VARIABLE GEOMETRY FOR THE WTO: CONCEPT AND PRECEDENTS

In the aftermath of the breakdown of the multilateral trade negotiations in Cancun in mid-September 2003, various ideas have been put forward not only for their re-launching but also more broadly for the reform of the WTO as an institution and as a repository for agreements on trade and related matters. Amongst the latter is the idea of a WTO characterized by variable geometry, in other words of a WTO that would serve as an umbrella framework for agreements on trade issues whose signatories would not necessarily include all its members, and thus as a vehicle for some countries to undertake deeper integration or liberalization regarding selected subjects without trammels due to the unwillingness of other members to go along. This paper reviews this concept in the context of the history of the GATT/WTO and of different views as to its underlying rationale. It also takes a preliminary look at what a framework of variable geometry might involve and considers some of the benefits and problems likely to be associated with a multi-tier WTO. The paper begins with a review of features of the rules of the GATT which allowed for various kinds of non-uniformity in their application. While some of these were of a highly specific nature, others involved more fundamental departures from the principle of universal applicability. Of particular interest in this context are the Codes negotiated during the Tokyo Round. In the discussion of pertinent issues regarding the rationale and function of the GATT/WTO which follows, attention is drawn to the contrast between those who emphasize the role of non-discriminatory trade rules as a vehicle for reducing sources of economic and ultimately political and military conflict, on the one hand, and those who give greater importance to the WTO´s role as an instrument for achieving convergence in business regimes worldwide, on the other. In a sketch of possible solutions to some of the problems of reconciling variable geometry with WTO rules, the paper devotes special attention to the deviations from the MFN principle which would be involved, and to accession conditions for plurilateral agreements. The idea of variable geometry was raised during the Uruguay Round when the constitution of the new multilateral organization (which was eventually to be the WTO) was under consideration. However, the structure eventually adopted reflects the concept of a "single package" or "single undertaking". More recently the European Union has floated recourse to a plurilateral approach as a way of getting out of the present negotiating impasse regarding certain subjects. However, developing countries have not proved receptive partly, it is reasonable to assume, because the approach would not do anything to resolve the major conflicts in the areas of tariffs and subsidies currently blocking resumption of the negotiations or to deal with features of the outcome of the Uruguay Round which some consider should actually be rolled back. The counter-argument, which refers as much to the longer- term as to the present impasse, is that a multi-tier framework may enable the WTO to avoid the paralysis which could result from attempting to reach uniformly applicable agreements on trade-related subjects among countries with interests and concerns reflecting different levels of economic development.

STATISTICS FOR INTERNATIONAL TRADE IN BANKING SERVICES: REQUIREMENTS, AVAILABILITY AND PROSPECTS

This paper addresses the availability of statistical data for international trade in banking services. Such data are required for WTO negotiations and the General Agreement on Trade in Services (GATS). Following a discussion of areas of work for which data on international trade in banking services are required and of the outcome so far of international initiatives directed at the development of statistics for international trade in services, the availability of statistics relevant to the different GATS Modes of Supply of banking services of the GATS is reviewed. None of the currently available statistics under these headings provides a satisfactory measure of trade in banking services under Modes of Delivery 1 and 3 of the GATS. Thus the paper focuses on two other more promising categories of information, namely the income statements of banks, which depend on data already generated by private-sector entities, and data on trading in financial markets. In particular, the paper shows how information in the income statements can be approximately matched to the activities specified in the definition of financial services in the Annex on Financial Services of the GATS, exemplifying the argument with recent income statements of Jordanian banks.

ENRON AND INTERNATIONALLY AGREED PRINCIPLES FOR CORPORATE GOVERNANCE AND THE FINANCIAL SECTOR

Recent corporate scandals have led to a wide-ranging re-examination of standards for corporate governance with repercussions that extend to financial regulation and the key standards for financial systems which are a major component of current initiatives to strengthen the international financial architecture and include corporate governance as one of their subjects. This paper contains an account of the breakdown of corporate governance in the most baroque of recent scandals, that involving the collapse of Enron, where there were not only conflicts with standards for good corporate governance but also unusually extensive use of sophisticated techniques and transactions to manipulate the firm´s financial reports. Good corporate governance presupposes satisfactory performance not only on the part of auditors but also of other "watchdogs" or "gatekeepers" from the private sector such as credit rating agencies, lenders, investors and financial analysts. Their role in turn must be complemented by effective regulation, which in the case of a firm with operations as complex as Enron involves several different bodies. The paper documents the extensive failures of these different parties in the Enron case. This discussion serves as a backdrop to a discussion of policy initiatives in the aftermath of Enron´s collapse and other corporate scandals at the international level - most importantly the strengthening of the OECD Principles of Corporate Governance - and in the United States - where the response has included the far-reaching Sarbanes-Oxley Act whose repercussions will also be felt outside the United States owing to global importance of the country´s financial markets. The discussion also points to links between policy responses involving corporate governance proper and initiatives regarding international financial regulation. The paper also includes reflections on alternative models of corporate governance and of some of the implications of the weaknesses of the much touted United States model highlighted by recent scandals for the development and reform of corporate governance in emerging-market and other developing countries.

COMMENTARY ON THE FINANCIAL STABILITY FORUM’S REPORT OF THE WORKING GROUP ON CAPITAL FLOWS

This Report consists principally of recommendations and guidelines. It acknowledges the threat to the benefits of a liberal global regime for international capital flows posed by their instability. Concern is expressed as to risks to stability linked to reliance on short-term borrowing from banks, the interaction between different financial risks, and faultlines in global financial markets resulting from firms’ own hedging and risk management that may be difficult to identify in advance. But, in general, the Report’s recommendations focus mainly on changes in recipient countries in practices with regard to the monitoring and management of financial risks, rather than on changes in the main sources of international lending and investment. Those directed at the latter would require no major deviations from the thrust of existing policies in the countries concerned. In particular, the Report does not discuss proposals put forward in some quarters for substantial improvements in transparency regarding operations in currency markets widely considered to have contributed to recent episodes of instability. On the subject of controls over capital movements, the Report limits itself to cautious endorsement of those over inflows.

THE BASEL COMMITTEE´S PROPOSALS FOR REVISED CAPITAL STANDARDS: MARK 2 AND THE STATE OF PLAY

The Basel Committee´s Proposals for Revised Capital Standards: Mark 2 and the State of Play. The new 500-page consultative document on capital standards of the Basel Committee on Banking Supervision (BCBS), “The New Basel Capital Accord”, gives what is likely to prove a reasonable idea of the eventual shape of the new capital accord. However, many detailed issues remain to be resolved before completion of the drafting process in 2002. The scale and duration of this process reflects both the increasing complexity of banking operations and the role of the BCBS as the institution responsible for globally applicable standards for banking regulation and supervision. The basic structure of the 2001 consultative document follows that of the June 1999 proposals, in particular three Pillars treating the calculation of capital requirements, supervisory review, and the disclosure necessary for effective market discipline. But the 2001 proposals are much more concrete and detailed. In their present form the proposals of the New Accord raise several concerns likely to apply to all countries but in some respects particularly to developing ones. One set of concerns relates to the New Accord’s impact on supervisory divergences among countries, cross-border competition between banks, and cooperation between national supervisors. The New Accord has been crafted to accommodate banks of very different levels of sophistication. Yet this may compromise its basic objective of enhancing competitive equality by actually creating regulatory divergences in some areas of banking practice both within and between different countries. As a result the difficulties of achieving effective cross-border cooperation amongst supervisors may well increase. A second set of concerns involves the relation of the New Accord to ongoing exercises involving codes and standards. Here the key standard is the BCBS’s Core Principles for Effective Banking Supervision for which the capital adequacy requirements of the Basle Capital Accord provide the principal benchmark. The New Accord will represent a quantum increase in the complexity of supervisors’ responsibilities in most countries, and the resulting administrative burden will be aggravated by its in corporation in assessment exercises regarding compliance with the key standards. Furthermore, the link between the New Accord and key standards for financial systems also implies that implementation will become a subject for IMF Article IV surveillance and part of the conditionality associated with the IMF’s new CCL facility. A further set of issues involves possible effects on regulatory arbitrage, since the comprehensiveness and detailed character of the rules of the New Accord will almost inevitably be a source of new opportunities for such arbitrage. Finally, there are concerns as to the effects of the New Accord on economic activity and international capital flows. The proposed risk weights of the IRB approach would lead to substantial rises in interest rates for lending to borrowers with low credit ratings both within countries and internationally – rises likely to affect borrowers from several developing countries. Moreover, owing to their links to the ratings of credit rating agencies and to observed default rates, the risk weights proposed in the New Accord are capable of contributing to the pro-cyclical character of bank lending both within countries and across borders, since they would be likely to translate higher credit risks in more difficult times into increased capital requirements (and thus more restrictive lending policies). Prudential rules which would minimize such dangers can be sketched but would nonetheless be difficult to incorporate in the design of regulatory systems.

THE WTO NEGOTIATIONS ON FINANCIAL SERVICES: CURRENT ISSUES AND FUTURE DIRECTIONS

Trade in financial services is a major item on the agenda of the Doha Round of multilateral trade negotiations stalled since the ministerial meeting in Cancun in September. This paper reviews trends in such trade and major issues which have been raised in these negotiations so far. The WTO agreement on financial services reached in December 1997 is generally regarded as having contributed more to transparent policy regimes in the organization´s member countries than to the opening of markets to foreign suppliers. The paper reviews statistical data bearing on trends in the market access of foreign banks since 1997, and finds no increase in the presence of banks from developing countries in the markets of developed countries but a large rise in the presence of banks from the latter in the markets of the former. However, the latter increase is likely to reflect less the impact of the 1997 agreement in the WTO than a more general movement in the direction of financial opening which was taking place anyway and helped to shape the agreement. Watchwords in the submissions of major developed countries to the new round of negotiations include expanded market access and the removal from countries´ commitments of limitations affecting several different financial activities (horizontal limitations). Moreover attention has been drawn to the need for greater regulatory transparency in the treatment of foreign banks. Similar objectives were also pursued on the developed-country side in the negotiations which ended in 1997. In the WTO - as in many policy fora - developing countries continue to express their concerns about vulnerability to destabilizing capital movements. Although the rules of the GATS were designed to decouple liberalization of trade in financial services from that of capital-account transactions, they have not succeeded in alleviating several developing countries´ misgivings. Other matters to which developing countries have drawn attention are the need for greater harmonization of different limitations in countries´ commitments at the levels of national and local Government, and greater participation of developing countries in the setting of international standards with a bearing on market access and national treatment. Some subjects have been raised by both developed and developing countries but from divergent points of view. Thus both developed and developing countries have raised the need for clarification of the distinctions between the modes of delivery of financial services specified in the GATS where these have been blurred by recent technological change, though concerns on the two sides are motivated by differences of perspective. Moreover both have also focused on the connections between work on financial services in the WTO and that on different aspects of the international financial system elsewhere. But whereas the thrust of developed countries´ interventions here favours managing these connections in a mutually reinforcing way, developing countries are more circumspect owing to apprehensions as to the multiplication of factors incorporated in IMF surveillance and conditionality and of consequent constraints on national policy autonomy. Similarly the question of the scope of the prudential carve-out of the Annex on Financial Services developed countries appear to favour a tighter definition of its permissible scope, while many developing countries prefer to keep the carve-out broad and unconstraining. Both developed and developing countries have expressed support for more uniform classification of financial services in countries´ commitments but there has been less consensus as to problems linked to statistics for different modes of delivery.

THE BASLE COMMITTEE’S PROPOSALS FOR REVISED CAPITAL STANDARDS: RATIONALE, DESIGN AND POSSIBLE INCIDENCE

The Basle Capital Accord of 1988 was the outcome of an initiative to develop more internationally uniform prudential standards for the capital required for banks´ credit risks. The objectives of the Accord were not only to strengthen the international banking system but also to promote convergence of national capital standards, thus removing competitive inequalities among banks resulting from differences on this front. The key features of this Accord were a common measure of qualifying capital, a common framework for the valuation of bank assets in accordance with their associated credit risks (including those classified as off-balance-sheet), and a minimum level of capital determined by a ratio of 8 per cent of qualifying capital to aggregate risk-weighted assets. The 1988 Basle Agreement was designed to apply to the internationally active banks of member countries of the Basle Committee on Banking Supervision but its impact was rapidly felt more widely and by 1999 it formed part of the regime of prudential regulation not only for international but also for strictly domestic banks in more than 100 countries. From its inception the 1988 Basle Accord was the subject of criticisms directed at features such as its failure to make adequate allowance for the degree of reduction in risk exposure achievable through diversification, at the possibility that it would lead banks to restrict their lending, and at its arbitrary and undiscriminating calibration of certain credit risks. In the aftermath of the East Asian crisis other issues of special interest to developing countries also became a focus of attention: firstly, the Accord´s effectiveness in contributing to financial stability in developing countries; and, secondly, the incentives which the Accord was capable of providing to short-term interbank lending, a significant element of the volatile capital movements perceived as having contributed to the crisis.

BASEL II: THE REVISED FRAMEWORK OF JUNE 2004

A major aim of Basel II has been to revise the rules of the 1988 Basel Capital Accord in such a way as to align banks´ regulatory capital more closely with their risks, taking account of progress in the measurement and management of risk and of the opportunities which these provide for strengthened supervision. Achievement of this aim has involved the incorporation in Basel II of methods for quantifying banking risks introduced since the late 1980s. The task of the designers of Basel II has been complicated by the way in which the BCBS´s rules for banks´ capital, originally intended for the internationally active banks of its member countries, have become a global standard widely applied in developing as well as developed countries. Acceptance of this role by the BCBS has entailed a global consultation process, whose results have been reflected in three consultative papers and the RF, and the different approaches and options for setting numerical capital requirements which are intended to accommodate banks and supervisors of different levels of sophistication. As well as providing a commentary on the main features of the RF this paper documents the response of the BCBS to some of the more important points which were raised during this consultation process, including the outcome of decisions taken at a meeting in Madrid in October 2003 following comments on the consultative paper of April 2003, and summarises the results of the most recent of the BCBS´s initiatives to estimate the quantitative impact of the Basel II rules on banks´ capital. This discussion includes a review of papers issued by the BCBS as part of the last stage of its work preceding the RF.

REVISING BASEL 2: THE IMPACT OF THE FINANCIAL CRISIS AND IMPLICATIONS FOR DEVELOPING COUNTRIES

This paper is concerned with the following aspects of Basel 2, the new internationally agreed framework for assessing the capital adequacy of banks: (1) its rationale and origins; (2) the process leading to the agreement, including the way in which problems and criticisms which emerged during drafting were handled; (3) data on the introduction of Basel 2 in different countries; (4) the quantitative exercises designed to estimate Basel 2’s effects; (5) the global pattern of introduction in relation to Basel 2’s objectives; (6) the way in which Basel 2 addresses the control of banking risks; and (7) outstanding issues requiring regulatory reform which have been highlighted by the financial crisis and which are either covered by or closely related to the rules of Basel 2. The paper devotes much attention to the challenges to regulation and banks’ role in economic development which are posed by its widespread introduction in emerging-market and other developing countries.

CAPITAL FLOWS TO DEVELOPING COUNTRIES AND THE REFORM OF THE INTERNATIONAL FINANCIAL SYSTEM

Recent financial crises, whose effects have been particularly severe in developing countries, have led to a wide-ranging debate on international financial reform. This debate has had to confront the implications of the huge growth of international capital movements, one of whose consequences has been the increased “privatization” of external financing for developing countries. The paper begins with surveys of major features of the post-war evolution of the system of governance of the international financial system and of the principal trends in capital flows to developing countries during the past three decades. These set the stage for a selective review of appropriate policy responses to international financial instability, with the main focus on proposals for remedying structural and institutional weaknesses in the global financial architecture through such means as greater transparency and improved disclosure, strengthened financial regulation and supervision, more comprehensive and even-handed multilateral policy surveillance, and bailing in the private sector by arrangements for orderly debt workouts. In view of the continuing absence of effective measures at the global level for dealing with financial instability, the paper puts special emphasis on the maintenance by developing countries of national autonomy regarding policy towards capital movements.