How to restore trust in the financial system?

Finance | Kevin Lynch and Liao Min

As government and business leaders get to grips with 2014, they are confronting a global economy that is still underperforming, at a time when trust and confidence have both taken a hit.

Not far beneath the surface, there is a widening divide between advanced and emerging economies and growing concerns about what the increasing trust deficit means in these uncertain times.

The spark for this angst and division is a global economy that, five years after the onset of the financial crisis and recession, continues to drift, still supported by extraordinary levels of monetary stimulus, still experiencing bouts of volatility, and now lacking the commonality of purpose for effective international coordination across advanced and emerging economies.

Political leaders in the West face a public whose expectations for a rebound in jobs, growth and living standards have still not been met. Although their counterparts in emerging economies largely avoided the financial crisis, they are increasingly feeling the constraining embrace of its global aftermath.

While certainly not the only factor in the weak global recovery, an international financial system not yet running on all cylinders is a definite contributor. Of course, much progress has been achieved in regulatory reform since the 2008 and 2009 G20 summits in Washington and London.

But there are still good reasons to worry about emerging tensions in the global financial system, centered around regulatory fragmentation at the expense of harmonization, unilateralism rather than coordination, and declining levels of trust rather than mutual confidence.

In a number of advanced economies, particularly the United States, the United Kingdom and the eurozone, there has been a large decline in public trust in banking systems. While this is likely indicative of the lingering impact of the nature and severity of their recessions, the extent is striking.

According to public relations firm Edelman, which conducts a global trust survey across 26 countries, almost 60 percent of US residents lack trust in the nation's financial sector, while in the eurozone, the figure stands at more than 70 percent.

As an example of how much times are changing, most emerging economies indicate high levels of trust in their financial systems, reflecting the simple fact that they largely avoided the financial crisis.

Beyond sovereign borders, there is a growing lack of trust among national financial systems, as evidenced by increasing regulatory fragmentation and fraying international coordination.

This regulatory fragmentation has a range of causes: the ring-fencing of some national banking systems; the adoption by major regions such as Europe and the US of different accounting systems; and unilateral and differing implementation of agreed principles.

Whatever the causes, the impact is the same: a less efficient and effective international financial system because of uneven and unequal rules, and lower global economic growth as a consequence.

Trust between advanced and emerging economies is also at risk. Financial sector reforms, developed in response to the financial crisis that primarily originated in the banking systems of the major Western currency areas, are being implemented globally.

While this reflects the reality of an integrated global financial system, it masks another reality: that emerging markets are largely "policy takers" rather than "policy partners".

Emerging markets feel that their specific concerns such as providing banking services to everyone are not being treated as priorities.

Many emerging markets worry that they lack the infrastructure and financial platforms to ensure effective implementation of some highly complex financial reforms. With immature capital and bond markets and limited supervisory capacity, unintended regulatory fragmentation could occur, with negative consequences for the global financial system.

Does international cooperation have to involve a one-size-fits-all prescriptive approach, or could it allow for more principles-based equivalency for countries at different stages of financial sector maturity?

The simple reality for governments around the world is that a more rapidly growing global economy needs greater growth in lending and credit, but regulatory fragmentation, loss in trust and unnecessary complexity are inhibitors, not facilitators.

It is time for G20 political leaders to reconsider whether the extent of international policy coordination is adequate given the emerging fragmentation and trust deficits.

Part of this much-needed renewed international coordination should involve making emerging economies greater "policy partners" in the common purpose of building a more efficient, effective and resilient global financial system. And international coordination cannot be successful unless trust in national financial systems and among systems is improved.

Kevin Lynch is vice-chairman of BMO Financial Group. He is chair of the Global Agenda Council on the Global Financial System. Liao Min is director-general of the China Banking Regulatory Commission's Shanghai office and a member of the Global Agenda Council on the Global Financial System. The views do not necessarily reflect those of China Daily.