FINANCIAL REFORM AND THE G 20 : A HARD CLIMB / THE ECONOMIST

Financial reform and the G20

A hard climb

Sep 6th 2009
From Economist.com

The G20 meeting in London marked a step along the way, not a summit















WHEN G20 leaders met in Washington, DC, in November and then in London in April, fear and uncertainty reigned. Ringing statements that the big economies would do whatever it took to shore up the system had real value. The crisis required clarity. The latest round of talks, a meeting of G20 finance ministers and central-bank governors in London on September 4th and 5th, took place against a different backdrop.

The world economy is still fragile but far more stable than it was six months ago. Questions on how to withdraw fiscal and monetary stimulus compete with discussions on what more needs to be done. Ministers and bank governors, whose meeting set the stage for a pow-wow for national leaders later this month in Pittsburgh, promised decisive implementation of expansionary policies “until recovery is secured” and transparent plans to withdraw those programmes when the time is right. Periods of limbo do not make for stirring communiqués.

On financial reform, too, there was little really to catch the eye. The build-up to the London meeting was dominated by noisy European calls, largely orchestrated by the French and Germans, to rein in bank bonuses after a round of booming quarterly profits. Ministers duly put compensation and governance reform at the top of their list of reform priorities. The Financial Stability Board (FSB), a Basel-based body of regulators, is to report to the Pittsburgh meeting with detailed proposals on global standards of pay disclosure and structure. A more radical French suggestion to impose absolute caps on bonus amounts seems to be headed for the long grass.

None of this is exactly new. The need to overhaul compensation structures has been part of official thinking since the Washington summit. Even perfidious Anglo-Saxons agree on the need for change. The Financial Services Authority in Britain came out with guidelines on compensation policy in August that adhere to principles set out by the FSB in April. The Americans have moved less quickly on pay to date but there is broad consensus among international regulators, and most of the industry, that significant chunks of bonus payments should be deferred and that “clawback” provisions should enable firms to reduce variable pay if risk-taking positions go wrong.

The building-blocks of financial reform—higher capital, a focus on systemic risk, countercyclical rules to build bank buffers during good times, better incentives—have been known since the Washington meeting. A host of initiatives are under way in each of these areas. Some have started to yield solid results—on higher capital charges for instruments such as collateralised-debt obligations (CDOs), for instance. But swift progress is difficult. Many topics are fiddly and technical, so rule-making takes time. And many initiatives would have the effect of dampening lending growth and so will not be implemented while economies are weak.

All of which meant that this weekend’s gathering struggled to find anything new to say. The same will be true of Pittsburgh, although governance reform at the IMF may provide world leaders with at least one headline-grabbing agreement. Does that matter? In one sense, no. Reforming the world’s financial system is bound to take time. And an ongoing international process for resolving the problem of global finance is critical. Synthetic though the row over pay has been, it has underlined how difficult it is for any one country to press ahead alone with measures to constrain the industry.

There are dangers, too. Agreeing the detail of reform is harder than setting the direction. The build-up to this weekend’s meeting revealed worrying fractures between the Americans and British, on the one hand, and the continental Europeans, on the other, on how much tighter rules on bank capital need to get. Sensible calls to improve the supervision and resolution of large, cross-border institutions have yet to produce really meaningful change. What’s more, the things that really need to change in finance are as dry as they come: it is far easier to channel public outrage about pay than it is about Tier-1 capital ratios. If momentum matters to financial reform, this month’s meetings keep the ball rolling, not much more.

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