September 30, 2010

To reform financial regulations we need to reform the Basel Committee.

In May 2003, as an Executive Director of the World Bank, I told those many present at a risk management workshop for regulators the following with respect to the role of the Credit Rating Agencies. “I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit-rating agencies. This sure must be setting us up for the mother of all systemic errors.” And this I repeated over and over again, even in the press, even in formal statements at the Board.

Now as reported by Alan Beattie and James Politi in “IMF points to danger of ‘over-reliance’ on credit ratings for sovereign debtors” September 30, the IMF is finally admitting “Policy makers should work towards the elimination of rules and regulation that hardwire buy or sell decisions to ratings”

That is good, better late than never. But the real question that needs an answer is why on earth it had to take a financial crisis of monstrous proportions to reach a conclusion that should have been apparent to any regulator from the very beginning.

I saw it happen in front of my eyes and I know why it happened. As I wrote in a letter published in the Financial Times in November 2004, it was the result of the whole debate about bank regulations being sequestered by the members of a small mutual admiration club.

Therefore if there is now something even more important than rectifying the faulty financial regulations, that is to break up the Basel Committee and make absolutely sure it represents a much more diversified group of thinkers. That would have at least guaranteed that the basic question of what the purpose of the banks should be would have been put in the forefront before regulating them. Current regulations do not contain one word about that.

Besides me there were not plenty of experts who raised the question of whether the credit rating agencies should have such a prominent role and made many other valid criticisms. These persons should participate in designing and putting in place the needed reforms. It is simply unacceptable that the reforms that carry with them such huge global implications are implemented exclusively by Monday morning quarterbacks.