20 years of hard work eases impact of financial fiasco

David Mutch

Thursday, Feb. 29, 1996 | 11:59 a.m.

A stable, orderly era in international finance?

That may not seem to be the case, in light of three financial episodes that have been in the news.

On Wednesday, Japan's Daiwa bank admitted concealing $1.1 billion in trading losses at its New York office - a problem first revealed last November.

This week marks the one-year anniversary of the collapse of Britain's venerable Barings Bank. It went bankrupt when a poorly supervised trader in Singapore bought stock-futures contracts that went awry.

On a bigger scale, there was the Mexican peso crisis, from which Mexico is still trying to recover despite a $50 billion international bailout package a year ago. The rescue has prompted criticism from American economic nationalists, such as Republican presidential candidate Pat Buchanan.

All three are serious cases.

Yet to Ethan Kapstein, director of studies at the Council on Foreign Relations in New York, the most important news is that the world's financial system is sounder than it once was.

In these three cases, trade and finance generally hummed along soundly, without rising interest rates and disruption of currency markets - far different from past collapses such as the 1982 third-world debt crisis. The Mexican currency crisis was localized.

The reason, says Mr. Kapstein, is 20 years of hard work by the world's top economic powers in building a stable regulatory structure for all commercial banks operating internationally. He recently wrote a book on the topic and an article in the January/February Foreign Affairs magazine.

He sums up the improvements as acceptance of common banking standards, better supervision, and higher capital levels held by banks relative to their loans.

Some other experts add a different emphasis.

"'I would put improved management practices in banks at the top of the list of factors that have increased stability," says Barbara Matthews, counsel to the Institute of International Finance, a trade group in Washington representing more than 180 private financial institutions. She also praises banks' diversification of assets over the past few years and increased coordination on the international scene.

Ms. Matthews also faults Kapstein's choice of the three collapses as not being directly relevant to the successes of work done by the Basel Committee, set up in 1975 to improve international financial stability. It has focused on credit risk, while the Daiwa and Barings failures were fraud cases. But she agrees with his thesis that the global financial system is much sounder.

Kapstein's article describes steps taken by guardians of the world's financial markets since 1974, when there were two disruptive bank failures - Bankhaus Herstatt in Germany and Franklin National Bank in the United States. Bankers from the Group of 10 (G-10) industrialized nations formed the Basel Committee on banking regulations that year.

In 1975 this committee took the "modest" steps, as Kapstein describes them, of setting up information-sharing channels and finding out exactly which national regulators in each country were charged with overseeing banks that operated overseas. And they agreed that no bank would be permitted to "escape supervision" in its international operations. All must identify a domestic regulator and have readily available records. These steps were detailed in a 1975 agreement called the Basel Concordat.

In 1982, Italy's Banko Ambrosiano failed; then, Mexico suspended its debt payments, kicking off the third-world debt crisis.

Further work was obviously needed. In the summer of 1982, the US launched a three-part plan involving grants to debtor nations, international banks increasing their equity, or capital levels, and the International Monetary Fund pressing developing countries for economic policies to head off future debt cancelations.

More than five years later, after much work by the Basel Committee to find agreement on the 1982 concepts, another G-10 Basel deal was reached, the Basel Accord. At the heart of this 1988 accord was a system to increase the capital adequacy of international banks. It was implemented only in 1992, and it is still evolving. Other international bodies adopted similar standards for investment banks. Bank supervisors within each nation are responsible for implementing the policy.

But there are costs, says Raj Bhala, professor of law and international finance at the College of William and Mary in Williamsburg, Va. Smaller banks are being squeezed out, and the non-G-10 nations see Japanese and Western banks getting stronger and stronger in international finance, compared with their banks, says Dr. Bhala.

Matthews and Bhala say that the Basel Committee also took a giant step in 1995 when it agreed to let international banks use their own internal systems to calculate market risks, rather than seeking one generic rule.

In the end, Bhala says banks hold the main responsibility, since they usually "know more than the regulators" about managing risk.