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Symposium 2014

Proposal - The New Global Financial Architecture

The Challenge

The 2008/09 economic and financial crisis taught the world an important lesson: while the nature of the financial industry has become truly global, with an increasing number of actors and institutions ...

The 2008/09 economic and financial crisis taught the world an important lesson: while the nature of the financial industry has become truly global, with an increasing number of actors and institutions on the credit market, regulation is still highly fragmented among different national supervisory authorities. To maintain systemic stability and prevent contagion, more is required than merely ensuring the orderly operation of individual financial institutions. Different regulators—including monetary authorities—must cooperate in order to achieve better, but not necessarily more, regulation. Better regulation should aim at identifying overleveraging and emerging vulnerabilities, ensuring the adequate pricing of risk, and promoting better incentives for prudent behavior. In pursuing these targets, regulation will require changes to institutional structures, the content of rules, and especially the structures of supervisory agencies.

Global financial stability is a global public good and therefore requires global policy coordination and cooperation.

Financial stability is a public good. In economics a public good has two main characteristics: it is non-excludable and non-rivalrous. Financial stability is non-excludable since individuals, firms and institutions cannot be excluded from its externalities. It is non-rivalrous because it will still be there no matter how many people benefit from it.

And most importantly, financial stability is global. It has a direct impact on the livelihoods of people all over the world – even if they have never travelled abroad or their nations are relatively less connected by modern standards.

At the same time, like any public good, financial stability provides a good example of market failure. Beneficiaries of global financial stability do not have sufficient incentive/ability to maintain it individually, but indeed do have incentives to free ride from it.

The way financial (in)stability spreads is less and less hierarchical. It does not just move from big powerful nations to smaller ones, as we have observed during the global financial crisis. “Infection” can also run in the opposite direction. In 1931, the insolvency of Kreditanstalt, a small Austrian bank, has created a global run on financial systems from Europe to the United States, and put the international gold standard under strain.[1]

As defined by the chaos theory, this is the butterfly effect in finance. A failure of a small financial institution in one country may result in the collapse of the overall financial system in another country.

The web of our banks and non-bank financial institutions is such that even the smallest misstep in the smallest of jurisdictions may turn what seems like an idiosyncratic, localized problem into a global and systemic one. Much like malaria-carrying mosquitos do not stop at national borders, financial contagion may spread rapidly.

In order to contain the pandemic of global financial crises, countries must therefore accept that financial stability is a public good that requires policy coordination and cooperation. They must also actively embrace this idea.

Such an insight may not come easy to some countries and/or cultures that cling to the notion of “sovereignty”, but that introverted decision-making process is simply no longer realistic in today’s highly interconnected world.

Aggressive quantitative easing in the United States, for example, was arguably the right response to deal with the liquidity crunch in the U.S. financial system. But both the injection of market liquidity through quantitative easing and its subsequent withdrawal have had significant global consequences to the rest of the world. It first flooded emerging markets with easy money in search of high yield and then exposed those markets to capital outflows. In either case and in either direction, these flows created imbalances and financial instability in emerging markets.

We have three proposals to enhance the global financial architecture.

First, a global monitoring, regulatory and policy framework should be the bedrock of the new global financial system.

After the global financial crisis, at the G-20 Pittsburgh Summit, a reform agenda was formulated with the aim of reducing the vulnerability of the financial system against shocks.

In this context, the Financial Stability Board (FSB), the Basel Committee on Banking Supervision (BCBS), the International Association of Insurance Supervisors (IAIS), and the International Organisation of Securities Commissions (IOSCO) have actively worked on a strengthened regulatory framework. The overall goal is to reduce systemic risk caused by the financial sector. We believe these steps are significant and we should improve on them.

As Turkey’s finance minister, I have a special interest in this topic. As you may know, Turkey is hosting the G-20 Summit in 2015. This provides us with a great opportunity to push for more global policy coordination and cooperation.

Second, at a global level we should have more rules and regulation, such as setting thresholds for important macro-financial indicators, similar but not limited to Basel III, and thoroughly covering fiscal, monetary, external, and financial sectors.

Third, we propose an incentive mechanism for global coordination. For instance, this could be in the form of swap lines for countries in need of emergency by leading central banks, or it could be in the form of insurance by international financial institutions for the countries that maintain prudent macro policies and cooperate with global IFIs and that are willing to coordinate policies.

To sum, interconnectedness makes global financial system vulnerable to shocks, and therefore, countries should be willing to coordinate and cooperate policies at the global level.


[1] Conlin, J. R, 2007, “The American Past: A Survey of American History,” Enhanced 8th Edition, Thomson.

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