Intl cooperation needed for global financial system reform

Monday, February 2, 2009

Davos - International cooperation, not protectionism, is the precondition for global financial system reform, world leaders and financial experts have agreed at this year's World Economic Forum meeting in Davos, Switzerland.

During the five-day forum, which ended on Sunday, participants sent a strong message to combat financial protectionism. British Prime Minister Gordon Brown warned that financial protectionism was a greater danger than trade protectionism in the current world economic scenario.

Cooperation between major powers and global financial institutions is vital to ensure a continued flow of credit to developing and smaller countries, which are likely to be the biggest victims of the recession, he added.

There is an implicit protectionism in what is happening now, said Mr Brown, referring to the moves of several countries to restrict government funding for bolstering endangered banks to national financial institutions and barring overseas operations from benefiting.

This is leading to the withdrawal of capital from these institutions' foreign operations. "If this continues, what you will see is a form of financial protectionism and financial isolationism," he said.

Developing countries, likely to suffer most in the global crisis due to their still weak domestic financial sector, have already seen a dramatic loss of capital, Mr Brown added.

Meanwhile, German Chancellor Angela Merkel said the global financial crisis may lead to the formation of a UN Economic Council, like the UN Security Council, based on a global economic charter.

Participants at the forum agreed that one of the important steps for reforming the global financial system would be to rebuild international financial institutions such as the International Monetary Fund (IMF) and World Bank.

According to Mr Brown, new forms of international institutions are vital to tackling future problems.

The IMF should take a greater role in heading off crises and preventing them rather than dealing with the after-effects, while the World Bank should tailor its operations to better deal with environmental issues, he suggested.

However, it is not easy to strengthen international financial cooperation and reform the global financial system.

Stephen Roach, Chairman of Morgan Stanley Asia, said that a multilateral financial entity needs teeth. "The problem is that there is no enforcement mechanism, no penalties for bad behavior. Nobody wants to relinquish national authority."

In an era of globalisation, only international financial cooperation and financial supervision can help establish a new and effective global financial system, which has been agreed upon by both advanced and emerging economies.

Last November's G20 Financial Summit in Washington hammered out a blueprint for the new global financial system. The London G20 Financial Summit in April is expected to work out details for realising that goal.

Current financial rules must be "fundamentally revised" as they had deepened the global financial crisis, financial experts at the Davos forum said.

Rules such as capital adequacy regulations and fair value accounting were "well intentioned," but had proved to be inadequate, said Stephen Green, Chairman of the HSBC Group.

"Fair value accounting has added considerable volatility to results, only part of which is economic, and the capital adequacy regime has hobbled many banks with spiraling capital requirements just when customers need them to be flexible with lending," he said.

These rules encourage banks to build up their capital instead of lending money to their customers, which is against the efforts taken by the governments.

So far, the US and British governments have taken a series of fiscal and monetary policies to push banks to restore lending. Central banks in these countries have launched "quantitative easing" with an aim to increase money supply in the market.

The financial system must also be less leveraged, the experts said.

Improved risk management skills are required and there must be an end to the "go for broke" incentive systems, both for traders and for corporate chiefs, they said, adding that there should be limits on "wild" derivatives with better and safer capital requirements.

In future, banks should clarify their business and be put under strict supervision.

Alessandro Profumo, Chief Executive Officer of Italy's UniCredit Group, believes that banks in the future would specialise either in commercial activities such as deposit-taking and lending or in investment activities such as operating proprietary trading desks and underwriting derivatives, not both.

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