Exploration of the first results of the global reform of financial sector regulation

The purpose of my research is to explore the global reform of financial sector regulation. Such reform was a response to the global financial and economic crisis of 2008-2009. The current reform is truly global in contrast of attempts to make reform in the late 1990s - early 2000s following after the Asian crisis of 1997-1998. It includes both developed and developing countries, because only such approach avoids regulatory arbitrage. In the scope of its coverage the reform is universal, because the regulatory and supervisory standards applicable to all financial institutions and financial instruments, including those that were previously outside the scope of control. 

Theoretical Framework

The most important feature of this reform is a comprehensive approach to ensure financial stability, combining macro- and micro-prudential regulation, strengthening the coordination between all areas of fiscal policy, as well as between different groups of financial regulators for the joint counteraction against systemic risk.The reform envisages stiffer supervision and monitoring of the fulfillment of obligations, including on the part of international organizations, whose status is elevated and whose functions are expanded.

In my research, I set myself the goal to review the financial regulation of the leading centers in the world financial system – the US, European Union (EU) and Japan.

In particular, I suppose to:

• review Dodd-Frank Act and the implications of its adoption for the US financial system;
• consider the steps of the European financial regulatory reform, including the Banking Union project;
• analyse the position of Japan at the implementation of the principles of Basel III and other areas of global reform (and also to consider the dissenting opinion of the country to further reform the global financial system) [1, 2].

International regulatory framework (Bank for International Settlements in Basel, Financial Stability Board, Basel Committee on Banking Supervision, etc.) expanded the composition of its participants by including developing countries – G20 members. Thus nowadays the global financial regulation includes three levels: global, on which international standards are developed and agreed; regional with elements of supranational (EU); and national, where these standards are implemented in practice. Exactly the contradiction between developed countries and the national interests of individual countries is a major stumbling block to the successful reform implementation!

Working Hypothesis

For today, the global financial regulatory reform includes the following main directions:

• Strengthening the stability of the banking systems in the framework of the Basel agreements and the implementation of Basel III;
• The special policy concerning systemically important financial institute- ons (“too big to fail” or systemically important financial institutions, SIFIs), including the procedure of bankruptcy, increasing the transparency and regulation of financial intermediaries (including the shadow banking system) as well as the financial instruments (primarily derivatives);
• Ensuring greater transparency in fiscal policy and the expansion of inter- country exchange of information and mutual supervision (peer reviews) [1,2]. Meanwhile we have to state that the creation of a European financial supervision system has not solved numerous serious problems caused by the crisis of the banking systems and the ensuing sovereign debt crisis of the EU countries. The main objective of the European Union at the moment is to form such a banking system that could function in the framework of a single financial market and could also have common rules, supervision and a single regulator represented by the European Central Bank.

I believe that the "vicious circle" between banks and public finances could break a number of pan-European measures, such as:

1. Providing a single supervisory mechanism of more stringent require- ments of banks in respect of their capital adequacy and
2. "Salvation" of problem banks will no longer be at the expense of taxpayers. Redemption of bank liabilities at the expense of state finances will not be
3. Banks should no longer exist on the principle of "European in life and national in death", because their supervision will be carried out by the European body, and in the case of bankruptcy, management will also be conducted of European, not a national

In further research, I would focus on the above mentioned hypotheses and opportunities of their implementation at the European level.

Abstract Overview

It should be noted that although the financial crisis particularly strongly affected the developed countries, international regulatory structures are doing their best for implementation and adaptation the new regulatory standards by most of the developing countries. After the crisis the international regulatory structures (including the Bank for International Settlements (BIS) in Basel, the Financial Stability Board (FSB), the Basel Committee on Banking Supervision, and others) have expanded the composition of its participants by including developing countries – the G20 members. As a result, the Group of 10 (G10) has given way to the Group of 20 (G20) [1, 2].

Global regulation mechanism which has been formed under the G-20 in response to a crisis includes:

• coordination of strategic decisions, coordination and approval of the final recommendations (G20 level);
• the development and harmonization of global standards in the main areas of reforms: the Basel Committee on Banking Supervision, the International Commission for the Securities Market, the IMF, OECD and other interna- tional organizations, activity of which has become more coordinated;
• implementation of global standards at the regional (EU) and national levels;
• monitoring of the implementation of international processes by governing structures;
• the adoption of special measures in the case a flagrant denial of the country's international cooperation [3].

In the framework of financial regulation and supervision such measures often have the character of moral condemnation, but for violations related to tax evasion or terrorist financing, financial institutions may incur administrative (to be subject to penalties) and even criminal liability. It should be emphasized that although sanctions may be agreed in the frame- work of international organizations, their administration is performed exclu- sively by national jurisdictions.

In my further research I plan to explore the results of the first global reform financial regulation in the main centers of world financial system – USA, European Union (EU), Japan. I plan to find, examine and develop other directions of further global reforming of the Global financial system.

United States of America.

US were at the origins of the international financial regulatory reform. The ideas set forth in the US papers during the beginning of the crisis had a huge impact on the formulation of new international standards. US proposals for international regulation included in the US financial sector reform project were announced by President Barack Obama at the G20 summit and were the basis for the declarations adopted there. Other US officials in the early years of reform have also repeatedly stressed that the country has built a new system of financial regulation, which will become a model for the rest of the world.

In July 2010, Obama signed the Dodd-Frank Act about the reform of financial sector and consumer protection (Wall Street Reform and Consumer Protection Act). At the beginning of 2016 in the US first results in the field of financial reform were achieved and were estimated by experts and public and political figures in different ways. Significant improvement of the macroeco- nomic situation in the US is often used by financial reform proponents as evidence of its success.

According to the Dodd-Frank Act were created the Council for Supervision of financial stability and FSOC (Financial Stability Oversight Council) with the systemic risk monitoring functions. The Council is chaired by the Minister of Finance and consists of representatives of financial regulators. FSOC in conjunction with the Federal Reserve make decisions on assignment of the financial status of systemically important companies.

Bank regulation has become one of the most actively implemented and effective areas of financial reform. According to the Dodd-Frank Act for the bank holding companies with assets of more than 50 billion dollars already being introduced annual stress tests. Banks are obliged to provide the Federal Reserve with capital allocation plans (capital planning), as well as with contingency plans in the case of their bankruptcy (resolution plans) [4].

In 2016 it became apparent that the improvement of the economic situation moves the financial reform on the background of socio-political life. In addition, in the leading country which stood at the origins of the financial reform arose significant difficulties in its own national jurisdiction in reform implementation. As of December 31, 2015, about 70% required under the Dodd-Frank Act regulations were adopted by regulators, 10% was published in draft form and just over 20% are not yet developed European Union.

The EU participates in the global financial reform both at the level of national jurisdictions and through its supranational institutions, while endeavoring to deal with its own integration challenges. One of the most important areas of the European financial reform standards (coordinated at the G20 summit in 2009-2010) is to eliminate the gaps in regulation and to strength the stability of the banking system. Implementation of the principles of Basel III in the EU is carried out on the basis of CRD-IV Package, which includes a revised Capital Requirements Directive (CRD-IV) and the Capital Requirements Regulation (CRR-IV) [1,2].

The aim of CRD-IV package is the introduction of new, more stringent requirements for capital adequacy, liquidity and leverage for all EU country

At the same time the task is not only to accept the basic principles of Basel III, but is to create unified set of rules for all EU countries (Single Rulebook) which goes beyond the latest version of the Basel Accord.

Only in matters of macro-prudential supervision and assessment of systemic risk, some independence of national regulators governed by Directive CRD-IV is maintained (for instance taking into account the communication of macroeconomic development and lending). Package CRD- IV applies to all commercial (depository) banks in the EU, as well as investment banks and companies (although with some exceptions) [4].

The European system of financial control includes: European Systemic Risk Board (ESRB); European Banking Authority (EBA); European Insu- rance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA). ESRB is a cornerstone of the European system supervision at the macro level.

The task of ESRB is to monitor systemic risks and to improve the stability of the EU financial system to potential shocks (both internal and external). At the same time in contrast to the US, ESRB is headed by a representative of the European Central Bank rather than the Ministry of Finance. This structure represents the EU during the discussions on financial stability in cooperation with the International Monetary Fund (IMF) and the Systemic Risk Council.

A very important stage of the Banking Union is the creation of a unified mechanism for the settlement of bank failures (Single Resolution Mechanism - SRM), as well as the creation of a special fund to finance it. The decision to create SRM was proposed to the EU in 2013 after long debate and numerous compromises. SRM Directive entered into force on 19 August 2014 and is used since January 2016 (in particular, SRM came into force at the EU level EU Bank Recovery and Resolution Directive) [1,2].

By the end of 2026 the SRM Fund will amount up to 55 billion euros which is approximately 1% of the guaranteed deposits. If the “bank rescue” will require larger amounts, the SRM Fund participation will be limited to 10-20%, and in any case the amount shall not exceed 5 billion euros. In some cases, is possible to use the European Stability Mechanism (ESM) - a "European IMF".

It is obvious that towards the creation of the Banking Union could arise a number of problems: the complexity of the implementation of a uniform set of regulations and standards on banking supervision in certain countries; interaction of the European Central Bank with the European Banking Authority. At the moment the transfer of authority within the new projects during the reforming of financial architecture occurs only partially. Because even in a supranational regulation the greater role in decision-making is played by national interests that sometimes could lead to unexpected consequences (for ex. BREXIT) [5].

Japan.

Japan works closely with the G20, Financial Stability Board and the asso- ciated regulatory structures of the coordination and development of a comprehensive order of international regulation and supervision. Speaking of the global nature of financial reforms, Japan is developing inter-state cooperation including in this field synchronization of the principles, norms and mechanisms of banking regulation (especially in respect to international agreements such as Basel III) [5].

At the same time, Japanese regulators criticize international rules affecting, primarily, the interests of the Japanese or Asian banks in general. The main criticism concerns the adoption of the Volcker Rule, which prohibits US banking institutions and branches of foreign banks located in the United States, to carry out trade operations with foreign government debt at the expense of their own assets. Such policy of US may cause serious harm to the market liquidity of government bonds including JGB. On this point, a number of governments have expressed their concern to the US authorities, and are asking for appropriate consideration of such issues in the process of finalizing the rule [6].

Indicators of capital adequacy of international and local Japanese financial institutions are currently at a level that exceeding the standards of Basel III. The minimum required level of capital ratio CET I (Common Equity Tier I) for internationally active banks increased to 4.5% at the end of March 2016.

The Japanese banking system has reached high development level at the moment. Japanese banks are major competitors of American and Western European banks in many regions of the world, particularly in the United States and Southeast Asia. However, it retains elements of the old Asian network structure where banks are the main element that unites and finance a number of different profiles of the companies in a single group. The restructuring of Japanese financial system took painfully long and a lot of provisions of the law from 60-70th are still in use.

List of References

1. Annual Reports of the Bureau of Economic US Department of Commerce. http://www.bea.gov
2. The Failures of Dodd-Frank. Financial Services Committee. US House of http://financialservices.house.gov.
3. Ash , Koch C., Siems T.F. Too Small to Succeed? – Community Banks in a New Regulatory Environment. Financial Insights. Financial Institution Relationship Management. Dallas Fed.
4. Reports of the OTC Derivatives Regulators Group (ODRG) to G20 Leaders on Cross-Border Implementation Issues, http://www.cftc.gov.
5. EU Directives (especially on the prudential supervision of credit institutions and investment firms), http://eur-lex.europa.eu.
6. Global Systemically Important Banks: Assessment methodology and the additional loss absorbency requirement. Bank for International Settlements, http://www.bis.org.

Summary

Summarizing all the above mentioned analysis it shows that international regulatory structures have achieved some progress in the development of global standards of financial regulation and coordination of the recommendations in certain areas of reforms. The implementation of international standards in national jurisdictions and at the level of the European Union supranational institutions have begun. One of the main achievements of the reform is the introduction of Basel III standards on capital adequacy and liquidity. Another successful project in the framework of the G20 is the solution of the problem of international banks that are «too big to fail». The latest standard TLAC (Total Loss Absorbing Capacity) that could sole such problem was adopted at the summit in Antalya (Turkey) in 2015.

In further research, I would focus on the following key points:

1. Find the ways of the implementation exactly those global standards that require cross-border cooperation between countries (not just a way of implementation of standards through appropriate national legislation, such as the implementation of Basel [1,2].
2. Find the ways of standardization and harmonization of cross-border operations, the level of globalization of which in this area is very
3. To consider the possibility of creating a mechanism for finding compromises with the interests of all parties: the state, national, global and private financial institutions, consumers of financial

However, for global financial regulation on the one hand remains a problem to ensure financial stability and neutralize systemic risks and on the other hand - to maintain equal competitive field and not to hinder innovation in the financial sector. Such dilemma needed to be solved by creation of a mechanism for finding compromises with the interests of all parties: the state, national, global and private financial institutions.