Friday 15 Oct 2021 | 00:37 | SYDNEY
Friday 15 Oct 2021 | 00:37 | SYDNEY

Geithner comes out swinging


Stephen Grenville

14 June 2011 10:32

US Treasury Secretary Tim Geithner provoked annoyance and pushback when he gave an update on financial sector reform since the 2007/8 Global Financial Crisis. 

He made US progress sound impressive. The US has closed or restructured nine of its fifteen largest financial institutions, passed legislation widening regulatory authority, rejigged the regulatory organisational structure to make it less dysfunctional, raised capital requirements and lowered banks' leverage limits.

This reform has important international dimensions. Finance is foot-loose: if tough rules are applied just in America, 'regulatory arbitrage' may occur, with financial intermediation shifting to those countries with lighter regulation. And finance is so internationally interconnected that serious problems in one country will spill over into others.

This interconnectedness is not a trivial issue; even a relatively small country could threaten the world financial system. For example, Swiss banks' balance sheets equal eight times Swiss GDP. Recall the way Iceland, with a population of 300,000, became financier to the world, then collapsed. Greece is being propped up largely because its default would do so much damage to the German banking system.

This risk is sharpened by the realisation that, if there is another crisis, few countries will repeat Ireland's mistake of bailing out its banking system. Next time around, foreign creditors will be left in the lurch.

The Bank for International Settlements (BIS) in Basel provides the forum for banking sector coordination, but there are unresolved issues. Thus Geithner urged other countries to see it Washington's way. So far there is international agreement on an increase in banks' capital requirement, but not on additional requirements for systemically-important institutions.

Another unresolved area is derivatives. The enormous scale of these instruments is difficult to comprehend and many of them might be likened to bets on unforecastable contingencies.

International agreement has been reached that common standardised derivatives should be traded on central exchanges. This provides some opportunity for transparency, regulation and supervision. But so long as 'over-the-counter' (OTC) non-standard derivatives are outside regulation, this illiquid and non-transparent market (currently US$600 trillion face value) is likely to expand, threatening a repeat of Lehman Brothers' collapse.

The US has decided to impose a capital requirement on institutions providing such OTC derivatives. Geithner called on other countries to impose similar requirements to avoid a regulatory 'race-to-the-bottom' as countries bid to attract this financial business. Asia was specifically mentioned, with Hong Kong and Singapore on Geithner's mind.

Needless to say, Geithner's lecture on financial rectitude did not go unanswered. His description of the UK's 'light touch' regulatory framework as being 'tragic' provoked much understandable, if irrelevant, comment about people in glass-houses throwing stones. The head of Hong Kong's securities regulator accused Geithner of 'talking nonsense' in urging the world to follow the US lead. The CEO of JPMorgan Chase took the opportunity to blame the new higher capital requirements for the slow US recovery. 

But Geithner kept his most explicit criticism for those closer to home. He warned of 'the efforts by politicians and groups which oppose financial reform to starve the regulators of resources...Those in the financial community who are supporting these efforts to block resources and appointments are looking for leverage over the rules still being written. There is a long tradition of similar efforts'.

The last three years have toughened Geithner up, but the battle is not yet won. 

Photo courtesy of the US Embassy in New Delhi.