The Expanding Role of the "Financial Stability Forum"

A perhaps underreported aspect of the credit crunch is the growing role of internation regulatory efforts such as the Financial Stability Forum (FSF).  The FSF, as described by Treasury Undersecretary David McCormick, "brings together supervisors, central banks, finance ministries, the International Monetary Fund and the World Bank, and other international regulators. Together, the members of the FSF assess international financial system vulnerabilities and identify needed actions among responsible authorities. This provides critical coordination between globally integrated capital markets and national regulatory agencies." 

The FSF reported to the G-7 with recommendations for an international response to the market turmoil:

Prudential oversight: Firms need to strengthen their risk management practices, liquidity buffers and capital. The Basel Committee should raise capital requirements for complex securities and off-balance sheet vehicles.  . . .

Transparency and valuation: Firms need to fully disclose their risk exposures and fair value estimates for complex securities. . . . The International Accounting Standards Board should urgently act to improve standards for off-balance sheet entities and improve guidance for fair value accounting.

Credit ratings: Investors should improve their due diligence efforts, reducing their reliance on credit ratings. Credit rating agencies need to clearly differentiate the ratings for structured products, improve their disclosures, and reassess the quality of the information they use to determine ratings for structured products.

Authorities' responsiveness to risksDealing with stress in the financial system: Supervisors and central banks need to increase their cooperation and information exchanges, including assessments of financial stability risks.

Dealing with stress in the financial system: Central banks need to effectively provide liquidity when the financial system is under stress. In addition, authorities should strengthen arrangements for dealing with weak and failing banks, domestically and across borders.

As has been demonstrated by the sub-prime crisis, international markets have not decoupled from the U.S.--on the contrary, securitization spread risk and reward internationally.  Many of the financial institutions most affected by the sub-prime mess are multinational, and better regulatory coordination among the nations at interest should be welcome.  Still, another layer of regulation means more bureaucracy.  Paulson's efforts to clear (or at least rearrange) the deck with respect to some U.S. financial regulation is perhaps in recognition of the fact that international or supranational regulation will take on greater prominence with globalization--the result is not so much a net decrease in regulation (not for most larger public companies, at least), but a relative increase in international regulation and (hopefully) a slight decrease in overlapping domestic regulation.

UPDATE:  The Basel Committe has also just come out with proposals for tighter regulations on banks; see report here.

Posted by: Paul Rose