Failure of financial supervision

This piece is in continuation of my previous column, “In G-20's cloud cuckoo land” ( Business Line , November 18). Shorn of long homilies and nebulous verbiage, the reason for the occurrence of every financial or economic crisis — indeed, every kind of crisis in every field of activity — can be traced to the failure to anticipate, monitor and supervise the course of events leading to it.

In life, nothing happens, all of a sudden, or without warning. In fact, in regard to even an earthquake which is taken to be beyond prediction, birds and animals are credited with the capacity to be wise to them in advance. Coming events invariably cast their shadows before. Those with ears to the ground can easily divine the tell-tale clues that presage the shape of things in the offing.

So also, behind every financial crisis there is always a record of a series of omissions and commissions over a period, resulting in a build-up of pressure within, followed by an explosion. The longer the neglect, the more extensive the devastation. The core of any strategy for crisis prevention is the drawing of lessons from earlier crises and applying them to monitor the situation pertaining to the current state of affairs.

The world will never be able to forget the nightmare of the South Asian financial meltdown that nearly tore into the economies of the affected countries and left them prostrate for years. The question is: Could it have been anticipated and prevented? Most certainly yes, as per the studies undertaken by the academia and independent think tanks, including the in-house inquiries in the IMF and the World Bank.

They threw up enough convincing evidence to establish that the governments of the countries concerned, and especially the IMF, which preens itself as the repository of the revealed wisdom in such matters, either missed out, or ignored or, worse, misread signals and symptoms of looming economic disaster. The result was that they applied, often compelled by the IMF, the wrong remedies which aggravated, instead of mitigating, the crisis.

BRINK OF FINANCIAL ABYSS

As a sequel, there was a flurry of activities to put in place safeguards in the form of tighter oversight of the functioning of the banks, launching of appropriate financial sector reforms and the monitoring, evaluation and performance review of programmes aimed at strengthening regulatory and supervisory frameworks to make them more effective. Britain even adopted the innovative approach of unifying all agencies for financial supervision into a single Financial Services Authority soon after the currency meltdown.

What then explains the industrial countries finding themselves on the brink of yet another financial abyss in 2007-09? In particular, how is it that advanced economies which had instituted supposedly the strongest grid of supervisory mechanisms based on the Basel Core Principles for Effective Bank Supervision, and the findings of the IMF-World Bank Financial Sector Assessment Programmes were the most fiercely hit?

The answer, inexplicably, is once again the tendency of the governments and the central banks concerned to lower their supervisory guard and letting the institutions in the financial sector run on a loose rein on the pretext of facilitating unhindered operation of free market forces.

Confused thinking

India, luckily, has been spared the agonies of both the South Asian and current financial turmoil. But the same cannot be said of the fragile economies of some other developing countries which are facing the tough task of maintaining and sustaining the pace of economic growth. Willy-nilly, they become a prey to the adverse effects of the follies of industrial countries and the confused thinking of financial watchdogs such as the IMF.

At this rate, the world may once again be reduced to the position of a hapless witness to the propensity of the industrial countries to get on the treadmill and indulge their propensity to self-destruct. The emerging market economies hoped that the G-20 at Cannes will come up with a tangible formula or framework for intensive and continuous supervision with a dependable system of checks and balances, capable of keeping the rapacity, recklessness and roguishness of financial marauders under constant scrutiny.

Alas, that was not to be!

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