The third G20 Summit is scheduled to be held in Pittsburgh on September 24-25, 2009. Earlier, the G20 finance ministers met in London on September 4-5, 2009. The G20 website and media reports indicate that there is consensus on continuation of countercyclical monetary and fiscal stimulus and about efforts to avoid protectionist tendencies in trade. Hopefully, the G20 will be able to dispel the incipient clouds on the trade horizon created by the US raising tariffs on imports of Chinese tyres. Concurrently, the differences among G20 countries on how best to reform financial sector regulation, align compensation for finance professionals with long-term performance and deal with tax havens need to be addressed. This article’s focus is on the implications of G20 deliberations for the international financial sector.
It is apparent that banks and other financial intermediaries around the world would like to revert to business as usual and for the moment they seem to be succeeding. For instance, the dubious role of the credit rating agencies is no longer on the public radar screen, high bonuses for bankers are back, and any suggestion about increasing risk capital requirements is labelled anti-innovation.
From September, 2008 till about March, 2009 money markets in developed countries froze and trade credit dried up for India. Clearly, developments in international financial markets have a wide-ranging impact on India. It is for this reason that India has an interest in: (i) better oversight and promotion of competition among credit rating agencies; (ii) urgent implementation of central counterparty clearing of over-the-counter (OTC) derivatives; and (iii) revised norms capping leverage (asset to equity) ratios in financial firms. More generally, there is wider recognition that securities markets do not auto-correct and greater international coordination is needed. It follows that India, which has a co-equal representation on G20’s Financial Stability Board (FSB), is expected to take an active interest in the working of FSB’s three Standing Committees on: (a) Vulnerabilities Assessment; (b) Supervisory and Regulatory Cooperation; (c) Standards Implementation (including controversial issues such as mark-to-market versus held-to-maturity accounting standards). These Committees are headed by a General Manager in the Bank for International Settlements (BIS), the Chairman of the UK Financial Services Authority and a Canadian Associate Deputy Finance Minister, respectively. The Financial Stability Forum (FSF), whose membership was confined to the G7 and a few other developed countries, was expanded after the G20 Summit in London to form FSB. Its secretariat is hosted by the BIS in Basel and is chaired by the Governor of the Central Bank of Italy, a former managing director in Goldman Sachs. It is surprising that FSB and its Committees are all headed by nationals from developed countries.
The G20 has discussed the modalities for reform in the Bretton-Woods institutions including raising the voting shares for developing countries to better reflect their contribution to global output. India’s voting shares in the International Monetary Fund and the World Bank (IBRD) are currently 1.89 per cent and 2.78 per cent, respectively. The ownership of the IMF and the World Bank, which is weighted heavily in favour of G7 countries, and their location in Washington DC continue to make it difficult for the management/staff in these institutions to think independently about policy issues. Further, the importance of these institutions as a source of hard currency funding for India has diminished greatly. For instance, in 2008, forex remittances into India were more than ten times the gross annual disbursements received from multilateral development banks. Since the changes in the IMF and the World Bank are likely to be very slow and limited, their reforms would be of marginal interest to India.
Taking a step back to reflect, the rules for the financial sector have been such that since the 1950s financial companies have periodically achieved a higher rate of return on equity (RoE) as compared to real sectors. More recently, some investment banks and hedge funds have raised their leverage ratios to as high as 40:1 and reported extremely huge RoEs. Financial sector votaries claim that the high RoEs are due to the ingenuity and productivity in this sector and consequently finance professionals have a legitimate claim to extraordinarily high remuneration. FSB could commission a cross-country study on risk-adjusted RoEs over the last five decades, normalising for leverage and Sharpe ratios, in the four segments of the financial sector (banking, pensions, insurance and capital markets) and real sectors. Such a study would find that measured over a decade or more, risk-adjusted RoEs for financial firms were not significantly higher than the average RoEs for other sectors.
In the run-up to the G20 Summit in Pittsburgh, the media has spotlighted the topic of irresponsible risk-taking in financial firms engendered by the prospects of outlandishly large annual bonuses ranging from several million dollars to over $100 million. Such rewards are inconsistent with performance since governments invariably end up providing funding support to prevent systemically important financial institutions from failing. At the forthcoming G20 Summit, FSB is expected to present its proposals to “align compensation-related incentives with the long-term profitability of firms.” It remains to be seen whether FSB’s formulations will be specific enough and will be acceptable on both sides of the Atlantic.
As compared to the US and Europe, India was less adversely affected by the bursting of the housing asset-price bubble. This was partly due to RBI’s prudent policies, relative lack of securitisation, and public sector dominance in the banking and insurance sectors in India. In finance, as in economics, there are no universally applicable rules. Therefore, we need to question whether the US and UK model of an excessively dominant role for the financial sector’s sponsors is relevant for India. We should also maintain a healthy sense of scepticism about the premature nature of proposals such as making Mumbai an international financial centre. At the same time, our longer-term policies cannot be to ensure the primacy of the public sector. The “mantra” has to be adequate regulation and capitalisation, as we continue to raise FDI caps in the financial sector. This should happen gradually as we progress towards greater capital account convertibility. Hence, our efforts at G20 forums in promoting reforms in the international financial sector should be to focus on the technical aspects of capital adequacy and guard against a reversion to business as usual.
The author is Ambassador of India to the European Union, Belgium and Luxembourg. Views expressed are personal.