One lesson from the crisis is just how important it is for international standards like Basel to be applied uniformly across countries. Furthermore, decisions related to compliance with standards, such as equivalence or mutual recognition through which countries declare that their regulations are aligned, should not be left to the full discretion of national authorities. Reports international authorities already carry out could be used for this purpose, allowing countries in adherence with the standards to receive equivalence, or mutual recognition.
In recent years, we have witnessed the paradox of international regulatory standards becoming increasingly detailed, as implementation has become vastly different among countries. This creates a situation of market fragmentation. These divergences can occasionally be justified by adapting to the characteristics of the market or local product, so a certain degree of flexibility is needed.
However, in some circumstances regulation is stricter in order to protect the local market. Fragmentation also sometimes occurs when some countries adhere to the standards after others, putting foreign banks at a competitive disadvantage (especially if they are retail banks with a decentralized business model and financed by local deposits). They often have to comply with these standards across the board because their country of origin has adopted them.
Extraterritorial regulation is another source of fragmentation. For example, European capital regulations require that the trigger for the conversion of an AT1 instrument be calculated according to European legislation, even if it was issued in another country.
In a recent article, Santiago Fernández de Lis and Ana Rubio of BBVA Regulation advocate for using the degree of compliance with standards as an element of presumption for countries in processes such as equivalence or mutual recognition. In mutual recognition, two countries affirm that their regulations are consistent for fundamental issues. In equivalence, country A recognizes that the regulations in country B are in line with their own and therefore gives institutions from country B the right to operate in country A.
In Europe, it is also used to give sovereign debt from country B the same treatment that domestic debt receives in country A. There are no pre-established procedures for these processes. The concession or withdrawal of this treatment is left to the discretion of national authorities, with the uncertainty this entails.
Reports that international institutions or forums already elaborate on the level of implementation of standards in countries could be used to address this. Reports such as peer reviews, reports on the observance of standards and codes (ROSCs), or the IMF’s Financial Sector Assessment Programs. Countries that reach a certain level of compliance in these reports could automatically be given access to equivalence or mutual recognition, unless demonstrated that it would not be appropriate. In fact, these reports could be even more useful if they included aspects normally used in mutual recognition or equivalence decisions. This should lead to more efficient, predictable processes, and better relations among supervisors. In the context of Brexit, for instance, an efficient, predictable process would be especially beneficial.
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