Korea to Represent Voice of Emerging Economies

By Chin Dong-soo

Chairman of the Financial Services Commission

Last November, in the midst of the global financial crisis, considered the worst since the Great Depression, world leaders gathered at the first-ever G20 summit in Washington.

They pledged to make concerted efforts to stabilize the financial system and reform the global financial regulatory and supervisory system to prevent the recurrence of such a catastrophic event.

In April, at the second G20 summit in London, the leaders decided to expand and re-establish the Financial Stability Forum (FSF) as the Financial Stability Board (FSB), bestowing a broadened mandate to promote financial stability by, among other things, devising and coordinating regulatory reform agenda of the global financial system.

Thus the FSB, which was previously dominated by the G7 countries but with the 12 new member countries, including Korea, held its inaugural meeting in June.

The FSB is comprised of financial policy makers, supervisors, regulators and the central banks of member countries, as well as international financial institutions such as the International Monetary Fund (IMF) and the World Bank, and international standard-setting bodies.

The FSB will take up a crucial role of making recommendations for regulatory reform to the G20 summit which, once approved and adopted by the leaders, become international standards to be implemented by each country.

Korea has not only become a new member of the FSB along with Mexico and the BRICs countries of Brazil, Russia, India and China, but also will play an even more vital role as a member of the FSB Steering Committee, providing operational guidance and setting the agenda to carry forward the directions of the FSB.

Thus, Korea has now joined forces with China, India, and Japan, to represent Asia at the FSB's plenary and Steering Committee meetings and will act as a ``rule setter'' rather than a ``rule taker.'' Through these meetings, we will make conscientious efforts to raise the concerns of emerging countries and become an effective bridge between emerging and advanced countries.

Key FSB Agenda

The FSB currently deals with extensive topics relating to financial reform geared toward global financial stability, which will have direct implications for the Korean financial industry.

I will briefly introduce some of the key issues:

First of all, the FSB seeks to reduce systemic risk and mitigate pro-cyclicality of the economy through macro-prudential supervision and regulation.

One acute lesson that we have learned from this global crisis is the fundamental weakness of the current regulatory system based on micro-prudential supervision and regulation.

This system is premised on the expectation that so long as individual financial institutions are safe, the financial system as a whole will also be safe, but was proven ineffective at managing systemic risk.

Moreover, it has been recognized that in order to minimize systemic risk arising from interconnectedness among financial institutions and markets as well as the herd behavior, we need a well-balanced system of both micro- and macro-prudential supervision and regulation.

Secondly, to raise banks' crisis management capability, the FSB is reviewing, together with the Basel Committee on Banking Supervision (BCBS), various ways to strengthen regulations on capital, leverage and liquidity.

To mitigate the pro-cyclicality under the current capital requirements, it is being considered to require banks to build a capital buffer above the required minimum capital during boom periods, which will be permitted to be depleted during recessionary periods. In addition, various efforts are being made to (i) improve the quality of capital to raise the loss absorbing capacity of banks during a crisis, (ii) introduce a simple leverage ratio to supplement the current risk-weighted capital requirements, and (iii) introduce regulations on liquidity to strengthen liquidity risk management of financial institutions. Detailed measures will be finalized by the end of the year. Meanwhile, the level of increase in minimum capital requirements will be determined by the end of 2010.

Thirdly, this global crisis has taught us an importance to reduce the size of the "shadow banking" such as hedge funds and off-balance sheet entities and minimize regulatory gaps. Therefore, measures to expand the scope of regulation to cover all systemically important financial institutions, markets and instruments are being reviewed.

They include adopting international regulatory standards on hedge funds, establishing Central Counter Parties for over-the-counter (OTC) derivatives and using more standardized OTC products, and strengthened regulation on credit rating agencies.

Fourthly, concerns have been raised that unreasonable compensation practices based on short-term profits for executives and employees of financial institutions resulted in excessive risk-taking activities.

Thus, discussions are in progress to promote sound compensation practices for the industry. In support of the previously announced compensation principles set by the FSF, detailed guidelines are currently being devised by the FSB and will be discussed more thoroughly at the upcoming Pittsburg summit.

Lastly, in accordance with the agreements reached at the London summit, the FSB, together with the international accounting standard setting bodies, including the International Accounting Standards Board (IASB), is trying to make significant progress toward a single set of high-quality global accounting standards and reduce the complexity of accounting standards for financial instruments. In line with such efforts, the IASB has targeted 2010 the completion of relevant revisions to the accounting standards, including those relating to financial instruments and loan-loss provisions.

Significance of Second FSB Plenary Meeting

On Sept. 15, exactly one year after Lehman Brothers filed for bankruptcy, which prompted the global financial crisis, the second FSB plenary meeting was held in Paris. The meeting had a special significance in that it reviewed the progress made on the proposals for financial reform agreed by the G20 leaders, and finalized the report, "Improving Financial Regulation," which will be submitted to the Pittsburg Sept. 24-25 summit.

The report contains proposals for a wide array of issues including strengthening the global capital framework, making global liquidity more robust, reducing moral hazards posed by systemically important institutions, and improving compensation practices.

An in-depth discussion took place at the plenary meeting especially on the issue of how to stabilize the foreign currency liquidity in emerging countries.

This particular subject has been adopted as an official part of the meeting agenda as we proposed based upon our own experience in the current crisis.

Through the process, we believe we demonstrated our dedication towards the FSB as well as our competence, and successfully brought to attention one of the most serious stability issues faced by emerging economies.

With the spread of the current financial crisis to emerging economies whose monies are not reserve currencies, their foreign exchange markets have experienced significant volatilities caused by the lack of foreign currency liquidity. This has in turn become another source of instability for the advanced countries.

We have successfully argued, and drew agreements from many member countries, that in light of the great importance of this matter from the perspectives of both the emerging economies and global financial stability, the FSB must consider alternatives for the stable supply of foreign currency liquidity.

Thus, it was agreed that the regulators and supervisors in emerging countries would enhance their supervision on operations of financial institutions in foreign currency funding markets, while the Committee on the Global Financial System, which is set within the Bank for International Settlements, was mandated to investigate policy options to reduce system-wide cross-border liquidity risk during a financial crisis and, based upon such investigation, further coordination efforts will be made among national authorities and international financial institutions including the IMF.

Role of G20 and Korea's Contribution

As the global economic condition shows signs of recovery and the near-bankrupt financial institutions start making enormous profits, there is a broadening concern that the momentum for reform is slipping and the window of opportunity for accomplishing visible change is closing, with the "business as usual" attitude and excessive risk-taking activities reviving.

Despite such concern, we have no doubt that the FSB will be determined to move ahead with the financial reform as planned, with unwavering and strong support from the G20 leaders.

Korea, not only as a member of the FSB but as the chair nation of the G20 in 2010, will play an active role in ensuring sustained global economic recovery as we collaborate closely with other G20 nations. In this regard, it is noteworthy that on Sept. 3, President Lee Myung-bak and Australian Prime Minister Kevin Rudd jointly contributed an article to the Financial Times, outlining the ``Three-Stage Process for Balanced Global Growth.'' First, national governments should develop their own national strategies for balanced growth. Second, they should deliver these strategies to the IMF before the end of this year and the IMF should report back on their consistency with sustainable balanced global growth. Third, G20 leaders should meet again in 2010 when Korea is the chair of the G20 to agree to their responsibilities and actions to achieve this goal within the framework of post-crisis global economic management. At the Pittsburg summit, we will strongly promote the three-stage process to strengthen policy coordination among the G20 countries as well as heighten discussions for the establishment of a reliable support system for the emerging countries.

Going forward, in order to promote regular meetings among the G20 leaders and to continue active discussions, we must contemplate mid- to long-term international issues such as green growth and sustainable balanced growth. To make this a reality, unfailing interest and support from the G20 leaders is crucial. Korea pledges taking part in that endeavor through continued research, suggesting the course of a new direction.

Lastly, we sincerely hope that next year's G20 summit will take place in Seoul, but more importantly that the G20 will lead the world through thoroughly discussing ways to sustain global growth and agree on effective exit strategies to prevent the recurrence of a financial crisis.