Key report on financial reform

Image via WikipediaImage via WikipediaImage via WikipediaFrom The Economist - An important new report on regulating the financial industry released Thursday (Jan 15) should play a crucial role in shaping the financial reform agenda.


The Group of Thirty’s “Financial Reform: A Framework for Financial Stability” is important both because of the concreteness of its 18 recommendations and because of who was involved. The authors were led by Paul Volcker, Tim Geithner, Larry Summers, and Jean-Claude Trichet, (president of the European Central Bank).

Banks:

• banks deemed systemically important would face restrictions—in the form of “strict” capital requirements—on high-risk proprietary activities, that is bets made using their own money
• strongly encourage investment banking arms of banks to focus on client businesses, such as merger advice, rather than trading
• separating these needed because they seem “unmanageable in financial conglomerates"
• also require raising the level at which banks are well-capitalised
  

Non-bank financial institutions:

• pools of private capital that live on borrowed money should have to register with a regulator and produce regular reports, disclosing things such as leverage and performance.
  
• biggest of them would even be subject to capital and liquidity standards.
  
• bank-like regulation for money-market funds
  
• legislation in America to set up a mechanism for dealing with non-bank failures

Other key issues:

• Central banks should be more involved in supervising banks—but to safeguard integrity the role of chief firefighter should be played by others once trouble ignites. Central bankers “need to be more concerned about financial stability, but less involved in crises,”
• formal system of regulation for over-the-counter derivatives, such as the type of credit swaps that sank American International Group
• urges regulators to force banks to hold on to a significant portion of credit risk when they package loans into securities and sell them on, in order to curb reckless underwriting of mortgages and other debt.
  
• calls for a rethink of certain accounting principles that may exacerbate downturns through pro-cyclicality, including the practice of marking assets to the current market value;
  

The other important message is that a global crisis requires a global fix. Mr Volcker was typically modest, insisting it was more an agenda for discussion than a hard-and-fast blueprint. But, given his closeness to Mr Obama, it is hardly far-fetched to imagine much of it becoming official policy. All that talk of the biggest overhaul of financial regulation since the 1930s just took a step towards reality.
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