Global Financial Regulator

There are a number of possible types and forms of international regulation. Henry Kaufman (1998) and others would have suggested the creation of a world financial regulator, manned by investment professionals drawn from the private sector, that would oversee both nonblank and bank financial intermediaries.  There is much to be said for harmonizing international banking standards in the global financial system.  The 1988 Basle Capital Accord, and the most recent 1999 Basle II accord, is seen by most observers as very positive steps in this direction.  Basle I required that banks possesses enough capital to cover 8 percent losses on most loans.  Basle II allows for much richer and much sophisticated differentiation across loan classes, with capital reserve ratios reaching as high as forty percent in some cases.  The idea of requiring banks to have capital is simply so that bank managers will not be able to make one way bets: if risky loans pay off, the bank wins big, and if they do not, the taxpayer foots the bill for paying off depositors.  Requiring high capital ratios is thus a means of forcing financial institutions to internalize some of the costs of having a portfolio which is risky.  The Basle accords are useful but, as the case of Japan in the 1990s illustrates, enforcement of these standards by national authorities can be quiet lax.  In principle, a global financial regulator might be more distant from client banks, and better able to enforce regulations.  But this is very hypothetical.  Even if some day there did arise potent political mechanism for creating a powerful international financial regulator, it would be important to think carefully about how much power to vest in it.  Hedge funds, which have been responsible for some important innovations in global financial markets, initially thrived by making use of regulatory loopholes that exempted foreign investment firms from some US financial regulations.