Czech governor slams one-size-fits-all regulation

The right mix of regulation for advanced economies is not necessarily the right mix for everyone else, says Miroslav Singer, governor of the Czech National Bank (CNB).

On Monday, the CNB hosted a Basel Consultative Group workshop on the impacts of Basel III on emerging market and smaller economies (EMSEs). In his opening statement, Singer stressed that EMSEs should not be "passive recipients" of the "regulatory earthquake" spreading from advanced economies through the global financial markets.

He laments the focus on forming a single set of exhaustive rules and questions the purpose of harmonising regulations across countries, which he suggests is leading countries to pursue further insulation and buffering on an individual basis.

Singer argues this is "not such a bad thing" if coordinated, but warns that it would likely hinder free trade in financial services and the flow of financial assets if not.

"I believe that the marginal benefits of focusing more on space for co-ordinated diversification of approaches to regulation are now much higher than those of trying to find ‘the ultimately and finally correct set of rules' and imposing them on all countries," he says.

It seems to me that the much smaller size of the financial sector relative to the real economy in emerging or less developed economies has profound consequences for the optimal mix of regulatory rules - consequences that are neither acknowledged nor discussed

One of the main reasons regulation translates poorly from advanced economies to EMSEs, Singer says, is the difference in the size of their financial sectors relative to the size of their real economies. Cyprus' banking system, for instance, grew to around eight times the size of its real economy in 2011.

It follows that EMSEs have more space for – and likely more desire for – stronger financial sector growth than many advanced economies. Regulators have to strike a balance between facilitating this growth and mitigating the accompanying risk. But Singer believes they are neglecting the fact this balance differs between countries.

"It seems to me that the much smaller size of the financial sector relative to the real economy in emerging or less developed economies has profound consequences for the optimal mix of regulatory rules – consequences that are neither acknowledged nor discussed," he says.

Throughout the workshop, staff members from the CNB and from participating central banks delivered presentations describing some of the more specific impacts Basel III will have on EMSEs, and how to mitigate any unintended consequences arising from them.

Jan Frait, the CNB's executive director of financial stability, has considered the consequences of implementing a countercyclical capital buffer. Changes in the buffers employed by either advanced economies or EMSEs could influence capital flows.

In particular, he says, a stronger buffer in large, advanced economies could cause capital to flow into smaller economies which may, in reaction, "be forced to consider implementing macro-prudential measures" to stabilise their foreign exchange flows.

Frait also identifies practical issues with the methodology recommended by the Basel Committee on Banking Supervision – a Hodrick-Prescott filter with a high smoothing parameter – to determine when to increase or decrease the size of the buffer.

The filter, under the committee's guidance, should be used for calculating the credit-to-GDP gap. Frait argues the gap is "only a proxy for leverage" and "cannot capture turning points of credit cycle well".

Michaela Erbenova, a member of the International Monetary Fund's (IMF) monetary and capital markets department, has assessed the impact of the Basel III liquidity coverage ratio (LCR) on EMSEs.

The LCR requires banks to hold sufficient high-quality liquid assets to cover total net cash outflows over a given 30-day period – it is designed to ensure banks can weather short-term liquidity disruptions.

Erbenova is concerned there is an "insufficient supply" of high-quality liquid assets in EMSEs for them to implement the LCR, and while progress has been made addressing this, "obstacles remain".

Banks in "several" jurisdictions have been using covered bonds to meet part of their LCR requirements, which Erbenova says have proved to be a "reliable source of secured funding during the crisis".

Nonetheless, she warns that their use has implications for bank resolution, and recommended that jurisdictions impose "prudent limits" on the amount that can be utilised.