Global Financial Governance – Definitions by Alexander, Eatwell and Dhumale
Alexander, Eatwell and Dhumale make this causal explanation for the need of Global Financial Governance (p. 14):
In the post-Bretton-Woods-Era, banks and financial instutions have adopted innovative financial instruments to diversify earnings and to hedge against credit and market risk.
[Is this really the case? Wasn't it rather to hedge primarily against exchange rate movements?]
This has led to increased international banking activity and to the rise of multifunctional universal banks. These developments [produced] economic growth and development. But they also made financial institutions more dependent and exposed to systemic risk [...]. [T]hese forces of financial globalisation [led to] efforts to strengthen the institutional framework of financial regulation.
They define Global Financial Governance using three principles (p.15):
- Effectiveness in devising efficient regulatory standards and rules
- Accountability in the decision-making structure and chain of command
- Legitimacy (those subject to international regulatory standards have participated in creating them.
None of these three dimensions are particular to financial markets, so the authors introduce (p. 16) the concept of Systemic Risk, which is an underpricing of risk that spreads through the markets. According to the authors, financial regulation has the task to promote the efficient pricing of risks.
The authors follow (p. 17) the route of Political Economy (especially Douglas North) and Game Theory (especially Robert Axelrod) by looking at the role of institutions in financial regulation. However, in Game Theory and Political Economy, institutions are often defined as “regularities in social behavior” (Axelrod: 1984). Accordingly, international institutions can be defined as “a set of rules that govern the ways in which states cooperate and compete with each other” (Kahler: 1995).
Such a definition would also encompass all kinds of informal or tacit arrangements and agreements. But the authors add a legall dimension to their definition of International Financial Institutions (IFIs). Applying the concept of an institution to the current financial architecture, the authors state “international public- and private sector bodies that are involved in setting standards and rules to govern financial markets” (p. 17) have been created. In other words, the authors use the concept of “institution” dynamically: regularities of behaviour will lead to a set of rules which in turn create a public or private body receiving the mandate to create further rules.
Normally, “global governance” is defined in opposition to “global government”: in the absence of any clear-cut global institutions to act as legislative, executive and judiciary, states create binding international rules. “Global governance” is the process of creating “global institutions” without a “global government”.
The authors however chose to discuss the shortcomings of “Global Governance” in a principal-agent-framework through the “creation and operation of rules at [international] level through the involving transnational and subnational actors” (p. 18). These rules are intended to avoid systemic risk and create financial stability, a “public good [which] will never be provided adequately by the market without regulatory intervention” (p. 18).
Despite their economic background, the authors interestingly seem to have a different notion of “public good” than often used in economic textbooks. Normally, a public good is a non-rival, non-excludable good which means that everybody can have access to it and consuming the good does not diminish the possibility of other users to access it. Yet there are some arguments why financial stability does not necessarily need public regulatory intervention, and even with public regulatory intervention is not necessarily a non-excludable good.
The authors definition of “financial system” clearly shows the ambiguity of having to use a different understanding of a public good. They define a financial system (p. 20) through:
- the extent of intregation of relevant financial sectors
- the scope and design of financial regulation and legislation
The authors would hopefully agree that in this sense of financial governance, financial stability becomes a public good for a certain financial systems that are defined through integration and legislation. Global financial governance is providing a public good of financial stability through global integration and global legislation (for instance by setting standards).
Topics of this post: accountability, definition, effectiveness, financial institutions, global governance, ifi, John Eatwell, JP Morgan, Kern Alexander, legitimacy, lender of last ressort, Memo, public good, Rahul Dhumale, systemic risk
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very nice theme