Political Realities Will Test G20's Plans for Financial Stability

June 23, 2010

As the G20 summit approaches in Toronto, there is much hope that this expanded club of world leaders will enlarge on the steps its members have already taken to promote global prosperity by coordinating their policies in the economic, financial and monetary realms.

The G20, in one of its most important actions to date, established the Financial Stability Board (FSB) out of the former Financial Stability Forum, a small, obscure organization located in Basel, Switzerland, in the Swiss mountains.  With the mandate given to the FSB, combined with a reinvigorated and recapitalized International Monetary Fund (IMF), in Washington, DC, there is talk of a new and better coordinated international financial system.  Lessons from previous years suggest, however, that some familiar political realities will intrude to challenge the efficacy of this new post-Bretton Woods order, despite the initiatives the G20 has tried to put in place to combat the dangers of contagion and moral hazard in the global economy.

Compliance and the FSB

After the financial crises in the late 1990s and early 2000s, the G7 industrialized economies developed a set of international financial standards that, had they been applied, might have helped prevent the crisis that hit the global economy in 2008-2009. Specifically, the G7 asked the IMF (with the assistance of the World Bank) to monitor member countries’ compliance with these standards through the mechanisms of the IMF’s Financial Sector Assessment Program (FSAP) and the Reports on Observance of Standards and Codes.  In the aftermath, some of the most important countries, including the United States and a number of emerging economies, insisted that the process of complying with the standards be made voluntary, and delayed or refused (the US and China) to commit themselves to undergoing the FSAP process — in hindsight, a tremendous folly, given that the US financial system was at the epicentre of the most recent financial crisis. Canada was the first country to submit itself to review under the FSAP and was followed by a range of countries. Some acquiesced because they saw advantage or because they had little to lose or gain; others agreed because they needed access to IMF financing. It has been noted that the main reasons behind the failure to implement the financial standards were that disclosure was voluntary for some and that many emerging market economies had no say in the decision-making process that led to the creation of the standards.

The advent of the G20 with its major emerging market economies should add legitimacy to the FSAP process and improve the mutual stake in coordination.  The G20 envisions collaboration between the IMF and the FSB in monitoring member countries’ compliance with international financial standards and on standardizing regulatory mechanisms in banking and other financial services. In the words of Managing Director Dominique Strauss-Kahn, the IMF will be the monitor of the “basic plumbing through which global capital flows”; the FSB will be the coordinator of information on what national regulators are allowing to pass through the drain. The idea is to use the moral suasion of a G20 peer review process, whereby countries are encouraged or shamed into fully disclosing  even politically sensitive information, all in the interest of maintaining global financial stability.

A Step Forward?

While this approach is a definite step forward, realism suggests that it may not be long before the honeymoon ends and the skirting of responsibilities returns to the fore.  The problem is the potential for countries to free ride: countries will tend to row less than their share in the joint movement toward financial stability. The problem of voluntary disclosures by national authorities to international bodies is that there are strong political and market incentives for countries to appear as stable as possible.  The crisis in Greece today underscores precisely this problem, and has greatly affected the European Union and the euro zone. International economic coordination will continue to face the reality that national officials and markets will act in their own interests and strive to first satisfy domestic constituents before meeting their international obligations.

In some respects, the G20 is entrusting the IMF and the FSB to not only help coordinate information sharing and provide oversight, but also to leverage the technocratic weight of their staffs to keep national and market interests in check. The reality, however, is that neither organization will be immune to external politicking, particularly to challenges of their analyses from powerful members. Moreover, imagine the uproar of legislatures, unions, banking or business interests at the mention of national regulatory changes being imposed by either the FSB or the IMF.  Neither organization has the power to challenge national sovereignty.  Both organizations will remain dependent on moral suasion. Despite the G20’s ambitions, the IMF and the FSB will continue to be hampered by individual governments’ determination to preserve their respective national interests.

Bessma Momani is a senior fellow at The Centre for International Governance Innovation and associate professor of political science at the University of Waterloo.

(Image credit: Flickr user tanakawho)

About the Author

CIGI Senior Fellow Bessma Momani has a Ph.D. in political science with a focus on international political economy and is full professor and interim assistant vice‑president of international relations at the University of Waterloo.