The subprime accountability deficit and the obstacles of international standards setting.

Today's financial crisis has triggered some of the largest bank failures in history, including Washington Mutual and Fortis, as well as substantial instability throughout US, European, and Asian banking markets. Bank failures around the globe will likely continue as housing markets collapse and credit markets dry up. Indeed, the crisis may get much worse. As of mid-2008, the US Federal Deposit Insurance Corporation (FDIC) has identified more than 100 banks on its "troubled bank" list, and European regulators are struggling to contain the fallout of the crisis in their respective domestic markets. Central banks have created ad hoc swap arrangements to ease international liquidity problems, and they have recently slashed interest rates in an unusual exercise of international coordination. However, the important question for global governance is whether the financial crisis will prompt a serious international effort to change the rules of domestic and global banking.

Despite the galvanizing effect that the financial crisis appears to be having on central bankers, the prospects for new international regulatory standards are fairly gloomy. The key problem is that US regulators are unlikely to champion new international standards. There are two main reasons for this assessment: first, the myriad proximate and underlying causes of the crisis; and, second, the considerable fragmentation of domestic financial regulation in the United States. Without US leadership, any modifications to the international standards and guidelines created by the Basel Committee, the International Organization of Securities Commissions (IOSCO), the International Association of Insurance Supervisors, or the Joint Forum will likely be cosmetic rather than substantive. (1)

While little may happen internationally, the most significant regulatory response to the financial crisis may be within the United States. The US Treasury's regulatory blueprint recommends the organizational consolidation of domestic financial regulation, including the dissolution of the Office of Thrift Supervision and the creation of a federal insurance regulator. The consolidation of US regulatory agencies might facilitate international regulatory harmonization in the long term simply by reducing the transaction costs of international negotiation and clarifying agency accountability.

Global Banking Standards: Learning from the Past

In the recent past, bank instability in the United States and the United Kingdom prompted both governments to press for new international financial regulation. A quick review of the 1980s may help to shed light on the prospects for a similar international response to the current financial crisis. For this period, the focus is limited to commercial banks and their regulators. Savings and loan institutions are not considered, as they were peripheral to the development of international standards.

US leadership on global standards for the prudential management of banks had its roots in the 1980s banking crisis. As US commercial banks began to falter in the early 1980s, domestic regulators responded quickly by tightening capital requirements. (2) However, their increasingly stringent regulations were not able to stem the tide of bank failures. A total of 468 commercial banks failed between 1985 and 1987, more than in the previous thirty years. (3) By the mid-1980s, regulators felt extraordinary pressure to tighten regulations further. Yet regulators also faced a rising competitive threat from Japanese banks, which faced less stringent capital rules. (4) The rise of the Japanese banking sector created an environment in which US regulators were hard pressed to maintain stability without harming bank profitability. It was precisely this environment that led US regulators to press for an international standard on capital adequacy. In short, US leadership on global regulation emerged from the specific domestic challenges of financial regulators.

The Bank of England's aggressive stance toward international regulatory harmonization emanated from similar circumstances. The UK's financial instability began a bit earlier, in the 1970s with the so-called secondary banking crisis. In 1979, largely as a result of this crisis, the Bank of England was finally granted the statutory authority to regulate and supervise the banking sector. (5) Then, in 1984, the London-based Johnston Matthey Bankers collapsed, triggering a strong regulatory response by the Bank of England. However, the London banking sector, like the US banking sector, was at the time aggressively fending off the incursion of Japanese banks (both in domestic markets and in international lending). By the late 1980s, regulators from the United States and the UK found themselves on the same side in advocating a new international standard for capital adequacy. The result, the 1988 Basel Accord, would subsequently become the most prominent example of international financial regulation.