LETTERS TO THE EDITOR

Spring 2010

by Othmar Karas

The problem of the ‘soft power’ of international financial regulation can only be addressed through the creation of a new global supervision entity along the lines of the World Trade Organisation.

Sir,
While I support Lorenzo Bini Smaghi’s central argument that the International Monetary Fund and the World Bank both need to be strengthened as part of the global response to the worldwide financial crisis, I do not believe the IMF could have prevented the current crisis even if it had been stronger. The Fund is especially important for emerging countries which are in need of money, but the primary causes of our present troubles lie elsewhere. I believe that we have to concentrate on these root causes if we want to avoid further financial crises in future.

In my opinion, the current crisis was triggered by a combination of factors, ranging from new financial products and loopholes within existing regulations to the widespread desire within financial markets to earn as much money as possible and to buy unaffordable products. It is therefore essential that the European Union (in cooperation with the G20) addresses the twin issues of inadequate regulation and international cooperation, as well as strengthening the role of the Bretton Woods institutions.

In terms of tighter regulation, the EU has been at the forefront of the global response. It is launching a number of regulations covering credit rating agencies, capital requirements and new structures for financial supervision. This is in line with its ambitious goal of dealing with systemic risk, as well as improving supervision of the three main financial sectors - banks, insurance and securities. The Directive for Alternative Investment Funds, for example, will be an important step forward for the securities industry.

In terms of international cooperation, it is now abundantly clear that no country can solve the problems of our times on its own. Only by acting together can we transform our common political will into legal reality and implement agreed standards such as Basel II in a coherent and effective manner. Governments therefore have to take their responsibilities more seriously and implement the changes already agreed within the G20. In the long term, the problem of the ‘soft power’ of international financial regulation can only be addressed through the creation of a new global supervision entity along the lines of the World Trade Organisation. This is an ambitious goal, one that will demand cooperation among all countries in the world.

Thus, while Bini Smaghi is right to say that savings and trade imbalances are serious problems, and that reforms in the IMF and the World Bank are necessary and desirable, I believe that an under-regulated and highly innovative financial services sector presents a greater danger to the world economic system. Without additional regulation and coherent supervision, especially of products and markets with a high degree of systemic risk, the global system will not be strong enough to avoid the build-up of dangerous bubbles in future.