Saturday, February 20, 2016

Global Financial Reform: Unintended Adverse Consequences in Connected Markets

Financial markets in the 21st Century are profoundly global. This fact was amply demonstrated by the 2007 – 2009 financial crisis, which was centered in the banking systems of the developed western economies but transmitted with devastating effect to economies worldwide. And yet, despite the global consequences of systemic risk transmission, the supervision of financial markets remains essentially a national discipline.

The Group of 20 nations (G20) concluded early that an intensive global reform approach was necessary. Their central banks, working through the Bank for Internatioal Settlements (BIS) and Financial Stability Board (FSB), have sought to coordinate reform efforts under common regulatory principles. Of course, sovereign authorities retain the duty and power to translate these into local regulations. And, naturally, lofty principles can evolve into globally divergent regulations that may be highly prescriptive and narrowly tailored in their practical formulation. As a result, national authorities may be laying the groundwork, unintentionally, for future problems in the international market system.

Some experts argue that, rather than encouraging supervisory uniformity, the pressure for global reform is bringing regulatory fragmentation. If true, the associated negative influences on the efficiency of global financial markets can actually bring an increase, not a decrease in the likelihood for systemic turbulence. Regulatory arbitrage can result when aggressive market actors shift their focus to less restrictive markets, thereby leading to riskier behavior in markets with fewer safeguards. At the same time, the flow of cross-border capital can be disrupted when restrictions in active, developed markets have a knock-on effect in dependent, developing markets.

An overemphasis on rigid principles, some say, when imposed without regard to size or complexity on financial market actors who are operating across borders, is bound to produce unintended adverse consequences.

CSFME (the Center) is now shifting its research efforts toward identifying the potential for unanticipated consequences resulting from these asymmetrical supervisory interpretations of regulatory reforms enacted in developed and developing markets.