G-20 summit: financial reform is needed. But how fast?

As G-20 summit to focus on a split over approach: Will reining in spending cut debt, or stall jobs and growth?

By , / staff writer

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    G20 summit: This artist's rendition of the media center in Toronto for the upcoming G8 and G20 Summits includes an artificial lake with canoes, trees, deck chairs and a fake dock. The G-20 summit will begin on June 26.
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The heads of state for the Group of 20 (G-20) – a body that seeks to coordinate financial regulation and standards across some of the world's largest economies – will hold a two-day summit in Canada starting June 26 at which almost all participants are expected to call for more banking regulation but where some, echoing St. Augustine's famous prayer, are expected to say "please, not yet."

While most agree major change is needed – the term "radical reform" is often bandied about by policymakers – they disagree on timing.

The divide between G-20 countries like the United States, which would like a tough regulatory regime enacted soon to limit the ability of banks to speculate in financial markets, and countries like France and Germany, which agree with the approach in principle but want more time, echoes a debate raging from Dublin to Tokyo.

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For two years, industrialized nations have watched their deficits soar, thanks to bank bailouts and stimulus spending designed to head off economic free fall. The question now is whether it's time to rein in spending and start reducing government debt. Some say yes, but others fear spending cuts could fuel unemployment and drive economic growth down.

A key component of economic growth is lending, which boosts consumption and encourages business expansion. But the mooted new rules would require banks to hold more cash in reserve and lend less of their capital in hopes of obviating the need for future government bailouts.

That, some critics say, could be another destimulative measure at a time when countries across Europe are planning steep budget cuts.

"The argument is that this will very significantly add to the cost of doing business, be passed on to the consumer, and reduce growth," says Uri Dadush, a former senior economist at the World Bank who is now at the Carnegie Endowment for International Peace in Washington. "There's a prima facie argument that there will in fact be serious costs and that will have to be balanced against the insurance that [governments] are buying against future financial crisis."

Banking industry's case

In mid-June, the banking industry made its case that regulation will undermine growth. The Institute for International Finance (IIF), a 350-member group of most of the world's large banks, argued in a report that the new rules would reduce economic growth by 3 percent in the US, Japan, and Europe and cost more than 9 million jobs over five years.

"The point of this report is not to argue against regulatory reform," Peter Sands, CEO of the UK's Standard Chartered Bank and an IIF official, told reporters at the time. "But there is a price for making the banking system safer and more stable, and that price will inevitably be borne by the real economy ... the challenge is to strike the right balance."

At the moment, the balance being sought has to do with time.

The Basel Committee on Banking Supervision is a multinational body that oversees standards set by the G-20 for global finance. The US, Britain, and others have been calling for the new set of regulations, called "Basel III," to be implemented by 2012 – requiring banks to hold more reserves to protect against losses and limiting how much they can borrow to speculate in the credit default swaps and other derivatives that accelerated the financial collapse that began in August 2007.

The measures are scheduled to be adopted at the second G-20 summit of the year, scheduled for Seoul, South Korea. Analysts expect the meeting in Toronto will provide hints of which way the leaders are going to jump in November, but no hard-and-fast commitments.

"The sense I get is that the big game will be played in Seoul in November," says Dr. Dadush.

Dadush says that while he supports more regulation of banks, saying that current "institutions are inherently unstable," he worries that it is being overemphasized to the neglect of other factors that fed the recent financial collapse, from "interest rates that were kept too low for too long" to "failures of corporate governance."

New regulations may be slowed

Signs are emerging that new regulations will be slowed, if not watered down altogether. Canadian central bank governor Mark Carney warned in a mid-June speech that "we should not sacrifice our ambition for these measures to speed of implementation, nor the economic recovery to an arbitrary timeline." But the G-20's ambitions have already been enormously scaled back since the group's first major summit on financial regulation in Washington in 2008.

"There was all this enthusiasm; they were going to reorganize the international financial system, the US wanted a global bank tax, some of the European leaders were keen on getting rid of hedge funds," says Ivan Savic, a political economist at the G-20 Research Group at the University of Toronto. "That was just way too ambitious; this is a very heterogenous group."

Dr. Savic says he's sympathetic for the need for balance in regulation, but warns that time is growing short. "The trick with financial regulation in responding to a crisis is, if you react too heavy-handedly too early, you can ... hurt the recovery," he says. "But the longer you wait for the recovery, the stronger financial markets get and they say 'we'll fight you on this.' Look at Wall Street: It was at first very contrite and now, I think we see them flexing their muscles again."

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