A Lesson From Emerging Countries

The International Monetary Fund believes it. Politicians, economists and consumer groups the world over believe it. And the leaders of Britain, Canada, France, South Korea and the United States have said it: the ongoing recovery from the world's worst economic crisis in decades may thwart efforts to reform the financial system that created the mess.

The risk is clear. As the world’s economy improves, politicians and regulators could lose the sense of urgency necessary to implement new rules for banks, particularly those deemed “too big to fail.” Thus Gordon Brown, Stephen Harper, Nicolas Sarkozy, Lee Myung-Bak and Barack Obama wrote a public letter last month to reiterate their own commitment and to urge the rest of the G-20 nations to get serious about reform in advance of their upcoming summit in June in Toronto.

Achieving internationally agreed upon reform won't be easy. Already there are substantial disagreements among key industrial nations over how to best approach new reforms. Moreover the existing international standards, known as the Basel II accord, took years to formulate and when tested proved too weak to prevent the crisis.

Meanwhile the banking industry is lobbying hard to stymie these efforts. In the United States, the “industry has four lobbyists per member of the House and Senate,” Larry Summers, President Obama’s chief economic adviser, recently said.

It should come as no surprise that the countries that weathered the storm relatively well were those with stricter statutes than those established by international regulators. More relevant still is that those with more stringent rules were primarily emerging economies.

In Brazil and India, for instance, banks are required to maintain larger percentages of capital in reserve than the Basel Accord's standard of 8 percent. In Brazil too regulators demand better bookkeeping, requiring every client and every trade be identified.

As Liliana Rojas-Suarez, international financial regulations expert at the Washington-based Center for Global Development observed, emerging economies “haven’t been too impressed with Basel.”

This global crisis has already accelerated the ascendancy of new economic powers and the decline of the old. Last September, the Group of 20 nations, which includes 11 emerging countries, replaced the Group of Seven industrialized nations as the official arena for coordinating an international response to the global economic crisis. By January, emerging countries should receive at least 5 percent of IMF voting rights and 3 percent of the World Bank’s, as part of international governance reform.

That means now more than ever those nations must assume greater leadership in establishing new standards. As much as the signers of the March 30 letter committed to set a good example, most of them have not been the best standard bearers.

It is unclear however how emerging nations will overcome an obvious hurdle of legitimacy in this changing international environment. For now, the largest among them -- Brazil, Russia, India and China -- are determined to reassure the international community that they are ready and able to be helpful brokers, despite their reputation as deal breakers in international trade negotiations.

Asserting their legitimacy will be on of their key goals as the four nations, which represent 40 percent of the world’s gross domestic product, hold a summit in Brasilia April 15-16. According to Roberto Jaguaribe, undersecretary of political affairs at Brazil's foreign ministry and Brazil’s chief ambassador to the summit, the BRICs, as the four countries are known, have no intention of antagonizing the developed world and complicate international agreements.

“We are not keen on segregating ourselves from others… and make our own rules. We are trying to cooperate within the multilateral format to help shape new rules,” he said in an interview.

Among proposals considered by G-20 countries are those requiring banks to maintain larger capital cushions, curbing big bonuses that encourage excessive risk-taking, and taxing the financial industry to share in the cost of future bailouts.
All of these need international coordination to be effective. Germany recently moved closer to adopting a proposal to tax banks saying that it would do so even if there is no international standard. While laudable, critics rightly worry that banks will simply relocate to nations that don't impose the tax.

There is no question that the more stringent regulations that helped Brazil and other emerging economies weather the recent financial crisis, were a legacy of their own tumultuous financial histories. But just as those nations proved able to learn their lessons, the hope is they can encourage richer nations to learn them too.