Any rush to implement improved regulatory standards must take into account the particular needs of developing markets, write Liliana Rojas-Suarez and Thorsten Beck of the Center for Global Development’s task force.

The regulatory reform effort following the 2008 financial crisis – most prominently through Basel III – was led by advanced economies, but for these standards to work, they must be implemented without unintended or harmful consequences for emerging markets.

The Center for Global Development led a task force that includes current and former senior officials from central banks to analyse what needs to happen for Basel III to meet the financial stability needs of all countries. Here is what we found.

Specific tailoring

First, the adoption of these global standards needs to be tailored to the specifics of a developing country’s financial system in order to work. While it might be in developing countries’ long-term interest to adopt Basel III, the one-size-fits-all style of the new rules poses new risks and challenges. For example, since the standard is largely designed for global banks in advanced economies, the rules do not take into consideration certain characteristics of developing countries that, while not universal, are common enough to not be disregarded, including limited access to international capital markets, high volatility, less developed domestic financial markets, limited transparency and governance challenges.

Many emerging markets ‘gold-plate’ capital requirements, demanding banks hold higher capital buffers than required under international standards, thereby reflecting higher risks. Instead of undertaking ad hoc adjustments to capital requirements through gold plating, we propose that local information on loan performance would more accurately reflect the riskiness of banks’ assets, and therefore the necessary capital buffers. For example, information such as loan data from credit bureaus or registries could be used to better calibrate risk weights to the realities and stability needs of emerging markets.

Unintended consequences

Second, as the international standards are implemented, regulators need to minimise negative spillover effects in terms of credit availability for sectors that are essential for development in emerging markets, such as infrastructure finance. Under Basel III, the upcoming limitations on the use of banks’ internal risk models could make infrastructure investments seem riskier and therefore make infrastructure funding more expensive and less attractive for banks. At the same time, new liquidity requirements mandate that loans with a maturity of more than one year must be matched with funding of a similar duration, which could push up the costs of longer term infrastructure funding. This is especially troubling given the limited sources of alternative market-based funding available in emerging markets.

To address this challenge, we support a stronger role for the World Bank and other multilateral institutions in the push for the standardisation of infrastructure projects, which would create better ways for banks to assess risk and raise capital, and ultimately boost funding available for these much-needed projects that will drive economic growth in emerging markets.

Experiences vary 

Finally, these regulations should not result in a zero-sum game between financial development and financial stability: both have to happen. Financial stability is obviously a top priority, but policy-makers must keep in mind the sometimes stark differences between advanced economies and their emerging market counterparts, where the costs and benefits of regulation may vary. That is why our report emphasises that cost-benefit analyses occur before the introduction of any new financial regulatory standards to assess the potential benefits of higher stability against the costs for local regulators, the institutions they oversee, and, most importantly, the economy.  

For example, the growth benefits from deeper and more efficient financial systems are typically larger in emerging markets than in advanced markets. And when banks are – correctly – subject to increasingly tighter regulatory standards, there is a premium on developing non-bank segments of the financial system, such as insurance companies, pension funds and public capital markets, segments that are still underdeveloped in most of these countries. If these differences between countries are carefully considered and addressed in the regulatory framework, there need be no trade-off between stability and growth.

It is clear that we need new rules to prevent a future global financial crisis, but we must make sure that these new rules do not ignore the plight of emerging economies or dampen their growth prospects. By paying attention to the differences between advanced and emerging economies, policy-makers can and must adapt this regulatory framework to make sure that no country is left behind.

Liliana Rojas-Suarez and Thorsten Beck co-chair the Center for Global Development’s task force, 'Making Basel III work for emerging markets and developing economies.' Ms Rojas-Suarez is a senior fellow at the Center for Global Development and was previously the chief economist for Latin America at Deutsche Bank. Mr Beck is currently a professor of banking and finance at Cass Business School in London and was founding chair of the European Banking Center at Tilburg University.

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