Financial Stability Board’s strong outreach in Global Financial resilience is expected

Korea will be the first emerging economy to host the Financial Stability Board meeting on the 20th of October, 2010. In its third plenary meeting in Basel, Switzerland, the board decided to have the fourth event in Seoul before the G20 summit. Since Korea is also the chair country of upcoming G20 forum, a Financial Services Commission official said that Korea will be able to take the lead in reforming the financial framework.

 The Financial Stability Board (FSB) was established in April 2009 as the successor to the Financial Stability Forum (FSF). The FSF was founded in 1999 by the G7 Finance Ministers and Central Bank Governors to promote stability in the international financial system. Yet, among the leaders of G20 countries, there had been a broad consensus on stronger institutional ground with an expanded membership. And this movement resulted in the creation of FSB, an extended form of FSF. In an attempt to strengthen its effectiveness, financial authorities from the G20 nations, international financial institutions and several global standard setting bodies joined the FSB as the new members. The FSB performs the initiative role to develop and implement strong regulatory, supervisory and other policies in pursuit of financial stability. 

 As a member of FSB, Korea, especially the Bank of Korea and Financial Services Commission came to have an even more crucial role. FSC is involved in FSB Steering Committee which provides operational guidance and sets the agenda in general. So FSC has been trying to boost regular meetings among the FSB leaders and to continue active discussions. One of them was the financial reform conference called “Envisioning a New Financial System: An Emerging Market Perspective” which Dong-Soo Chin, the chairman of FSC held on Sep.2 in Seoul. The conference called attention to the increasing impact of emerging markets to the world economy, paving the way for more balanced participation of emerging countries in the global finance sector.

 

 

(Sep.2th Korea-FSB Financial Reform Conference, taken from Herald Media)

In fact, a decade ago, Korea felt the tremendous pain due to 1997 Asian Financial Crisis. In the wake of 1997 crisis, Korea had no choice but to strongly restructure corporate and financial field, dealing with long-neglected structural problems hidden behind rapid growth. Passing a time of economic revitalization and renewal, Korea learned valuable lessons and now, it is positioned as one of the competitive global economies. This unique experience enables Korea to serve as a potential broker that can bridge the gap between the emerging and the advanced markets.

 Sharing Korea’s pre-experience and know-how, particularly on financial regulation reform, perspectives of emerging economies can be brought into the global reform process. Many experts admit that Asia will be the engine of future global economic growth. In order to make the emerging markets less vulnerable to external shocks, global financial safety net is strongly required and in this sense, international standards will help them free from poor financial infrastructure.

 Currently, a lot of critical financial agenda are on the FSB table. For instance, to enhance transparency among market participants, prudent oversight of capital, liquidity, leverage and risk management is necessary. Along with Basel III, which delineates the rate of bank capital buffer, Bank Levy is considered a possible measure to increase banks’ crisis management capability, although the feasibility of the proposal still remains to be seen. Furthermore, efforts to reduce systemic risk generated by interconnectedness among financial institutions worldwide led to global coordination to devise measures that cover broader range of financial markets and instruments. Systemically important financial institutions will be strictly monitored and the size of “shadow banking” such as hedge funds and off-balance sheet entities will be shrunk. New international controlling standards on hedge funds will emerge and Central Counter Parties will be installed for over-the-counter (OTC) derivatives. In addition, more standardized forms of OTC products will be used and regulation on credit rating agencies will be intensified. 

                                                                                               (Picture from the Korea Times)

The FSB will take up a vital role of making these regulatory reform recommendations to the G20 summit. Once a certain regulatory reform is approved and adopted through the Financial Stability Board and G20 forum, those international standards are to be implemented by each country. Throughout this highly critical process, Korea is anticipated to undertake a number of initiatives to assess each regulation across sectors, identify regulatory gaps and examine related issues, and reflect emerging Asian market perspective. Gearing up for the G20 summit, FSB activities are an important step in facilitating G20 reform agenda. Everyone hopes to see successful outcome from the impending FSB meeting in Seoul.

Lee, Ki Yeon (kiyeon.m.lee@gmail.com)

Can the ‘bank tax’ be the final answer for preventing banks from failing?

Many people agree that the global financial crisis was caused by growth competition among banks, which led them to invest risky derivative products to make more profits. In line with this view, many governments, such as the U.S., the U.K., Germany, France and Sweden, as well as the International Monetary Fund (IMF) are trying to introduce the ‘bank-tax’ to global finance system expecting to collect bail-out money for the means controlling and regulating financial institutions, especially the huge banks.  In G-20 Finance Ministers meeting, which was held on 23rd of April in Washington D.C, adapting the ‘bank tax’ to financial companies was discussed as the main agenda and the IMF submitted reports about what kind of method of levying banks would be most appropriate and acceptable world wide.

Four mainly considered ways of taxing banks

Currently, four main methods of charging tax to banks are considered and researched by the IMF. The four techniques are:

  • Balance Sheet Tax;
  • Excess Profits Tax;
  • Financial Trading Tax; and
  • Insurance Levy.

Let’s look through briefly about those methods.

The first method is ‘Balance Sheet Tax’. It is that a government charges a fixed ratio of taxes in terms of its level of assets or liabilities of each financial institution. The U.S. government and many other countries are positively considering using this method since it is considered as effective way of keeping under control of increasing banks’ assets and liabilities. The purpose of charging taxes for assets is a kind of burden of risks, particularly big banks because if they fail, the consequences will be substantial. Also the reason for taxing liabilities, mainly on non-deposit except long-term stable fund: is to restrain the unreasonable attempts to fund capital from borrowings.

The second one is ‘Excess Profits Tax’, which was proposed by Strauss-Kahn, the managing director of IMF. It is considered as the most efficient way of recollecting the bailout money, because it does not affect the bank’s operational strategy and prohibits moral hazard. However, it is realistically hard to measure the excess profit of banks, also there is a likelihood of negative effects to bank’s efforts of making profits.

The third one is ‘Financial Trading Tax’; also known as ‘Tobin tax’, which is mostly favored by some European countries. It charges for foreign currency trading or a certain financial transactions to prevent the flowing of short-term investment. However, it is an unrealistic way since it is difficult to monitor and charge everyday financial transactions. Also there is a possibility of distorting the flow of funds to escape the fees because of these reasons, the IMF and the U.S. and Canadian governments have negative attitudes toward this method.

The last one is ‘Insurance Levy’. It charges banks a compulsory amount of insurance fee, which is similar to the current deposit-protection rule. But this method is not welcomed by the IMF and to many governments because of the chance of incurring unfair competitive gains and the moral hazard of investing in higher-risk products to cover the insurance tax.

Prospects for bank tax

It is expected that the ‘Balance Sheet Tax’ will be the main plan chosen by the IMF and many other governments. However, there is a big difference in the view of the bank tax not only between developed countries and developing countries, but also the interests of each country. Especially, the Canadian government who is the host of June G-20 meeting, has strong objection to bank levy since they didn’t go through a serious financial crisis. Hence, it is likely to take more time to make globally accepted agreement.

Possible side-effects of introducing bank tax

The profits of banks are expected to be affected banks directly. Morgan Stanley expects that introducing bank tax will affect the EPS by decreasing it 3 to 6 % during 2010 – 12 to the U.S. and European banks. Also, there is a likelihood of reducing loans to public because of decreasing risky assets investment. This might have negative effect on the improvement of banks’ corporate governance and the economic recovery process.  On the other hand, banks can invest to more risky assets to recover their profit reduction and to pay for the taxes. Moreover, banks can transfer the service cost to customers to share the burden of taxes with customers.

Alternative approach in changing the internal problem of banks

 

Banks are not just a company, which operates for making profits. They are the substantial components of one country’s economic system. So they need to be safely operated with social responsibility. However, managers and directors have been trying to pursue a short-term achievement for their remunerations, such as unimaginably high salaries or stock options etc. For these reasons, banks lacked in long-term strategic planning, which leads them to poor risk management. Also, the managers and directors’ social responsibility and ethical behavior needs to be refined. Therefore, a long-term strategic management planning and directors/managers who have socially responsible minds will be required.

Can the ‘Bank tax’ be the final answer for preventing banks from failing?

The purpose of trying to introduce the ‘bank tax’ is to be prepared for any future financial crises. Many governments and the IMF recognize the current crisis is caused by the huge banks’ aggressive investment to risky assets and derivatives also funding capital by increasing liabilities. So they charge tax on banks’ level of assets or liabilities on their balance sheets to achieve a control of banks and to restrain their operational strategies. Also, for enhancing the stability of banks’ activities, it is considered necessary to improve banks’ internal management system by restructuring corporate governance, long-term strategic operation plan, and the directors/managers’ socially responsible minds. However, it is still a controversial issue because each country’s benefit will be affected differently by adopting the ‘bank tax’. Therefore, global consensus, which should be a generally accepted agreement, must be reached during the upcoming G-20 meetings and as the host of 2010 G-20 meeting, Korea is required to wisely negotiate different opinions between developed and developing countries.

So do you still think that the ‘bank-tax’ can be the final answer for preventing banks from failing?

How do you think about this issue?

Global trend in banking regulations

 

US president Barack Obama

  On January 21st, US President Barack Obama announced new regulations about financial institutions to limit the scope and size. The new regulations are going to separate investment and commercial banks with stringent regulations.

  Some people say that the new regulations are the revival of the ‘Glass Steagall Act’. The Glass Steagall Act was part of the New Deal policy that was imposed in 1933. Some people argued that the great depression appeared due to lax management of commercial banks. This assertion rose and promoted the Glass Steagall Act. Through this law banking, securities and insurance were totally separated. The Federal Reserve System was reinforced and ‘Securities and Exchange Commission (SEC) was established under the glass Steagall Act. However through separation in commercial bank and investment bank, companies had hardships in paying increasing procurement costs in long term investments. As a result, the Glass Steagall Act was abolished in 1999 and the US had to catch up with the global trend. The global trend in the financial industry has been a consolidation of banking, security business and insurance. Two good examples of this where Universal banking in Germany and Bancassurance in France .

  Since the start of the 2008 global financial crisis, there has been a growing need for strengthening regulations on financial institutions, particularly which used to be thought “too big to fail”. The reality is that the big banks, the freakish offspring of the Fed’s easy money are dangerous institutions, deeply embedded in a bull market culture of entitlement and greed. Consequently global attention focuses on reforming new financial systems. Barack Obama’s so called Volcker’s rule is cast in the same shadow as the Glass Steagall Act, as the new proposal prevents commercial banks from doing investment banking business.

Paul Volcker and Barack Obama

  So what happens if Volcker’s rule formulates the policy? It is too soon to tell. It would take time and efforts for Volker’s rule to be enacted and enforced. It is quite unclear that Volcker’s rule would fulfill its original purposes as it would cause lots of dissonance in separating commercial and investment banks. But we cannot deny the fact there is a need for global coordination in financial regulation.

  At the global level, there was a recent discussion about introducing a global bank tax. According to the Financial Times on Feb 11th, Britain’s Prime Minister Gordon Brown suggested there is an upcoming agreement on a global bank levy and at the G20 summit in June the various participating nations will try to reach an agreement about the levy. In addition, the global bank levy has gotten public support and US President Barack Obama stated that they are looking in to imposing a tax on the banks for the responsibility of the global crises on America banks last month.

  Last year, Mr. Brown had suggested a ‘Tobin Tax’ on bank dealings. As Tobin tax’s basis premise was consent of global world all over the country, it was considered to be impossible to use the theory in the real world. But, as the IMF was seeking several different ways to impose a tax on dealings among banks, an endorsement on bank levies seems possible at the upcoming April meeting in Washington. According to Mr. Brown, the bank levy imposed by the IMF will carry different aspects compared to US president Barack Obama’s way. In particular, imposing a tax on bank profit, turnover and wage rises. Britain asserts that bank levy should be used as source of tax revenue in each country. G20 countries are skeptical towards the idea that their enormous common fund could be used as savings for large banks in financial crises.

  There have been many discussions about how to manage post-crisis financial markets. Volcker’s rule and global bank tax are also part of the discussions and further discussions are needed.

By Han Joo Yeon (joo1990@ymail.com)