievement and Wall Street and the City will no longer be such an easy way to get rich quick. Smart graduates will be more tempted to go into industry or the professions. That will be healthy.
All in all, the new regulatory compact is likely to make the post-crisis world a safer but duller place. After the roller-coaster of the last few years, that is no bad thing.
Leaders of the Group of Twenty (G20) largest economies will adopt a global plan for stronger regulation for the world financial system, at their meeting to be held in London April 2, breakingviews.com has learned.
The G20 heads of states and governments are widely expected to approve in principle the 24 proposals put forward by the working group “on enhancing sound regulation and strengthening transparency”, which would establish an international mechanism of coordination to monitor systemic risk and expand prudential regulation and oversight globally. “Large complex financial institutions require particularly robust oversight at a national and international level”, the documents states.
The report, which Breakingviews.com has obtained, also calls for stricter oversight of credit agencies, and for changes in regulations that could “mitigate pro-cyclicality in the financial system by promoting the build-up of capital buffers during the economic expansion”. In that respect accounting rules and valuation practices should “reflect the evolution of risks through the cycle”, the report states, calling for some adaptation to current accounting standards. The working group also calls for international standards for the banks’ capital ratios to increase once the crisis is over, and states that “capital buffers above minima and loan-loss provisions should be built up in good times”.
Noting that “financial institutions failed to properly manage and monitor risks to liquidity” in the event of a freeze of over-the-counter credit derivatives, the working group asks for OTC transactions to be cleared through central counterparties subject to oversight by prudential supervisors.
On compensation, the G20 leaders should agree on measures to encourage financial institutions “to ensure that their compensation frameworks are consistent with their long-term goals”. Prudential supervisors would be asked to monitor remuneration systems while assessing risk management practices. The report also calls on the International Accounting Standards Board to facilitate the global convergence towards “a single set of high quality accounting standards”.
The G20 working group, co-chaired by Rakesh Mohan, the deputy governor of the Reserve Bank of India, and Tiff Macklem, a Canadian deputy finance minister, based its work on the weaknesses it identified as drivers of the current crisis, including the lack of oversight of systemic risks and of unregulated pools of capital; weak performance by credit rating agencies; the procyclical tendencies fed by regulatory and accounting frameworks; weaknesses in disclosure and resolution procedures; and the lack of transparency of various OTC markets. Three other working groups are expected to turn in their reports at the G20 meeting: on international cooperation and integrity in financial markets; on reforming the IMF; and on the World Bank and other multilateral financial institutions.