How the global financial architecture evolved and how that influences the probability of crisis is very rarely discussed. In the analysis, the network structures of the global financial architecture is often forgotten.

The financial architecture is the system of public and private bodies which try to influence the regulation and standards required for financial markets to function. These are the the main types of actors in the financial architecture:

• Governments
  1. National governments, in particular finace ministers
  2. Informal meetings of government officials, such as the G7
  3. Supra-national government organisations, such as the EC
  4. International organisations representing the interests of governments, such as the IFM, World Bank, OECD.
• Central banks
  1. National Central Banks
  2. Informal Meeting of Central Bank Governors, such as the G10
  3. Supra-National Central Banks, like the ECB
  4. International Organisations of Central Banks, such as the BIS
• Regulators
  1. National Regulators responsible for
     • Banks and other financial intermediaries
     • Securities Firms and other type of trade of financial derivatives
     • Insurers
  2. Supra-National Meetings of Regulators
     1. with specific regulatory tasks, such as CEBS, CESR or CEIOPS
     2. with over-arching regulatory tasks
  3. International Meetings of Regulators
     1. with specific regulatory tasks, such as BCBS or IOSCO
     2. with over-arching regulatory tasks
• Private Bodies
  1. National Lobbying Group of Financial Institutions
  2. Surpa-National Lobbying Group of Financial Institutions
  3. International Lobbying Group of Financial Institutions
• Academic Consultancies and Think Tanks
• NGOs

The heuristics still has some weakness, but it helps to get a first picture of the financial architecture.

It is difficult to get a meaningful categorization of the private bodies because scope and membership of these private bodies are overlapping. Some of these organizations have identical aims but conflicting interests because they represent financial actors from different regional constituencies without however saying this in their statutes.

The categorization concerning NGOs and Academic Institutions lacks details because they are not the main actors in standard-setting, which is the second part of the financial architecture. So in addition to the actors, a list of standards would be needed which then can be attributed to particular organisations.

There are quite a few hybrid bodies and it is difficult to put them into the system above, such as the FSF. Also the disction between public and private organisations are not as sharps, because many public bodies have advisory councils consisting of representatives from banks or other large financial institutions.

The distinction between regulation, standards and lobbying is also quite blurred. In financial markets, self-regulation and technical standards agreed upon without government intervention play an important role. Regulation sometimes reflects either the attempts of the industry to self-regulate (for instance in Codes of Conduct) or serves the interests of certain part of the industry to keep their competitors out of certain market segments.

The Mapping-Project undertaken here aims to get a better understanding on how standards are produced, how the financial actors communicate and co-operate and how the financial architecture is being build.

Key Questions to be asked will be:

• Decision-Making Process
• Established by law or statute

In summary, Banks take the blame for the credit crisis by saying that lending standards declined, securities were not sufficiently underwritten, structured products not fully understood, liquidity risks (when markets dry out) not anticipated and because of poor management reputational risk (which result in the stock prices of bank going down) not foreseen for the banks.

The IIF suggests a code of conduct for the major financial institution. The motivation is twofold: such a code of conduct should send a signal to the regulators that the financial industry does not need new regulation. It is questionable though, whether regulators continue to rely on voluntary standards, such as the IOSCO Code of Conduct (2004) for Credit Rating Agencies or the Hedge Fund Code of Conducts (2007).

The second motivation is toward the markets: a code of conduct can be a signal to the markets that certain risks are being addressed. However, markets are more difficult to fool than regulators: if a code of conduct is simply a piece of paper which does not reflect the practices of financial institutions, then markets won’t take the bait.

One weakness of the proposal by the IIF is already included in the proposal: because of the diversity, there will be no single standard for the whole industry. The report says:

Because there are substantial differences in business models, mix of business, exposures,
regulatory oversight and culture, there is unlikely to be a single solution to any issue that would be optimal for all firms and all circumstances. Thus, “best practice” as used here is not a legal obligation but a high standard for firms to apply in developing solutions appropriate to their own situations.

The IIF report calls for improved standards in areas: risk-management governance; technical risk-management issues; and stress testing. They admit that questions have been raised about…

…the ability of certain Boards properly to oversee senior managements and to understand and monitor the business itself.

The report wants to establish a “risk culture” and “three lines of defense” (business management, risk management, audit and control functions). The problem however is not so much that the existing regulation did not already establish these mechanism. The problem is that often the management encouraged the taking of excessive risks claiming that their competitors did the same. This “herding” led to the problem of prudent banks such as the German Landesbanken or the IKB speculating heavily with products they did not fully understand.

In essence, it is doubtful if voluntary standards will satisfy the regulators, but the debate between regulators and industry surely has taken an interesting turn.

(Will be continued)