G30 Report Calls for Far-Reaching Regulatory Reforms for Financial Services Firms, Central Banks and Supervisory Authorities, to Strengthen Global Financial System

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"The pervasive and deep-rooted financial crisis has amply demonstrated that our financial system is broken and it requires thorough-going repair", according to Paul A. Volcker, Chairman of the Trustees of the Group of Thirty (G30). A Report released today formulated by a small Steering Committee and assisted by a working group of G30 members reviews the needed restructuring of financial institutions and markets.

Financial Reform - A Framework for Financial Stability

"The pervasive and deep-rooted financial crisis has amply demonstrated that our financial system is broken and it requires thorough-going repair," according to Paul A. Volcker, Chairman of the Trustees of the Group of Thirty (G30). A report released today formulated by a small Steering Committee and assisted by a working group of G30 members reviews the needed restructuring of financial institutions and markets.

The report entitled "Financial Reform - A Framework for Financial Stability" includes 18 sets of recommendations. The general approach is to strengthen the oversight and stability of systemically important institutions that serve the needs of individuals, businesses and governments and that are largely responsible for maintaining the market infrastructure. Capital market participants, including hedge funds and equity funds, would be required to meet higher standards of transparency, with greater attention to capital, liquidity, and risk management practices. Attention is also directed to practices of credit rating agencies, settlement and clearance arrangements for derivatives, approaches toward common international accounting standards and the treatment of "fair value," and the need for closer international cooperation and coordination.

Mr. Volcker noted, "The issue posed by the present crisis is crystal clear: How can we restore strong, competitive, innovative financial markets to support global economic growth without once again risking a breakdown in market functioning so severe as to put the world economies at risk? We hope that our proposals, which explicitly relate to the weaknesses that have become evident in the financial system over the last year, will be a useful contribution to the debate about needed reforms both by private financial institutions and by public authorities."

Mr. Jacob Frenkel, Chairman of the Group of Thirty and Vice Chairman of AIG, said, "Financial markets today are fragile and highly vulnerable. These conditions require that policy initiatives must focus on restoring stability and rebuilding confidence in the system as a whole. For confidence to be fully restored, markets must be reassured that there is a coherent agreement on a comprehensive reform of the regulatory and supervisory system. We believe that policymakers must adopt changes that improve prudential regulation and supervision. We must also improve risk management, enhance transparency, strengthen the market infrastructure, and assure a greater degree of international consistency and coordination among regulators and supervisors."

The report's first recommendation emphasizes the need for the largest and most complex banking organizations to be subject to particularly close regulation and supervision, meeting high and common international standards. The G30 said these large, systemically important banking institutions should be restricted in undertaking proprietary activities that present particularly high risks and serious conflicts of interest.

This recommendation includes a proposal that nationwide limits on deposit concentration should be considered at levels appropriate to individual countries in order to guard against excessive concentration in national banking systems with implications for effective official oversight, management control, and effective competition.

Much of the report concerns the governance, operations, regulation, and supervision of banks. Mr. Arminio Fraga, G30 Steering Committee's Vice Chairman, founding partner at Gavea Investimentos and former Governor of Banco do Brasil, said: "The report recommends a series of significant reforms. On the prudential side they include the regulatory treatment of the so-called parallel banking system, the role of the central bank in maintaining financial stability and the need to improve information standards and to regulate over-the-counter derivatives markets. Given the pervasive failures in risk management in financial institutions, the report also emphasizes the role of proper governance and incentives, including the important link between risk taking and compensation systems. Finally, on the crisis management side the report focuses on how far the access to lender-of-last-resort facilities should go and on the importance of having in place a proper resolution mechanism for failed financial institutions".

Mr. Tommaso Padoa-Schioppa, Vice Chairman of the Steering Committee and former Italian Minister of Economy and Finance, stated that, "In rebuilding an efficient and stable system, certain guiding principles are particularly relevant. Incentives should be consistent with the principle that risks should be borne by those who take them. Regulatory policies and approaches should promote fair and effective competition and, insofar as is feasible, treat financial services common to different institutions uniformly. Reforms should be internationally consistent in approach and coordination."

He added that, "A number of our recommendations aim to promote significant improvement in the quality and effectiveness of prudential regulation and supervision for bank and also for non-bank financial institutions. We stress that regulatory policies and accounting standards that most affect banks, must guard against procyclical effects and be consistent with maintaining prudent business practices. We propose that regulatory capital standards should be enhanced and that benchmarks for bank capital should be raised."

The report includes recommendations that would strengthen the coordination and efficiency of national bank regulatory and supervisory institutions. It proposed a significant strengthening of the role of central banks, noting that in countries where the central bank is not the prudential regulator, the central bank should have: (i) a role on the governing body of the prudential and markets regulator(s); (ii) a formal review role with respect to proposed changes in key prudential policies, especially capital and liquidity policies as well as margin arrangements; and (iii) the supervisory role in regard to the largest systemically significant firms, as well as critical payment and clearing systems.

The G30 called for the consolidated supervision of non-bank financial institutions. For example, it said that for those countries lacking such arrangements, a framework for national level consolidated prudential regulation and supervision over all large insurance companies should be established. It also proposed that an appropriate prudential regulator should be designed for those large investment banks and broker-dealers which are not organized as bank holding companies. The report stated that there are compelling grounds for the regulation of hedge funds and it also recommended increased supervision of money market mutual funds and a variety of other private pools of capital.

A host of recommendations in the report are based on the key conclusion that financial markets and products must be made more transparent, with better aligned risk and prudential incentives. The report adds that the infrastructure supporting such markets must be made much more robust and resistant to potential failures of even large financial institutions. Several sections of the report also emphasized that given the global nature of the markets, it is essential that there be consistent regulatory frameworks on an international scale, and national regulators should share information and enter into appropriate cooperative arrangements with authorities of other countries responsible for overseeing activities.

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