With a career that includes stints as head of the International Monetary Fund and the Bank of France, Jacques de Larosière knows what goes on inside international financial markets. So it came as no surprise that he was asked to lead a panel of experts tasked with recommending sweeping changes to financial supervision in the European Union. De Larosière’s February report calls for the creation of a new supervisory body, the European Systemic Risk Council, as well as greater coordination between nations, a theme that is at the core of EU reforms expected to be approved in June. De Larosière spoke with Institutional Investor Senior Editor Jo Wrighton last month in Paris.
1 Institutional Investor: How urgent is financial reform?
De Larosière: We need to act with speed and determination to restore confidence. There are too many rules, too many exemptions and too many different interpretations of EU rules. That tempts financial institutions to move to countries where regulations are more lax, and leads to protectionism as countries harden national rules to keep their institutions at home. Changes have to be made in less than a year or two, and they have to be applied systematically — not just in Europe but around the world. Countries like the U.S. and the U.K. have the most to lose. If they allow the fragmentation of the system to grow into more protectionism, they would be hit first, as capital would flow, or stay, elsewhere.
2 Should there be a single European bank regulator?
It seems more practical and acceptable to members of the EU that national authorities supervise the financial system. But we make it clear in our report that more coordination is needed, including the creation of colleges of supervisors for cross-border institutions, as well as the granting of more powers to the existing EU supervisory committees. The IMF should also be charged with checking that national supervisors do a good job enforcing the rules. Financial assessment programs exist within the IMF, but they are optional.
3 What about the risks of nationalism and protectionism in regulatory and economic policy?
The government rescue of some banks compounds the dangers of nationalism because it distorts competition. When a bank with subsidiaries abroad gets into trouble, that bank often ring-fences its liquidity in its home country — another form of nationalism. That lack of consistent crisis management must be acted upon. If governments want to prevent the distortion of competition that stems from massive public aid, the state should oblige those institutions to sell some of their businesses to reimburse some state aid.
4 Should there be different rules for high-risk investment banking activities?
Institutions that engage heavily in proprietary trading should be more closely monitored. Conventional wisdom was that investment banks traded at their own risk and were subject to thinner capital requirements. Experience has shown that these investment banks had little capital in front of large trading books and were under weak supervision. These banks, and the hedge funds they own, must be subject to stricter, not lighter, capital requirements.
5 How can the IMF help stabilize developing countries?
Net capital flows into emerging countries globally have declined sharply, from $900 billion in 2007 to $460 billion in 2008, and this year the Institute of International Finance expects the figure to be about $160 billion. It’s important for the IMF to help these countries. I would like to see it with much more money, up to $1 trillion, that it would get from countries with significant reserves. But that means the fund would have to treat lending countries such as China in a manner consistent with their economic power by reviewing their quotas. China’s share of the fund is very small at present.
