Table of Contents

  • Seven years after the onset of the 2007-08 global financial crisis, reform of the international financial architecture and strengthening financial regulation remain at the top of the global agenda, but the vast majority of developing countries, including small states, are still excluded from the process.

  • This research was funded by the Commonwealth Secretariat. We are grateful to Cheryl Bruce for comments and feedback, to Chepete Chepete, Masalila Kealeboga, Senatla Lesedi and colleagues at the Bank of Botswana; Arvinder Bharath and colleagues at the Central Bank of Seychelles; Denton Rarawa, Michael Kikiolo, Raynold Moveni and colleagues at the Central Bank of the Solomon Islands; Jason Milton, Danny Bradlow, Raquel Abrahams and colleagues at the Reserve Bank of South Africa; and Christophe Edmond and colleagues at the Central Bank of Trinidad and Tobago, all of whom responded to our request for case study data; to Catherine Elliott at the Commonwealth Secretariat for co-ordinating this information; and to Wande McCunn for excellent research assistance. This paper benefited from feedback following a presentation at the Commonwealth Central Bank Governors’ Meeting in Washington, DC, in October 2014.

  • The financial crisis of 2007–08 triggered a plethora of regulatory reforms. The design of many of these reforms took place under the auspices of international bodies such as the group of 20 major economies (G20) and the Financial Stability Board (FSB). Yet their implementation remains a task for individual states. Whereas G20 member states have committed to comply with FSB standards, the FSB itself is committed to encouraging non-G20 states to comply too. Compliance by such states is pursued through co-operation with the World Bank, the International Monetary Fund (IMF) and various multilateral memoranda of understanding. States whose compliance is being encouraged by these means include many smaller states in the Commonwealth and elsewhere with little or no direct representation on these international bodies. Many of these states also lack the human and financial resources, technical capabilities and/or formal legal authority to implement all of the proposed reforms within the relevant timeframes. It is therefore desirable to identify a framework for prioritising the legal and operational implementation of these reforms, to economise on the scarce resources available for regulatory implementation.

  • In this chapter, we set out the context for our prioritisation exercise. The relevant context has three components. First, there has been a surge in the volume of international financial regulatory initiatives since the financial crisis. Second, the agenda-setting process for these initiatives has been driven by the large states most affected by the financial crisis. Third, small states are nevertheless exhorted to implement these initiatives domestically. Such states have very limited resources to devote to regulation, and feel swamped by the influx of initiatives. Hence the need for prioritisation.

  • To articulate priorities for implementation of financial regulation, it is necessary first to assess what is at stake. For this reason, we review in this chapter the goals of financial regulation. A well-functioning financial system facilitates payments, mobilises savings from individual investors, and selects and monitors investment projects which will yield good returns (Merton and Bodie 1995). These functions are, in turn, of vital importance to the functioning of the real economy. Well-functioning financial systems help to facilitate economic growth by, amongst other things, supplying funds for investment and making effective selection of good projects. The converse is also true: failures in the financial system can retard the real economy. The early work of Ben Bernanke, latterly Chairman of the US Federal Reserve Board of Governors, as an academic economist identified the channels through which banking collapse in the USA during the Great Depression of the 1930s led to economic contraction (Bernanke 1983; see also Friedman and Schwartz 1963). Similarly, there were contractions in investment and growth in Asian countries following the Asian financial crisis in the late 1990s (see, for example, Barro 2002), and in the USA and EU following the financial crisis of 2007–08 (see Campello et al. 2010; Becker and Ivashina 2014; Kahle and Stulz 2013). The effects of banking crises in particular are especially strong on developing countries, which typically rely more heavily on bank, rather than market, finance (Dell’Ariccia et al. 2008).

  • The financial crisis has been followed by an unprecedented wave of regulatory reforms. Many smaller states lack the human and financial resources, technical capabilities and/or formal legal authority to implement all of the proposed reforms within the relevant timeframes. This paper has sought to articulate and illustrate the application of a framework for prioritising such implementation.

  • The following is a questionnaire listing the information required to construct a preliminary map of a state’s financial system and identify potential channels for the transmission of systemic risks. This questionnaire is designed to assist states in identifying both the potential sources of systemic risk which might reside within their domestic financial system and the ways in which such risks – if they materialise – might metastasize across borders.