It was inevitable that regulatory reform of the financial sector should figure high on the agenda of the Pittsburgh G20 summit. The financial sector crisis emanating primarily from the United States that turned into a global economic crisis was basically a systemic failure that the regulators failed to foresee. When Lehman Brothers was allowed to collapse, its implications across the global financial system were not fully clear to the regulators or the Wall Street. Aggressive intervention by governments and central banks saved the day but it was obvious that the financial sector regulatory apparatus in the U.S. and other developed countries needed to be urgently revamped. The G20 decided on a set of reforms that will discourage excessive risk-taking by banks and compel them to hold substantially more capital than at present. Although the thrust of the revamp initiative is directed at the U.S., countries such as India have more than an indirect stake in the outcomes, given the global ramifications of the move. The crisis had frozen inter-bank lines of credit, leading to an unprecedented squeeze in the credit markets. Trade finance has been severely curtailed, resulting in a dramatic fall in global trade volumes. In any case, given the high degree of integration among financial markets, almost all regulations, though framed by national regulators, have a global impact.

The G20 agreed to back new standards for remuneration to the executives in banks. In a move meant to curb incentives for risky behaviour by bankers, a significant proportion of bonuses is to be paid in the form of deferred compensation. Regulators will be empowered to limit the share of profits paid out in bonuses and dividends. Larger banks will be subjected to stricter standards. Rules such as these are overdue, but surprisingly even in the U.S., where these are needed most, there is no sense of urgency to adopt them immediately. One reason could be that the worst of the economic crisis has ended and this has led to complacency. In the U.S., banks that survived the crisis with very generous support from the government are declaring huge profits. Fortunately, the U.S administration is alive to the need for enhanced regulation, including the setting up of a new consumer financial protection agency. Banks in India are better regulated than their counterparts in the developed countries and state-ownership of a large segment of the financial sector has helped. Regulation should ensure a smooth transition by all banks to the adoption of the Basel II capital adequacy norms.


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