IFI governance


The impact of financial regulation on developing countries

Istanbul, 5 October 2009

5 October 2009 | Minutes


Alvir Hoffman, Central Bank of Brazil

Mingkang Liu, China Banking Regulatory Commission

Joseph Stiglitz, Columbia University

Moderator: Nancy Birdsall, CGD

Initial Presentations

Alvir Hoffman

  • small banks and export firms effected first; central bank took action to provide liquidity
  • resilience to the crisis has two reasons: low exposure to toxic products; high liquidity buffer
  • we have strong limits, high capital requirements, supervision based on central counterparty clearing agency for derivatives, strong supervisory system
  • lessons – EME banks will be effected by global regulatory framework – it should be seen as opportunity to strengthen our regulatory frameworks
  • Comments on the existing proposals
    • Tier 1 capital changes should not be a big problems; leverage ratio should be designed with new international reporting standards in mind
    • We are comfortable with new liquidity measures
    • Countercyclical buffers – prefer through capital than provisions
    • Compensation –
    • Need to regulate/supervise all systemically important institutions
  • We need more representation in intl bodies – including IMF, BCBS, FSB


Mingkang Liu

  • cause of the crisis? Not trade imbalances, 1997 crisis didn’t have these kind of spillovers, neither did dot-com bust, real causes need to be found
  • complexity & interconnectedness – ie end of Glass-Steagall, banks reliance on capital markets
  • driving force is distorted incentives, market practitioners were seeking quick profits, not sustainable growth path
  • inadequate regulation and supervision, inadequate cross-border cooperation
  • Lessons
    • corporate governance is key to every institution; leadership must be responsible for institution. Duty to monitor from the head
    • market forces are not invincible or universal, we have no globalised standards; our duty is to be prudential – tell practitioners to stick to tested practices
    • traditional limits and ratios worked, we still use loan-value, loan-deposit, simple capital adequacy; 80% of  capital of Chinese banks are common stocks
  • we used countercyclical approach since 2004 – both capital adequacy and provisioning (coverage ratio) – discretionary basis not rule basis
  • be careful on financial infrastructure, it is not perfect, so we draw firm limits
  • regulation, legislation and supervision do have borders despite globalisation; information flow was really bad cross-border
  • As we go towards new FSB/BCBS regulation, in transition period need something basic and simple


Joseph Stiglitz

  • purpose of fin market – allocate capital and mitigate risks at low costs – US financial sector failed on all fronts, profitability of fin sector should be signal that something was wrong
  • pervasive externalities as costs put on the whole world
  • innovation in US fin markets were not creating better markets, they were tax regulatory and accounting arbitrage, they were mostly negative innovations
  • developing countries can’t afford these kinds of failures, don’t blame the saver, blame the investor – mistakes happen over and over again in history;
  • but regulators failed as well, regulatory capture and financial lobbying was a key reason
  • think of positive agenda about directing capital to where we want it to go; with regulatory rules can stop this. We didn’t learn lesson from AFC
  • We have bailed out the financial system over and over again – gave perception that markets were working fine; even though we bailed out the lenders in crisis so many times
  • We haven’t fixed things, they are worse now – moral hazard problem is larger, concentration, complexity still there
  • Financial market and capital market liberalisation are responsible for the mess we are in and helped spread the problem; EMEs had better regulation should be giving TA to the West about policies
  • We can’t allow home country regulation any more; Basle II should be dead – risk models were garbage; go back to basic plain-vanilla financial products


Birdsall -Should Basle II be dead? Is it bad for developing economies?

Hoffman – three pillars of Basle II – risk models are optional

  • original idea was only for internationally active banks, but it got too overblown
  • transparency of complexity does not help

Liu – Basle II has not been tested by any problems before, it is not perfect, but it is progressive, we are gathering lessons and modifying Basle II

  • practice makes perfect, we have to modify based on learning
  • three balances needed:
    • no complacency in EMEs on Basle, but no excessive risk aversion
    • international best practices and concrete domestic concrete situation
    • balance between domestic homework (safety nets, restructuring etc) and implementation of intl economic standards based on our perspectives

Birdsall – go to US politics on loose monetary policy and regulatory capture

Stiglitz – do a thought experiment, it was global imbalances that brought on the problem

  • low interest rates were due to weak aggregate demand, to keep economy going
  • financial sector saw large profits and they used large wealth to get loose regulation
  • stupid economic ideas: can’t see a bubble in advance, no tools to stop a bubble, cheaper to clean up afterward

Birdsall – is it too big to fail or too complex? They can be different solutions

  • insufficient aggregate demand was due to concentration of wealth and inequality



Questioner – how can we make sure with global regulation that crisis will not be easily transmittable between countries? How to get responsible parties to pay for those effected?

Questioner – products demanded by pension funds and inst investors driven by need for profit for baby boomer retirements

Questioner – How do you see selection for regulators in EMEs? What are key qualities for a good regulator?

Questioner – regulatory capture more complex than any model, you can’t quantify

  • Basle II – not designed to prevent crisis, model came from banks themselves

Questioner – new role of Fed in systemic risk regulator? How should it be done?

Liu – stopping spillovers is still open question, home regulators must control risks from the very beginning

  • cross-border cooperation don’t be naive, gaps between national legislations on resolution, accounting standards, etc
  • we need new rules for the game – should be simplified, stop people from playing games
  • greater leaders are almost always great simplifiers, regulators should give market practitioners simple, basic rules that they must follow
  • models are always controversial and complicated, we can not rely on them alone; we need new Basle II or Basle III with some rules-based system but also lots on discretional basis – must balance, be cautious
  • crisis management – have to look at commercial banks but also counterparties, look at interconnectedness; building block approach; get things in the right order
  • calm your panic, make sure the sequence is correct

Stiglitz – first we need to ask what kind of fin system we want; if we want money to go to SMEs, need to use regional banks, small banks

  • we continued to do this after crisis management
  • Basle II was simply for big banks to reduce their capital requirements, undertake more risk

Questioner – what about future of reserve currency?

Stiglitz – I think we need a new global reserve system

  • investors can’t have free lunch either – a series of agency problems

Liu – far too early to think Chinese currency could be an intl reserve currency

  • in reality – “countries with reserve currencies have to be more responsible, we have to be more supportive, in long run working together we can make some difference”
  • lets hurry up – time and tide wait for no man

Hoffman – supervisor needs autonomy and authority to do macro-prudential regulation