BY G.O. OMEH
Introduction
The shock of 2007-2008 global financial crisis had triggered increasing research effort in the area of global regulatory reform in the banking system which no doubt is the hub of the financial system. This research interest became stronger upon realization that the global crisis was induced substantially by failure of the regulatory agencies. The financial and economic losses associated with the crisis as reported by the World Bank was estimated at $15 billion. It is reported that the 2007/2008 global financial crisis remains the worst since the Great Depression of the 1930s.
Banks the world over play vital roles in the financial system such as: facilitation of payment system, provision of liquidity, credit intermediation between savers and investors; pooling saving and risk-sharing etc. The absence of any or some of the above functions will result in financial instability which imposes great costs as it many generate systemic effects. In fact, some banks have been described as institutions “too big to fail” or Global Systemically Important Financial Institutions (G – SIFIS).
The dominant view of experts is that regulation is required to offset market failures associated with failure of banking system operators to appreciate the externalities associated with their particular behaviors; operators excessive policy short-termism and ignoring of risks and poor attention to safety nets and moral hazards by operators.
The global financial crisis has also underscored the need for a globalized banking regulatory regime. In response to the world financial crisis, nations of the world had made some policy changes and had also enacted new laws to forestall future occurrences. For examples, in the year 2010, the United States enacted a new Act while in February 2009, the United Kingdom enacted a new Banking Act. Germany on the other hand responses to the crisis by banning “short selling” and also by restructuring the German banking system: France in response to the crisis passed into law a new banking and financial regulation rule.
International efforts towards global regulatory standard were evident prior to the global crisis. Basel I and Basel II. Basel I (also known as Basel Accord of 1988) was the initial international response towards setting cross-border standards in banking regulatory regime. Basel I adopted the concept of ‘risk-weighted’ capital requirements whereby assets of bank were “pigeon-holed” into varying capital requirements imposed, depending on the relative riskiness of the assets of the assets concerned. No optimal level of capital requirement was set under Basel I, rather the level was designed to be slightly above what the banks were already holding.
Basel I however, did not stand the test of time in the face of rising economic and financial crisis. Basel II came on board as a significant improvement on Basel I. Under Basel II, level playing field was not only introduced in capital regulation but capital requirements were made more sensitive to risk with a view to reducing regulatory arbitrage. The appropriate method of arriving at the capital requirements of banks using credit relating, the supervisory oversight and scope of judgment and transparency and credibility of reporting standards are all issues buried in Basel II prescriptions.
One major criticism of Basel II is its inherent feature that will likely promote “procyclicality” in lending practices. The problem of procyclicality centres on “risk weights” being subjected to “economic boom” or “burst” thereby distorting the basis for setting capital regulatory standard. Another challenge of Basel II is that its major concern is in the safety and resilience of individual banks rather than the condition of banking system as a whole.
Responses To Global Financial Crisis
The G-20 nations in response to the global crisis also passed the Basel III Document as new global framework of post-crisis banking regulation and supervision. Based committee on Banking Supervision is a long standing committee of the Bank for International Settlement (BIS) that is mandated to review and develop banking guidelines and supervisory standard at a global level. The Committee sets these rules internationally while local regulators may adopt and enforce them.
Though China was not affected by the global financial crisis, she did not hesitate to jettison some “old fashioned” banking rules in search for more collaboration in building a global level playing field in financial regulation.
Prior to the 2007 global banking crisis, the global banking system had been characterized by swings in regulatory practices. It had been a trend of less restrictive regime to more restrictive regime back to less restrictive and currently to more restrictive regime due to the global crisis. For instance, prior to 1930s, there was little or no regulation. Tighter regulation was introduced later with the belief that banking excesses led to the “Great Depression”.
Bank Regulation versus Bank Supervision.
These two terms are applied in every day usage as being synonymous. However, technically speaking, they are not the same. According to Ajayi, while bank regulation entails the body of specific rules governing expected behavior that check the activities and business operations of financial institutions, supervision of banks involves not only the enforcement of rules and regulations but also the process of passing judgment regarding the quality of financial institutions’ assets, capital adequacy and management.
Through bank regulation laws, rules and regulation are issued or enacted to govern the operation of banks. Supervision on the other hand ensures that banks are carrying out their activities in accordance with the laid down rules, laws and regulations. Bank supervision is a means of ensuring compliance to the laws and regulations. To ensure that banks operate in a safe and sound manner, there must be supervisors who go to the field, observe what is happening in banks and send their reports to the regulators. Tools for regulation and supervision include prudential regulation, periodic returns, bank examination, take over of banks, deposit insurance incur- scheme, information disclosure, incorporation and licensing.
The challenges to regulation and supervision globally have been identified as immunity; credibility and independence of regulators or supervisors; nature of regulation in terms of single or multiple regulatory models; moral dilemma during crisis; and expected role of government.
Conclusion
The fundamental issue is whether a globalized banking regulatory regime is achievable in view of the varying cultural, technological, political, economic and social environment of nations. For instance, argument is raging internationally on whether or not nations should allow single powerful, credible and independent regulator or a multiple regulatory system with other levels of control or supervision.
Omeh, a Ph.D Student in Corporate Finance and Management, can be reached via 08032743875
