Global Governance and Regulatory Failure

The Political Economy of Banking

R. Goldbach

• Publisher: Palgrave Macmillan
• Year: 2015
• ISBN:
  9781137500038
• Topic: Politique et relations internationales
• Subtopic: Relations internationales

The author provides a theoretical framework of the global political economy of banking regulation and analyses the policies and politics of the Basel Committee on Banking Supervision. He demonstrates how global governance has contributed to the onset of the Great Recession and continues to increase the likelihood of future global financial crises.

1

The Great Recession, Regulatory Failure and Global Governance

Succumbing to one form of interdependence may be the price one pays for avoiding another.

(Keohane & Nye 1974, 61)

1.1 Global governance and financial crisis

Did global governance through transgovernmental networks lead to regulatory failure that caused the Great Recession? And, if yes, should we enhance global cooperation to prevent future crises or focus on the national level? In 2005, bank supervisors from industrialised nations – within the transgovernmental network of the Basel Committee on Banking Supervision – agreed to harmonise their regulatory standards with the purpose of controlling excessive risk-taking of globally active banks and pre-empting global financial turmoil. In 2009 these standards were considered a cause of the Great Recession as they had facilitated the spread of imprudent practices globally, rather than enhancing regulation. Their origin, the transgovernmental network of the Basel Committee, is frequently considered problematic with a view to regulatory failure. Nevertheless, in 2010, the BCBS presented its new framework, Basel III, as the centrepiece of global regulatory reform, which the G20 happily endorsed. Can we expect that these standards, this time, increase rather than undermine financial stability even though they originate in the same governance networks and through the same policy processes?

More generally, should we enhance the global approach to prevent future financial crises? Or should we rather focus our efforts to regulate banks on the national, or maybe the regional, level? In the public’s attempt to regain control over the financial sector without choking its growth engine, the seeking of the optimal, or at least best possible, locus for policy and regulatory action is crucial. Pundit and scholarly opinion is divided. Some tend to favour global or transnational governance approaches to the standard-setting problem (Slaughter 2004), some see the nation state as the locus of authority to be better suited to providing the necessary confluence of polity and market (Germain 2010). Probably, most authors (including those mentioned above) would argue that the spectrum of realistic options involves some mix of both national and global/transnational authoritative structures and agents. This leaves us with a complex global governance (dis)order (Cerny 2010b, Lake 2010), in which nation state bound and nation state-transcending governance layers interact in setting the rules to reduce risks of future global financial turmoil.

In this book, I argue that a persistent key problem of global financial regulation as well as other transnationally governed areas of the global political economy is that policymakers pursue both, national and transnational governance, but do not reconcile these approaches. The unchecked simultaneity of national and transnational influence in (transnational) standard-setting is a major, unresolved problem at the core of global governance, since it leads to durable disorder and, in consequence, to global policy failure. With a view to the financial governance reforms in response to the Great Recession, I argue that the unreconciled competition of national and transnational governance continues to condition global policymaking, which implies the undiminished probability of future regulatory failure and turmoil – the reforms actually foster this aspect of the pre-crisis constellation.

1.2 Transgovernmental governance and regulatory failure

This book is about the transgovernmental harmonisation of standards to regulate globally active banks – in short global banking regulation – and in particular about the structures and dynamics of its global political economy. More specifically, the study is about the effects that the Basel Committee on Banking Supervision (BCBS, Basel Committee) and its most recent agreements, the Basel II and III frameworks, have on the stability of the global financial system. Thus, my aim is to explain the role that global governance plays in regulatory failure, a main cause of the Great Recession.

It is by now accepted wisdom that this latest crisis, the most severe financial turmoil in six decades, was in part caused by regulatory failure to prevent imprudent banking strategies, which, in turn, resulted in global financial instability. It is, furthermore, a widespread conviction that the transnational harmonisation of regulatory standards between developed nations in the Basel Committee was a crucial element of this regulatory failure – by diffusing faulty standards, the infamous Basel II rules, transnationally. This is particularly concerning, since it was the Basel Committee that was commissioned to strengthen financial stability after the crisis – the same transgovernmental network of the G20 nations’ regulatory agencies with its problematic transnational governance structure (Verdier 2013). Accordingly, as first evidence suggests, the resulting Basel III reforms remain largely insufficient to enhance the provision of (global) financial stability (Admati & Hellwig 2013, European Systemic Risk Board 2014). Moreover, with the reconstitution of the Financial Stability Board (FSB), the centrepiece of the governance reforms is the addition of another transgovernmental network – with potentially comparable structural effects. These BCBS and FSB reforms are arguably the most important changes to the global regulation of banking and financial stability. Therefore, with the aim to explain global regulatory politics and failure, and given that largely the same transgovernmental regulatory networks that have harmonised the faulty rules of banking regulation prior to the crisis are also the central hubs of post-crisis reforms, I will investigate how this governance structure conditions influence in regulatory processes and outcomes. At the same time, I will assess the question of whether the post-crisis reforms, Basel III and the FSB in particular, actually constitute significant change.

In sum, then, the question that guides my analysis is how the transnationalisation in the governance structure of regulating banks and financial stability conditions the influence of actors in the political process of standard-setting, and, thereby, the content of regulatory standards.

There are several excellent studies on the Basel Committee and its standards. Ethan Kapstein (1989, 1992, 1994) has revealed how supervisors assembled informally in the early 1970s within the Basel Committee to overcome control problems in their jurisdictions. Following his example, other studies have emphasised that standards are set through a two-level game of national and international politics, with a particular focus on the influence of US-based market power in setting these global rules and domestic US interests – Congress, banks, regulators – driving this cooperation (see e.g. Simmons 2001, Wood 2005, Singer 2007, Drezner 2007, Tarullo 2008). A second group of studies rather puts emphasis on the transnational mechanisms driving Basel standards, be it the transgovernmental epistemic community of supervisors within the BCBS or the transnational banks and their associations (see e.g. Underhill 1995, Slaughter 2004, Porter 2005, Goodhart 2011, Young 2012). The present investigation, however, is motivated by the promise of what the integration of these state-bound and transnational approaches can yield in explaining global politics and regulatory failure.

My aim is to combine previous insights to construct an encompassing, systemic understanding of how the different actors and institutions that affect global banking regulation interact in bringing about the global standards, and how this relates to regulatory output and, potentially, failure. I will introduce a theoretical framework that synthesises these diverse mechanisms and will provide new empirical data on the politics and policies of the Basel Committee and its Basel II/III frameworks, which adds up to a detailed account of the global political economy of banking regulation during the time period from 1998 to 2014. While I am interested in regulatory failure, I designed the empirical analysis rather neutrally, with a view to explaining who was influential, through which channels, and which policies resulted from that. This, however, allows me to draw substantiated conclusions about the link between governance structure and regulatory failure. Furthermore, I assess whether the post-crisis reforms have changed the governance structure’s conditioning of influence and outcomes.

A new aspect in the area of transgovernmental banking regulation, which however builds on Goodhart’s (2011) historical study on the Basel Committee’s early years from 1974 to 1997, is my emphasis on the evolution of the Basel Committee and its surrounding governance and opportunity structure. Thus, the Committee constitutes a prime example of the incremental evolution of global politics. As such, the continuous development mirrors the incremental transnationalisation of the political process and the deepening global institutionalisation of the governance structure. In order to explain how global harmonisation works in this setting, I delineate how standards are diffused transnationally through, and how the rule development takes place within, the transnational regulatory regime that connects national, interstate, and transnational actors and institutions. This constellation, however, is prone to asymmetric influence and policy failure.

1.3 Interdependence and the collision of competition state and global governance

Beyond these policy and governance challenges of global banking regulation, this study is also rooted in the fascination of the broader phenomenon underlying these issues. That phenomenon is the transnationalisation (or globalisation) of politics and political economies, and the resulting tensions of the simultaneity of nation state-bound and state-transcending mechanisms.¹ In accepting that there is neither a neat international system of state units nor a global polity, my interest is rooted in two sets of closely intertwined questions concerning the state of the global political economy. First, how does the (partially) global political economy structure the policy process and the influence of different actors? And, second, how do the multiple factors of this complex constellation dynamically interact in affecting (global) policy outcomes, i.e. regulatory standards?

Underneath these questions lies the continuous transformation of structures and processes in the international political economy since the 1950s and 1960s – and in particular the transformation of the nation state. This trend and its effects can be stated succinctly to encompass three broader developments: (1) the incremental break up of the (never complete) unity of national polity and economy and the corresponding reduction of national independence in setting rules for the economy; (2) the state’s adaptation as ‘competition state’ that pursues the competitiveness of its economic actors in the global market place in order to enhance its citizens’ wealth; (3) the growth of complex governance regimes that do not make the state vanish, but rather integrate its partially disaggregated components as well as interstate and transnational mechanisms in the societal attempt to govern partially globalising political economies.

This spans (at least) from the post World War II order of ‘embedded liberalism’ (Ruggie 1982), during which the free trade regime deepened the economic interdependence of nations, i.e. the activities of national economies increasingly unfolded reciprocal, transnational effects (Keohane & Nye 1977). Notwithstanding its wealth-enhancing effects, however, this also widened the gap between national governments’ aspiration for control and the capability to achieve it, i.e. this transnationalisation created a new quality of a ‘control gap’ (Nye & Keohane 1971b, 343). Attempts to narrow this horizontal control gap of economic interdependence through transgovernmental cooperation resulted in ‘policy interdependence’ (ibid) due to the emerging transnational governance layers. Yet, the incomplete compatibility between national and transnational rules and processes resulted in vertical governance gaps. Thus, in effect, global governance efforts change the nature of the gap rather than narrowing it. ‘Succumbing to one form of interdependence may be the price one pays for’ moderating the consequences of another (Keohane & Nye 1974, 61). As I will demonstrate in later chapters, it is this governance gap, first identified in the 1970s, that is constitutive of regulatory failure.

The challenges of this governance gap were augmented through the onset of free-floating currencies and the removal of capital controls. Furthermore, the third industrial revolution since the late twentieth century accelerated the globalisation of societal interaction and introduced new dynamics. Philip Cerny (1995) has delineated the core challenge to the spatial unity of state and market: in a world of increasingly open economic exchange, private market activity can relatively easily widen its transnational scale of production, while, however, the much more difficult endeavour of creating a spatially coherent public authority that can embed this market activity cannot catch up with the private interaction. Now, this is important to remember with a view on current global banking regulation, since the consequence of deepening interdependence was the incremental loss of national policymakers’ capacities to curb their own banks’ activities as well as transnational spillovers of financial turmoil from other countries (Kapstein 1994).

In other words, the global reach of financial intermediation – facilitated through the technological advancements that enabled electronic trading discerned from geographical space – was considered to make the state obsolete in governing economic relationships. With regard to the globalisation of finance, however, studies from the 1980s and 1990s revealed how states were active supporters of this development as it suited their governments’ and bureaucracies’ agendas (Helleiner 1994, Pauly 1997), even though many implications were rather unintended (Goodman & Pauly 1993). Moreover, several scholars have qualified the ‘retreat of the state’ (Strange 1996) by demonstrating that the state, rather than vanishing, is adapting to the circumstances created by globalisation. This adaptation has many faces (Berger 2000), however in this study’s context it is the new role as ‘competition state’ (or ‘regulatory state’, see Majone 1997) that is crucial (Cerny 1997, 2010a). Domestically, the development into the competition state was rooted in the diversion from the public goal of the positive or welfare state that widely engaged in producing goods itself and protecting many aspects of individual and social life from free market uncertainties. Under pressure of public fiscal constraints and neoliberal policy agendas the competition state reinterpreted the main aim of the state as one of enabling free markets to flourish. For that purpose, competition needed to be facilitated to the goal of which the state would focus its public interventions. This meant arm’s length regulation, rather than production and welfare spending (Cerny 2010b). Globally, the competition state logic implies that all actors of disaggregated states aim to maximise the competitiveness of the nation’s economic actors in the global market place in order to spur economic growth and enhance its citizens’ wealth. This logic is very important in the context of the global political economy, since it is the reasoning that underlies strategic decisions and the idea that underlies ideological actions of politicians, regulators and economic actors (Cerny 2010b). Whenever the competitiveness of a sector is supposedly threatened, ideational automatism and/or strategic calculation move parliamentarians in their support of crucial constituents. Likewise, governments are easily convinced of the need to negotiate for a specific exception or addition to international agreements, while public or sectoral concern is easily aroused and organised through appeals to national competitiveness in a globalised world.

As a result, national actors become international competitors for market share and industry location. In this context, regulatory policies become increasingly important as transaction costs for globally active firms, and may provide a competitive disadvantage, if other jurisdictions attract companies with less costly stipulations (Mattli & Büthe 2003). Regulatory/competition states, therefore, engage in ‘interjurisdictional competition’, which means that regulators have not only to ensure the societally beneficial functioning of markets, but also to ensure the attractiveness of their jurisdiction to global firms and the competitiveness of their jurisdiction’s main companies (Murphy 2005). Financial regulators, thus, ‘must walk a fine line between stability and competitiveness’ (Singer 2007, 23). The implications for the global quality of regulatory standards are far more complex than a race to the bottom of lowest possible standards (Vogel 1996). For the purpose, of this study, nevertheless, it is important to note that there are multiple factors that might incentivise regulators to adopt and enforce lenient supervisory approaches – and that these incentives are driven in considerable part by the logic of the competition state.

At the same time, however, deepening economic interdependence led policymakers to coordinate transnationally as well as internationally. In contrast to the state-unit bound approach of International Relations, the approach of global governance states that authority relationships do not neatly function in a hierarchical context of national and international organisation, but through the messy, often uncoordinated, interaction of national, transnational and interstate mechanisms (Rosenau 1995). ‘These centralizing and decentralizing dynamics have undermined constitutions and treaties in the sense that they have contributed to the shifts in the loci of authority’ (Rosenau 1992, 3). The reduced costs of transportation and communication have facilitated the immense increase in cooperation across the globe (Keohane & Nye 1998). As a result, global governance of state and non-state actors, in its numerous forms, deepened continuously. In sum, the increase in global governance efforts have created complex, dynamic governance regimes that do not make the state vanish, but rather integrate its partially disaggregated components as well as interstate and transnational mechanisms in the societal attempt to govern partially globalising polities and political economies.

A pivotal role in global governance is played by transgovernmental actors – sub-units of several nations’ governments and executive agencies that build transgovernmental networks – which, with increasing frequency of contact, have moved from early information sharing, to policy coordination, cooperation and even transgovernmental, informal agreements (Slaughter 2004). The deepening transgovernmental cooperation in banking and financial regulation, as in several other policy areas, has implied the incremental transnationalisation of governance structure and policy process (Cerny 2001, 2010b). While central banks have been building such a web at least since the 1930s in the context of the Bank for International Settlements, banking regulators have been deepening close transgovernmental coordination ties since the early 1970s (as will be discussed in Chapter 2).

Thus, at its current stage, the global political economy is simultaneously characterised by interjurisdictional competition among competition states and by the transgovernmental cooperation among the same actors from these disaggregated states.

1.4 Transnational layering and the New Interdependence Approach

This overlap of state-bound and state transcending authority leads to the layering of national and transnational rules and policy processes, which can create considerable loopholes in regulating economic activity, i.e. a global governance/regulatory gap. This global layering (national + transnational [+ international] layers = global layering) and the corresponding governance gaps have two aspects, one institutio...

Table of contents

• Cover
• Title
• 1  The Great Recession, Regulatory Failure and Global Governance
• 2  Global Financial Instability and the Evolution of Global Banking Regulation
• 3  Theory: Influence in Global Banking Regulation and the Transnational Regulatory Regime
• 4  Global Banking Regulation Before the Great Recession: The Dynamics of Basel II
• 5  Global Banking Regulation after the Great Recession: Basel III, FSB, G20
• 6  Conclusion: Layers and Gaps in the Global Political Economy
• Notes
• References
• Index