On April 2, a strange thing happened. No, it wasn?t that India?s Prime Minister rubbed shoulders with global leaders in Britain. He has done that before. It wasn?t that India was asked what was happening in India ?that happens all the time. It was that India was asked how should global finance?where India is a bit player?be re-ordered for the benefit of the world. Americans, Brits, French and other G7 countries are asked this all the time and they clear their throats before expressing their world view of financial regulation, one that is forged from a well-thought through assessment of their own national interests. But what formulations of international financial regulation are in India?s national interests and what are not? Does India know? In the past we didn?t care. India used to say that the best thing for global finance is for it to leave India alone. Today, India needs to develop ideas on a global financial architecture that would work for the world, as well as for India. There was no Indian signature to this G20 communique, no paragraph where you could say, ?ah, the Indians insisted on this?. There were UK, US, Chinese, French and German signatures. Next time it needs to be different. What should that Indian signature be?
I would leave it to experts like Dr Rajiv Kumar of ICRIER to develop a holistic view of India?s international agenda, but I would like to open the debate on India?s position on the desirability or not of global regulation. The knee-jerk reaction of the developing country intelligentsia in India and elsewhere is that we need a world governed by rules that reflect the wishes of the world as a hole. It?s a nice idea. Poor countries always favour rules in a forlorn attempt to constrain the hegemon?in this case the US. Certainly rules are far better than an ad hoc application of the hegemon?s power, but we have a poor record of constraining the hegemon. The reality is that when the hegemon agrees to rules it is because it expects to set those rules or their enforcement.
The nuclear non-proliferation treaty is used to beat up on any developing country with nuclear power pretensions but few point out that this was the quid pro quo of the nuclear powers disarming ?which they have not yet done. Indeed, a simple observation is that any organisation where developing countries have a strong voice, such as the UN General Assembly, has been striped of any real power and become irrelevant to global governance. Any international body that wields real power such as the UN Security Council, the Basel Committee of Bank Supervisors or in times gone by the IMF, have very little developing country influence. And yet the developing country intelligentsia still want global regulation governed by global institutions that employ the developing country intelligentsia, to do the work of the rich countries. They will all tell you of the one case in which a tiny country, Antigua, took the US to the WTO and won, but this is merely the exception that proves the rule.
When it comes to financial regulation, the developing country intelligentsia have bought in to the story told by big banks and supported by the rich countries that house them, that finance is global and so regulation needs to be global and without global regulation there would be a race to the bottom of poor regulation. This view has spawned the idea that the Credit Crunch of 2007-9 was, in part, a result of insufficient reach of regulation and that a solution is to take existing regulation and spread it more comprehensively across more institutions and jurisdictions. That would be an incorrect diagnosis. At the heart of the crisis were highly regulated institutions in regulated jurisdictions. The crisis has involved a regulatory failure as much as anything else. Global regulation for global finance sounds poetic, but it is what the big banks want?global reach and minimum capital requirements?and it doesn?t work for developing countries.
We tried global regulation in banking. It is called the Basel Committee of Bank Supervisors Accord on Capital Adequacy (I and II). This crisis has highlighted the failure of global regulation, not its absence. The first failure is what I call ?the Iceland? problem. How do you solve the problem that you have banks in your country from a jurisdiction that has overly lax regulation? There are two alternative solutions. The global regulation school argues that you should require all 192 countries to apply the same regulation and then you can relax. But this generates a whole series of other problems. A single approach to regulation is unlikely to be as applicable in India as in Norway or Iceland. And how do you know that these global rules are being enforced to the same degree in all 192 countries? Under global regulation you cannot relax.
The alternative is that you require every local branch of an Icelandic Bank or other country to be a stand alone subsidiary with sufficient capital to withstand the failure of its parent. This is doable, safer, and will likely mean more appropriate regulation. This is how India regulates today and should not give it up. The big banks hate it because it means more capital and constraints to their global reach. We need more national policy space, not global regulation of banks.
The second problem with global regulation is that what we really need to avoid crises is more macro-prudential regulation and that needs to be local not global. Let me explain. This is not the first banking crisis that the world has seen. It is more likely to be nearer the eighty-fifth. Credit default swaps were not around for the other eighty-four. Credit rating agencies and off-shore financial centres cannot explain the other eighty-odd. In reality, crashes follow booms. The current crisis is nothing but yet another instance of an all too familiar boom and bust cycle. But if crises repeat themselves, banning the products, players and jurisdictions that were circumstantially at the centre of the current crisis will do little to prevent the next one. We need to supplement micro-prudential regulation with macro-prudential regulation to calm the booms and soften the busts.
The most popular form of macro-prudential regulation is turning out to be Goodhart-Persaud Counter-cyclical Capital Charges. The purpose of these charges is not to eliminate the boom-bust cycle?this is neither possible nor desirable?but to lean against the wind. The monetary and regulatory authorities would set a range of bank asset growth and when growth exceeds this range, the amount of capital banks need to put aside for a rainy day rises and when growth falls below this range capital adequacy requirements fall.
Goodhart-Persaud counter-cyclical charges cannot be implemented or set globally but need to be done nationally. There is not a single global economic cycle. We are experiencing today the mother of all global recessions and yet, almost every country is at a different point in the cycle. India is certainly further behind the cycle than a big exporter like China. There is a need for information sharing and co-ordination of the principles of regulatory actions, but in the actual application of these principles, we need ?home country? regulation not global regulation.
We cannot hope to prevent crises completely, but we can perhaps make them fewer and milder by adopting and implementing better regulation everywhere. Better regulation means two principal things. First, the focus on micro-prudential regulation needs to be broadened to embrace macro-prudential regulation. Second, macro-prudential regulation means more national regulation. In reality, India?s bank regulation is too anti-competitive, but at G-20 it should be championing elements of the Indian approach: while nodding to international co-ordination and convergence in some areas, more national policy space and as part of that, more macro-prudential regulation. This is the beginning of an international agenda.
?The author is member of the UN Commission of Experts and chairman of the Warwick Commission on International Financial Reform
