Global financial governance : the power and resources of banks : a study of the different mechanisms of banks to influence international financial regulation

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Tessa Charlotte Werter

A study of the different mechanisms of banks to influence international financial regulation

U n i v e r s i t y o f A m s t e r d a m M S c . P o l i t i c a l E c o n o m y M a s t e r T h e s i s

S u p e r v i s o r : J . G . W . B l o m

S e c o n d r e a d e r : G . R . D . U n d e r h i l l

Global Financial Governance: the Power

and Resources of Banks

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Abstract

For decades scholars have discussed the influence of private actors on policymaking, also called ‘regulatory capture’. Since the recent global financial crisis the literature on regulatory capture in the financial industry has grown significantly. However, the tools through which the private sector exerts influence on global financial regulation are not sufficiently

researched and empirically tested. It is therefore unclear which mechanisms of influence are successful and which are less successful. This research contributes to this gap in the literature by examining the lobbying success of the different mechanisms of influence. It does so by investigating the lobbying success of the following mechanisms: concentration of wealth, revolving doors and structural power during the negotiations of the Basel III Accord. Contrary to what the literature suggests this research finds that a bigger concentration of wealth does not lead to more lobbying success. There is no convincing evidence that banks that possess more revolving doors and emphasize the structural power of the financial industry have more lobbying success, although there is a slightly upward trend. The results imply that more qualitative and quantitative research is necessary to amplify the theories on the mechanisms of influence. Moreover, certain policy measures should be taken to reduce regulatory capture in the policymaking process to render global financial regulation more legitimate.

Keywords: regulatory capture, global financial regulation, mechanisms of influence,

lobbying, Basel Committee on Banking Supervision, Basel III

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Preface

This thesis is the end product of five months of research on the lobbying influence of banks during the negotiations of Basel III. I would never have thought to write my thesis on financial regulation, a topic I was not particularly interested in and did not know much about before starting the master Political Economy. The first time my curiosity got sparked was just before the start of the first semester when I read the book “Swimming with Sharks” written by Joris Luyendijk. I almost could not believe that designing financial regulation happened with no accountability and so little consideration from the government while it affects all of us. I was even more astonished when I saw the documentary “Geldscheppers” of the Dutch television program Tegenlicht. It is a documentary on the European Central Bank, ‘creating’ 80 billion euros a month to try to stimulate the economy, although the long-term effects for the global financial system are not clear yet. From that moment on I wanted to learn more about the global financial system and the people who hold the power in this, in my opinion, mysterious system. However, financial markets and financial regulation were still vague and complicated concepts to me. During the Political Economy Specialization Course of prof. dr. Underhill I learned more about global financial governance and the market-based approach to the global financial architecture of the last 40 years. During the writing of this thesis, his articles served as solid resources for the basis of this research. Therefore, and for acting as my second reader, I would like to express my gratitude to prof. dr. Underhill. Moreover, I would like to thank my supervisor dr. Blom for the excellent advice, patience, and interesting suggestions he made to get the most out of this thesis. I also would like to thank my family and friends for their support and their understanding for seeing me so little. This thesis literally embodies for me that new things will always spark your interest during your life, although you never thought you would be interested in it.

Tessa Werter Amsterdam, 22 June 2017

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List of Abbreviations

BCBS – Basel Committee on Banking Supervision

BIS – Bank for International Settlements

FED – Federal Reserve

FSB – Financial Stability Board

IIF – Institute of International Finance

IMF – International Monetary Fund

IPE – International Political Economy

LCR – Liquidity Coverage Ratio

NSFR – Net Stable Funding Ratio

SOMO – Stichting Onderzoek Multinationale Ondernemingen

U.S. – United States

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1. Introduction

It is economic power that determines political power, and governments become the political functionaries of economic power.

- Jose Saramago

One of the oldest questions in political science is “who gets what, when and how?” (Laswell, 1936). For more than a century political scientists have been researching the question of whom, and especially why, certain actors are better in achieving their preferences than others (Bentley, 1908; Odegard, 1928; Schattschneider, 1935). This is especially an important question when it comes to financial regulation since the operation of financial flows is fundamental to our everyday economic life. Scholars claim that business actors often seem to solely benefit themselves, which raises questions about the accountability and legitimacy of public authority in international economic relations, which turns out to be influenced by private actors (Dür, 2005; Greenwood and Jacek, 2000; Hertz, 2001; Wallach and Sforza, 1999, Underhill and Zhang, 2008). George Stigler was the first scholar to introduce the concept ‘regulatory capture’: the phenomenon of private actors that influence public regulation. Stigler argued that public officials usually design regulation to favour groups that offer them the highest degree of political support. As such, the content of regulation reflects private interests of those groups that could successfully influence policy makers, rather than the public interest (Stigler, 1971).

Already before the crisis a number of International Political Economy (IPE) scholars stressed the capture of international policy-making processes by transnational lobby groups (Porter, 2005; Tsingou, 2006; Claessens et al., 2008; King and Sinclair, 2003). But, since the recent global financial crisis the literature on regulatory capture in the financial industry has grown significantly. Global financial regulation became politically salient. Topic of most concern were the factors that show that the financial industry can exert influence over regulatory content, which affect the legitimacy process of global financial regulation (Young, 2013: 693). For instance, Helleiner points out that the neo-liberal financial order of the last 30 years entered a ‘legitimacy-crisis’: multilevel regulatory capture was a key political and institutional constellation that facilitated the growing political and economic power of Wall Street and the City of London (2011). Underhill and Blom (2013) focus on the input and output legitimacy of the financial architecture and conclude that certain actors enjoyed better access to the policymaking process than others which makes global financial regulation less legitimate (279-280). Scholars consider Basel II as the prime example of regulatory capture at the international level (Helleiner and Porter, 2009; Underhill and Zhang, 2008). Moreover, others claim that as a consequence of regulatory capture, global bank regulation standards have tended to favour large advanced banks (Blom, 2009; Claessens et al., 2008).

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Clearly, there is consensus among most academic literature with regards to the ability of private actors to shape global financial regulation (Young, 2013: 692). They shape regulation by using a diverse range of ‘tools’ or to put it otherwise: by using diverse ‘mechanisms of influence’. These are mechanisms that allow private actors in some way to exert influence over the financial regulation policy process. Scholars focus on a variety of mechanisms of influence in the literature. Some scholars argue that the influence of private actors can be understood through their market size or their embeddedness in economic institutions (Baker, 2010; Johnson and Kwak, 2010; Chalmers, 2017: 5). Others emphasize the informal ties financial industry groups have to their regulators (Etzion and Davis, 2008; Seabrooke and Tsingou, 2009; Baker, 2010) or the structural power that financial groups exercise in contemporary capitalist economies (Bell and Hindmoor, 2015; Pagliari and Young, 2014). Other mechanisms discussed in the literature are the technical expertise of private actors that make them superior in “informing their positions better” (Griffith-Jones and Persaud, 2008: 266) or the complexity of topics that create a need for information gathering from market participants (Baker, 2010: 653). As a consequence, technical information may provide access for private actors to the regulatory process (Helleiner and Porter, 2009: 20). And finally, Baker (2010) emphasizes the political salience of a topic as mechanism of influence. Financial regulation is usually a topic that receives little political salience from the public, which makes it easier for interest groups to lobby for a topic and makes regulatory capture easier (Woll, 2013).

Although a range of different scholars have discussed these mechanisms, they are seldom empirically tested and therefore still not well understood. Young (2012) criticizes scholars that tend to just ‘accept’ the causal process without empirically demonstrating it. No existing International Political Economy (IPE) scholarship examines the variation in private sector lobbying success and the variation in these mechanisms of influence. Moreover, no research has been done to the degree of success these mechanisms have and which one, consequently, could be the most successful. Finding out which mechanism is the most successful could explain why certain banks are better in lobbying than others. This is a fundamental question that helps to find out who holds the power in global financial regulation policy processes. In short: there is a need for further research to the different relative effects of these mechanisms of influence. Hence, the research question of this thesis is: “How do private actors influence global financial regulation?”

This research will investigate which mechanism of influence was the most successful in exerting influence during the policy process leading up to Basel III. Basel III and the negotiations leading up to Basel III are chosen due to several legit reasons. First of all, within the banking sector, the primary transnational regulatory body designing international standards is the Basel Committee on Banking Supervision (BCBS) (Young, 2014; Underhill, 2013). Hence, the BCBS has a very important regulatory power. Secondly, Basel III is

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considered as the kind of global reform processes developed since the crisis: it is the prime example of post-crisis financial policy making. Which makes it a relevant case to study. Thirdly, comment letters on the consultation documents are public and available. And finally, the literature suggests that regulatory capture took place during the negotiations of Basel III. The BCBS has long been considered to be in the pocket of large, international banks, with the regulations issued by the BCBS serving as evidence of excessive bank influence (Baker, 2010; Helleiner and Porter, 2009; Underhill and Zhang, 2008) and even so-called regulatory capture (Griffith-Jones and Persaud, 2008; Lall, 2012). Basel III was meant to tighten the grip on financial institutions; however, scholars argue that some fundamental problems of the financial sector that caused the financial crisis to happen are still not addressed in the Accord (Blundell-Wignall and Atkinson, 2010). Other scholars argue that Basel III, the BCBS’s central regulatory response to the financial crisis, suggests nothing more than ‘business as usual’, with the lobbying efforts of banks effectively taking the teeth out of the new regulation (Hellwig, 2010; Lall, 2012). Hence, as the literature shows, it seems that banks have had some lobbying success. This makes Basel III an interesting case to look at because the mechanisms of influence could have been at work here.

Several analytical goals related to the negotiations of Basel III are pursued in this paper. In the first place, the two consultation documents of the Basel III Accord will be compared with the two final versions of the Basel III Accord. The changes between these documents could be attributed to lobbying influence. Secondly, the letters of the banks that responded to the consultations documents will be investigated. Consequently, this research will examine whether the responses of the banks were “heard” by comparing the topics the banks lobbied on in the comment letters with the differences between the consultation documents and the final Basel III Accord. Furthermore, the mechanisms of influence will be operationalized in order to be able to collect data of the banks on these mechanisms. Finally, the lobbying success rates of the banks will be compared with the scores on the mechanisms of influence. In this way the relative success of the mechanisms during the negotiations of Basel III can be tested.

This research seeks to shed light on the mechanisms of influence that banks may use to exercise influence on policy processes regarding global financial regulation. By conducting a case study of both effective and ineffective mechanisms of influence in one occurrence, namely the negotiations leading up towards the Basel III Accord, this research hopes to draw more general conclusions on lobbying success and the mechanisms of influence from this case. Although it is impossible to identify a strong causal relation between lobbying and actual influence on financial regulation, it is not impossible to research which mechanism is the most effective and most frequently used. By identifying this relation this research might be able to open a bit of the ‘black box’ of regulatory capture to indicate which banks are best

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relevance. Scholars argue that the output side of policy processes, the functioning of the financial system in this research, is more likely to be efficient and legitimate if the input side is a relatively inclusive policy process (Underhill and Zhang, 2008; Blom, 2011). Hence, the global financial system works better if these policy processes improve. It is key to examine the legitimacy process of global financial regulation because finance, and thereby financial regulation, is crucial to the economic aspects of our lives. The financial sector shapes and binds our contemporary economy. Moreover, the ordinary taxpayer is affected by the global financial regulation that is made. The most prominent example is the bailout of banks in 2008. Many voices called for a reestablishment of the regulatory mechanisms after the financial crisis with its devastating consequences. Due to the financial crisis and these devastating consequences many people consider that the regulatory mechanisms have failed. Since the financial sector is so significant, it is necessary that future global financial regulation is legitimate and that policy processes will improve. Research is required to investigate whether regulation is legitimate and who can be held accountable if it is not.

This research first examines the literature concerning regulatory capture of the private sector and the literature concerning the different mechanisms of influence. Next, a historical background in a political economic context of the Basel Committee for Banking Supervision and the Basel Accords will be given. In the empirical chapter, the approach to this research will be discussed first. Then the several analytical goals as discussed above will be examined. First, the comment letters of the banks to the consultation documents will be investigated. After this the consultation documents will be compared with the final Basel III Accords. Then the choices for the operationalization of the mechanisms of influence will be explained. Subsequently, the findings of the lobbying success rates on these mechanisms will be discussed. An answer on the research question will be given and a conclusion with policy recommendations will follow.

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2. Literature review

This chapter will first elaborate on the developments concerning the global financial architecture of the last decades. Secondly, the literature concerning regulatory capture in global financial regulation will be explained. Thirdly, the gap in the literature will be clarified. Finally, the different mechanisms of influence through which private actors can exert influence will be described.

2.1. Regulatory capture in global financial regulation

During the years before the crisis a shift was visible in the financial sector to less stringent, market-oriented forms of governance allowing market participants to access new market segments and countries (Blom, 2011, Underhill, 2013). A system of market-based forms of financial governance was developed by public sector financial elites in consultation with private sector agents and associations (Underhill and Blom, 2012: 277). Underhill and Blom (2012: 278) argue that two features of the pre-crisis international financial architecture should be noted. First, a shift has taken place from public authority to private, market oriented forms of authority that significantly enhanced the influence of private actors. Second, the inputs into the policy process were very limited at the international level. Hellwig (2010: 5) argues that the cause of these trends has to do with governance. The proposal for extending capital regulation to market risks presented by the Basel Committee in 1993 serves as an example. The financial industry argued in response that risk management on the basis of internal models was said to be much more precisely attuned to the actual risks that different assets posed for the banks. As a consequence, banks were given the option to determine regulatory capital on the basis of their own risk models, which made them more influential than many sovereign participants in the global financial system (Claessens, Underhill and Zhang, 2008, Underhill and Blom, 2012). According to Hellwig (2010: 14) the problem is that there is a discrepancy between the private interests of the bank’s managers and the public interest in financial stability. Blom (2011) calls this process of less stringent regulation “a symbiotic relationship between shifting patterns of governance and changes in market structure”. As a consequence, the system could facilitate the insertion of private sector preferences in the transnational processes of policy making (Underhill, 2013). Policies were developed that promoted cross-border market integration and a system with a high degree of capital mobility emerged. This system with international volatile capital flows caused a change in the balance of power between public authority and private market interests, according to Seabrooke and Tsingou (2009). The passive influence of private market agents on government decisions and their power to actively shape and set national and international rules in a globalized economic

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And then the 2007-2008 global financial crisis hit the world. The crisis unsettled the balance of power among different actors. Due to its severe consequences, many voices called for a radical change in the regulation process of the financial sector (Pagliari and Young, 2014; Young, 2014: 369; Underhill, 2013; Pagliari and Young, 2016). As a result, public opinion turned against the banks and demanded more stringent regulation. This ensured that the financial policymaking process was kept under a critical review. Moreover, political will emerged to reform the financial sector (Blom, 2011). Helleiner and Porter (2009: 14) argue that the crisis was not generated just by market actors but also by a failure of international regulation, which was developed in transnational networks. Many argued that the negative effects of the so-called ‘light touch’ laws were a result of the intense lobbying for deregulation (Hellwig, 2010; Underhill and Blom, 2012; Underhill, 2013). People realized that the deregulation of the financial sector took place in a non-transparent way and that industry representatives succeeded in influencing the Basel Committee in such a way that it served the narrow or private corporate interests of the financial industry (Baker, 2010; Johnson, 2009; Persaud, 2009). George Stigler (1971) used the concept ‘regulatory capture’ to describe the phenomenon of private actors having influence on public policies. Stigler argued that public officials usually design regulation to favour groups that offer them the highest degree of political support. As such, the content of regulation reflects private interests of those groups that could successfully influence policy makers, rather than the public interest. Thirty years later, Baker (2010: 649) argues that the regulatory capture in the financial industry is so extreme that it becomes dangerously pathological, because it facilitates the excessive risk-taking that led to the bailouts of 2008.

Influencing policymakers takes place in all sorts of policy fields but Underhill and Zhang (2008: 541) argue that the preferences of private actors are most dominated in financial regulation. Seabrooke and Tsingou (2009) also stress the capacity of financial power elites to maximise their potential for control. According to them, the capacity of financial power elites to influence global financial policy subsists in several mechanisms that are especially applicable to the financial sector. Mechanisms that the financial sector use to exert influence are the large concentration of wealth in the financial sector, the political salience of financial regulation, the phenomenon of revolving doors in which persons move between the public and the private sector, the technical information that the financial regulation possess and the structural power of the financial industry as a whole (Young, 2013; Baker, 2010; Seabrooke and Tsingou, 2009; Chalmers, 2017; Pagliari and Young, 2014; Pagliari and Young, 2016). For example, the mechanism technical information works in the following way: the financial industry possesses particular information and expertise, which are resources that supervisors admit they cannot reach. As a consequence, private actors have a certain power to define supervisory standards (Underhill and Zhang, 2008). Policies concerning the safety and

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soundness of the financial system are thus dominated by the preferences of those private market actors who stand to benefit from it most.

2.2. A lack of evidentiary standards

On the topic of lobbying and regulatory capture in financial regulation has been written a great deal, especially after the financial crisis. Most IPE scholars agree on the fact that private actors are capable of influencing global financial regulation. However, Young (2012: 667) points out that these causal relationships are merely presumed instead of actually documented and proved. Convincing evidence of lobbying proves hard to find for two reasons.

Firstly, the causality is hard to prove. Young (2012) argues that access does not necessarily equal influence. When a private sector group interacted with the BCBS that does not automatically mean that it managed to have its preferences met because of that interaction. This is one of the most problematic challenges in research on interest groups: the actual measuring of influence in policy making (Baumgartner and Leech, 1998; Mahoney, 2007; Beyers, 2008; Dür, 2008). The issue of proving causality has been debated for decades. Secondly, many academics argue that policy processes are too complex to actually recognize who pushed for what, when and with which results (Lowery, 2013; Brandon and Padovani, 2012; Young, 2012). Thus, the policy process is too complex to disentangle. For example, it is plausible to hypothesize that any interest group in the bargaining process exaggerates its initial requests in order to achieve the best possible result (Ward, 2004; Dür and de Bievre, 2007). Other forces may have influence on the policy making as well. Smith (2000) argues that during the agenda-setting stage public opinion and the media play a big role, whilst during the implementation stage bureaucrats may exert discretional power and become a new actor in the bargaining game according to Huber and Shipan (2002). Furthermore, identifying group influence as control over actors means acknowledging that one actor influences another, if the latter changes her/his policy position owing to the interaction with the former. But, it is never possible to infer that any actor’s change of policy position necessarily depends on the influence exerted by one individual on another. It might be due to other causes as well (Pritoni, 2015: 186).

Young (2013: 692) argues that the financial industry is able to shape the financial regulation to which it is subject for some of the time and under some conditions by using certain tools they have at their disposal, but that it is still “a long way off from being the savvy policy shaping force that many depictions suggest”. The tools that Young mentions in his article are the mechanisms through which the financial sector exerts influence. According to many IPE scholars banks make use of these mechanisms to influence financial regulatory policy (Baker, 2010; Young, 2013; Woll, 2013; Seabrook and Tsingou, 2009; Lall, 2015) but as argued by Young (2013: 693) we know surprisingly little about which of these tools help

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the financial industry ‘shape’ policy more effectively than others. Pagliari (2012b: 9) argues that the most important source of disagreement among the different scholars and commentators in this field concerns the mechanisms through which regulatory policies come to diverge from the public interest towards unduly favoring narrow interests. Moreover, private actors can exert influence through multiple of these mechanisms; therefore it is hard to prove how private actors exactly influenced the policy process and which mechanism was actually the most successful. More research is necessary to open the black box concerning these mechanisms of influence.

Researches so far on this topic have focused on other things than actually examining how these causal mechanisms work and how the mechanisms relate to each other. Earlier research on the mechanisms of influence has focused on the extent to which regulatory capture has weakened after the financial crisis (Baker, 2010). Other researches focused on solely one specific mechanism such as revolving doors (Seabrooke and Tsingou, 2009; Pagliari, 2012a, Puente, 2012). Moreover, the quantitative research that has been conducted on the mechanisms of influence is limited to investigating the campaign contributions of banks and the responsiveness to special interests of the financial industry in the United States (U.S.) (Mian, Sufi and Trebbi, 2010). Finally, some researches just assume that the financial industry gets what it wants due to the numerous tools they can use to exert influence. According to Johnson (2009), the financial industry gets what it wants because of this vast combination of tools it has at its disposal but he does not effectively conducts research on the tools.

Due to this sort of methodological and practical difficulties the influence of the financial sector is difficult to measure. A gap in the literature is visible: more research needs to be done on the workings of these mechanisms and their relative effect to each other. One mechanism of influence might be more effective in influencing financial policy than another. Provided that is the case, policy recommendations could be formulated on a particular mechanism to reduce the regulatory capture of private actors and to render the policy process more legitimate. As a consequence, the output of the policy process would be more legitimate and serve the common interest. This research will empirically investigate the lobbying mechanisms of private actors in the financial sector in order to make a contribution to this field. In the following section an elaborate explanation of the mechanisms of influence will be given.

2.3. Mechanisms of influence

Financial industry groups have a wide range of tools at their disposal to try to influence the regulatory policies they are subject to (Young, 2013; Pagliari and Young, 2016; Baker, 2010;

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Seabrook and Tsingou, 2009; Goldbach, 2015; Braun and Raddatz, 2010). These tools are also called ‘mechanisms of influence’ in the literature. Some of these mechanisms overlap but for the sake of this research the mechanisms will analytically be distinguished. This part of the literature review will group and explain the most discussed mechanism of influence in the literature.

2.3.1. Concentration of wealth

A concentration of wealth is an important source for lobbying power because it is crucial to fund lobbying activities (Baker, 2010; Chalmers, 2017; Woll, 2013). Lobbying activities that need to be paid are for instance funding campaign contributions, obtaining media coverage, and otherwise financing expensive lobbying strategies (Igan et al., 2009). Chalmers also indicates that groups with greater resources are capable of influencing regulation because they are able to expand the scope and sophistication of their lobbying efforts and develop new strategies to lobby at both the state and international levels (Chalmers, 2017: 5). Stigler (1971) argues that another advantage of greater resources is the fact that it is easier to overcome collective action problems that otherwise limit the ability of private actors to mobilize on certain issues. Groups with greater resources are therefore better in mobilizing on issues and as a consequence, better in lobbying on these issues.

The relation between material resources and influence is also present in the financial sector. Scholars claim that wealth is a considerable source for political lobbying power for banks (Baker, 2010; Johnson and Kwak, 2010). Baker (2010: 651) argues that during the 1990s and 2000s great concentrations of wealth in the financial sector gave bankers huge political weight, resulting in the emergence of an American financial oligarchy that provided enormous amounts of campaign financing. Baumgartner and Leech (1998: 13) demonstrate that issue identifiers tend to control significantly more material resources than others. Issue identifiers are able to put topics on the political agenda or to keep topics off the agenda, which is a crucial part of lobbying. Moreover, Young (2013) argues that financial industry groups or individual firms can offer campaign contributions to elected officials, which will serve their interest in return once they are chosen (692). As a consequence, one can argue that private actors, who possess significantly more wealth, are better in influencing policy.

2.3.2. Political salience of financial regulation

The prevailing view is that when a topic has little political salience, it is easier for private actors to lobby for this topic (Pagliari and Young, 2016; Bonardi and Keim, 2005). The salience of a given policy domain can be defined as the importance that the general public

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will assign to a specific issue compared with other issues on the political agenda (Wlezien, 2005). Scholars claim that private actors’ success is bigger on less contested policy episodes, when these actors face limited opposition from other actors (Dür, Bernhagen and Marshall, 2015). However, the increasing level of salience is not permanent. Pagliari and Young (2016: 313) emphasize that the level of salience is likely to wax and wane in accordance with the ‘issue attention cycle’ whereas issues that leaps into prominence inevitably fade from the centre of the public attention. Events, like a crisis, can thus increase the salience of a topic for a certain amount of time.

Usually, global financial regulation receives little political salience from the public (Woll, 2013). As a consequence, global financial regulation obtains little opposition. This is in line with Bakers (2010) argumentation that in all times, except for ‘financial bursts times’, the wider public has little interest in financial regulation, so the issue has little political salience. Accordingly, private actors that lobby on financial regulation find themselves relatively unopposed because countervailing societal interests are largely absent. Moreover, it is hard to mobilize groups in periods of ‘quiet politics’ (Culpepper, 2011). A period with little political salience constrains the capacity of groups beyond the financial industry to mobilize (Baker, 2010; Scholte, 2013). Pagliari and Young (2016: 328) also argue that non-business civil society groups are constrained in their role as countervailing force by their limited mobilization. They confirm the widely held notion that financial industry groups dominate financial lobbying. The opposition that exists finds it hard to make financial regulation more politically salient and as a consequence, private actors have more power to lobby. However, when regulation is politicized in the context of a crisis regulatory capture becomes harder. Crises have been presented by the literature as favouring the mobilization of opposition groups (Pagliari and Young, 2014). As a consequence, one may argue that private actors that lobby for less political salient topics will be more likely to influence global financial regulation.

2.3.3. Revolving doors

Actors that are responsible for governing the world economy can move between public and private roles. This entails that corporate employees can fill positions in executive branches of government and conversely, upon completing their service, many former government officials find employment in the corporate world (Etzion and Davis, 2008: 157). Baker (2010: 652) argues that the issue of revolving doors leads to ‘colonization’ of regulatory agencies and dysfunctional incentives for regulators as the legitimacy of the policy process will get harmed. There are several reasons why revolving doors could be of interest for private actors. In this manner, public directors know the private sector and it’s people well, which makes it easier for the private sector to exert influence. Young (2013: 693) describes this phenomenon

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as ‘utilizing their personal ties with public officials’. Seabrooke and Tsingou (2009) indicate that those who move through revolving doors are more likely to have mixed career experiences and can supply a diverse range of skills and knowledge to address policy uncertainties. As such, private actors could benefit from these close ties. Moreover, Braun and Raddatz (2010: 235) argue that links between politicians and bankers may be a way of fruitfully sharing ability, knowledge and experience between the public and private actors. Revolving doors help private actors in providing access to the policy process. Accordingly, actors can lobby to make a legitimate case to government officials.

Several scholars claim that the ‘revolving doors’ phenomenon is considered to take place in the financial sector (Seabrook and Tsingou, 2009; Baker, 2010, Young, 2013). Levine (2012: 41) argues that the financial regulatory agencies are not independent of private financial institutions. As an example, he refers to the Federal Reserve (Fed): banks help to choose the leadership of the Fed banks; many senior Fed officials worked for private financial institutions before; many Fed officials move to jobs in private financial institutions; and, Fed officials are in constant contact with the private institutions they supervise. Bhagwati (1998: 12) was the first to introduce the ‘Treasury Wall street Complex’. He argues that Wall Street has exceptional power in Washington because there exists an elite of like-minded luminaries among the powerful institutions. These people move from Wall Street to these powerful institutions and back. An example is Ernest Stern, who has served as acting president of the World Bank, and became managing director of J.P. Morgan. Another example is Altman who went from Wall Street to the Treasury and back. Baker (2010: 653) argues that the distinction between public and private authority in the financial sector is blurred as small transgovernmental international financial institutions evolve to dominate international agenda’s. Braun and Raddatz (2010: 272) find out in their research that politician-banker relationships are associated with poorer outcomes for society in the form of lower overall and financial development, and banks that have more of this sorts of relationships do better: they are larger and more profitable. Based on the literature above, one may argue that private actors that have high-level officials who went through revolving doors will be more likely to influence global financial regulation than private actors who do not have much high-level officials who went through a revolving door.

2.3.4. Technical information

Another widely acknowledged mechanism of influence is the technical information that interest groups possess, as stated by some scholars (Austen-Smith, 1993; Bouwen, 2002; Hall and Deardorff, 2006). Chalmers (2013: 39) argues that information plays an important role for interest groups, affecting decisions in its own favour. Groups are experts on the policy

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issues most affecting their interests and have considerable technical and specialist information on these topics. Therefore, they tend to supply information to decision-makers in exchange for legitimate access to the policymaking process.

Scholars argue that the financial industry also makes use of this mechanism through the relatively obscure and technical content of the subjects the industry deals with (Pagliari and Young, 2016; Rasmussen and Carroll, 2013). The technical complexity of much financial regulation creates a need for information gathering from market participants (Baker, 2010: 653). Moreover, the technical complexity of financial regulatory policies creates substantial ‘information asymmetries’ between different interest groups, regulators and the regulated (Lall, 2015: 128). Seabrooke and Tsingou (2009: 3) argue that the BCBS, the IMF and the World Bank value technical skills held by professionals in private markets. According to them, the view that financial markets are complicated and technical has led to greater reliance on knowledge transfer from professionals to regulators. Thus financial industry groups often offer valuable information to regulators (Young, 2013: 692). This gives financial industry groups superior access to the policymaking process. Mogg (2012) describes technical information as the ‘fuel’ that regulators require to regulate complex policy environments. Young and Pagliari (2014) emphasize technical expertise possessed by financial industry groups as a valuable resource in shaping regulatory policies in a complex domain as financial regulation (577). They argue that the level of expertise that is required to contribute to most financial regulatory issues is seen as a hinder for the participation of those stakeholders outside of the financial industry that are unable to develop a position (313). According to the literature set out above one may argue that private actors that lobby on more technical complex topics will be more likely able to influence global financial regulation due to the reliance of policymakers on the information of interest groups.

2.3.5. Structural power

Some industries have such an important role in the economy that they have a structural power: policymakers listen when the industry speaks (Young, 2013: 693). Fuchs (2007: 8) describes structural power as the power of multinational corporations to develop change in policy choices of governments. Moreover, he argues that the structural power has expanded from a more passive agenda-setting power to an active rule-setting power.

This increasing influence is particularly applicable to the financial sector, as finance has taken more and more a central role in the global economy. The financial sector has become increasingly important in operation of the domestic and international economy during the years. The concept ‘financialization’ comes in when the mechanism of structural power is at play. Financialization means the increasing role of financial motives, financial markets,

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financial actors and financial institutions in the operation of the domestic and international economies (Epstein, 2005: 3). Underhill and Zhang (2008) argue that financial integration and interstate competition for capital help to explain the increasing passive influence of private market agents on government decisions within relatively closed economies and their power to actively shape the rules. There are several implications of financialization, and a regulatory capture in global financial regulation is one of them. Because of the central role of finance, policymakers are wary of introducing policies that may disrupt the ‘golden goose’ of financial sector accumulation and they are more likely to listen to the concerns of financial industry groups than to those of firms in other sectors (Baker, 2010). Pagliari and Young (2014: 578) argue that the globalization of financial flows is understood as underwriting this structural power by constraining the policy environment in a way that benefits the interests of financial industry groups. Therefore, the financial sector has a structural power to influence policies. As a consequence, one may argue that private actors that emphasize the structural power of the financial industry will be more likely able to influence global financial regulation, as policymakers tend to listen to them.

2.4. Summary

As seen in this chapter, a shift has taken place from public authority to private, market oriented forms of authority that significantly enhanced the influence of private actors. Moreover, global financial governance receives limited input from stakeholders. As a consequence, private actors were able to influence global financial regulation. The financial industry has several ‘tools’ at their disposal to exert influence. Much has been written on these tools that private actors presumably use. However, it is unclear which mechanisms are more important than others. Theoretically it is clear how they work, but due to the little empirical research that has been done to these mechanisms, it is not clear how it empirically works out. Many academics normatively evaluate the influence of the private sector instead of analysing it systematically. The main question always calls to the presumed ability of the financial industry to influence international regulatory bodies. However, the question is never, how do they exactly influence these bodies and which mechanism of influence is the most successful? This research will focus on the working and successes of the mechanisms of influence that are considered as the most important by the literature.

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3. Historical background of the Basel Committee on

Banking Supervision and of the Basel Accords

This chapter will elaborate on the BCBS (the committee that sets the guidelines for worldwide financial regulation regarding banking supervision) and on the previous Basel Accords that have been made, as the negotiations on the final Basel III Accord are the main focus of this research. First the historical background of the BCBS will set forth. After this, the three Basel Accords, and the political economic context in which they were established, will be described.

3.1. Historical background of the Basel Committee on Banking Supervision

The Bank for International Settlements (BIS) was established as an international economic institution that is separate from the fiscal obligations of any country. Therefore, the BIS may be understood as something of an intergovernmental ‘quango’: a quasi-non-governmental organisation (Seabrooke, 2006: 142). Its original charge was to ‘promote the co-operation of central banks and to provide additional facilities for international financial operations; and to act as a trustee or agent with regards to international financial settlements entrusted to it under agreements with the parties concerned (BIS Statutes, 1930). Nowadays, the institution focuses more on the development of international banking regulation and the collation and dissemination of financial data to international financial institutions and private financial market actors (Seabrooke, 2006: 141).

An informal group within the BIS in Basel, Switzerland, established the BCBS in 1974 in the aftermath of serious disturbances in international currency and banking markets (BCBS, 2016b). The years before the establishment of the BCBS were characterized by a unique combination of inflation, floating volatile exchange rates, and high interest rates. Kapstein (1989: 325) argues that it became necessary for bankers to shield their corporate clients and their own institutions from macroeconomic stability. This fuelled three trends in financial markets: globalization of capital markets, innovation of financial practices and instruments, and speculation. These trends created a global banking system that became increasingly difficult to monitor. But at the same time the need for monitoring was greater than ever as the potential for rapid international transmission of a national banking problem posed a major challenge for public officials (ibid: 326). Hence, there was a need to establish communication networks among national authorities, where consequential common problems could be discussed, and cooperation sought, perhaps leading on to convergence of policies (Goodhart, 2011: 10). The BCBS charter describes the Basel committee as “the primary global standard setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters”. Its mandate is to strengthen the regulation,

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supervision and practices of banks worldwide with the purpose of enhancing financial stability (BCBS, 2016). The committee was for the biggest part of its history composed of regulatory and central bank officials of G10 countries1 (Peihani, 2015: 147). In November 2008 the Group of Twenty (G20) called to examine participation in standard-setting bodies. As a result the BCBS expanded its membership to include Australia, Brazil, China, India, Mexico, South Korea and Russia (BCBS, 2009a). Afterwards, the BCBS was expanded once more: Hong Kong and Singapore were included as well (BCBS, 2009b). This wider shift towards the inclusion of the G20 member states is partly the result of the global financial crisis of 2007-2008. After the crisis many voices called to enhance the legitimacy of the input-side of the international financial architecture (Underhill and Blom, 2012). Hence, changes were made in the membership of international institutions. But, according to Underhill, Blom and Mügge (2010), the rules of the game are still established by developed countries that benefit considerably. This affects the legitimacy of the process of global financial regulation.

The BCBS has established a series of international standards for bank regulation, most notably its landmark accords on capital adequacy, which are commonly known as Basel I, Basel II and, most recently, Basel III (BCBS, 2016b). The BCBS does not possess any formal supranational regulatory authority; its standards do not have legal force. Thus the decisions of the BCBS can be considered as ‘soft law’ (Peihani, 2015: 148). But, BCBS members established the unwritten rule that once policies are agreed upon within the committee and endorsed by governors, members are honour-bound to implement them. Moreover, the denial of access to financial markets or a bad reputation which is punished by less capital flows are possible consequences of disobedience (ibid). The participants within the BCBS are bureaucrats within regulatory agencies and central banks (Young, 2011: 41). Underhill and Zhang (2006: 29) argue that the BCBS is characterized by virtual separation from any political process to hold the committee accountable. The following paragraphs will elaborate on the evolvement of the Basel Accords.

3.2. Basel I Accord

There was a strong need during the 1980s for a multinational accord to strengthen the stability of the international banking system and to remove a source of competitive inequality arising from differences in national capital requirements. Scholars offer different motivations for the establishment of the Accord. Seabrooke (2006: 144) argues that in response to the debt crisis,

1_{Namely
Belgium,
Canada,
France,
Germany,
Italy,
Japan,
the
Netherlands,
Sweden,
Switzerland,} the United Kingdom and the United States.

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there was a loose consensus that there should be new regulations to ensure that international banks had capital adequacy and that they did not fall into ‘moral hazard’ traps. Kapstein (1994) argues that market failures due to internationalisation of banking led to a need for international cooperation. Whilst Oatley and Nabors (1998) focus more on the interests of the American banking sector and on the exercise of American power. They argue that the U.S. pushed for the Basel Accord afraid of being excluded from their own market. Hence, one may argue that both functionalist as political reasons pushed the establishment of Basel I. After extensive negotiations between G10 central bank governors, the ‘International Convergence of Capital Measurement and Capital Standards’, or Basel I, was formulated in 1988 (BCBS, 1988). Basel I established a general rule requiring banks to hold 8 per cent capital against risk-weighted assets. The deadline for banks to adjust was set for 1992. Jackson et al. (1999: 1) argue that there were two main objectives behind the adoption: the committee believed that the framework would help to strengthen the soundness and stability of the international banking system by encouraging international banking organisations to boos their capital positions. Moreover, the committee believed that a standard approach applied to internationally active banks in different countries would reduce competitive inequalities. According to Underhill and Zhang (2008: 543), the achievement of Basel I occurred with little formal consultation with ‘outside’ interests, private or otherwise. The BCBS operated back then in a more detached manner than today. Underhill and Zhang (2008: 544) argue that the national financial policy communities were closed and characterized by ‘business corporatism’ and the delegation of public authority to private agencies via self-regulation.

Soon after its implementation, market participants widely criticized Basel I because it would be risk-insensitive (Peihani, 2015: 149). Seabrooke (2006: 144) argues that the adoption of the Accord reflected the simplicity of the regulations: banks were going through a process of ‘disintermediation’ and off-balance securitisation. Blundell-Wignall and Atkinson (2010: 3) argue that Basel I gave banks the ability to control the amount of capital they required by shifting between on-balance sheet assets with different weights, and securitising assets and shifting them off balance sheet. The rise in these off-balance sheet instruments was the most direct and important response, according to Blom (2011). He argues that Basel I gave an impetus to the further internationalisation of the banking sector because the costs of doing international business were reduced by harmonisation. This meant rising inter-firm competition. This can be confirmed by the research of Jackson et al. (1999: 4-5) on the effects of the Basel Accord. They did not find persuasive evidence that the Accord reduced competitive inequalities between banks. Moreover, they claim that innovations in the market enabled banks to ‘effectively arbitrage between amounts, increasing bank risk relative to minimum capital levels’. One of these innovations is the technique of securitisation. These developments undermined the comparability and the meaningfulness of the capital ratios.

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Blom (2011) claims that globally active and increasing large banks emerged and made use of sophisticated tools to build a case why Basel I overstated risks and hence capital buffers. Several pushes from the private sector emerged to renegotiate Basel I. For example, the G30 published a study ‘Global institutions, national supervision and systemic risk’ in which they advocate for using internal models to assess credit risk (G30, 1997). Also, the New York Fed was active in supporting the renegotiation of Basel 1 (Blom, 2011: 125). This culminated in the renegotiation of Basel I in 1996. Because the renegotiation was concentrated in the Basel Committee, it provided a fruitful lobbying avenue for representatives of the international banking community. As a consequence, the BCBS amended Basel I in such a way that banks could make use of their own internal risk assessment models (Seabrooke, 2006: 144). These changes undermined the original intentions of the Basel I Accord to strengthen the stability of the international banking system.

3.3. Basel II Accord

As seen above, motivations for the new Accord arose from technical weaknesses in Basel I. Moreover, due to all the rapid innovations the traditional Basel I framework did not fit anymore (Claessens, Underhill and Zhang, 2008). The BCBS decided therefore in July 1998 to start negotiating a new Capital Adequacy Framework (Blom, 2011: 126).

The new negotiations started with more international consensus about the directions of the negotiations and were less driven by the preferences of the US in response to changing preferences of G10 supervisors and large international banks. In contrast with the first negotiations concerning Basel I, there was now a formal open consultation process managed by the BCBS secretariat with three rounds. This meant that all stakeholders could express their preferences to the BCBS, which opened up access for lobbying as well (Blom, 2011: 126). Barr and Miller (2006) consider the consultation process as evidence of the long way that the committee has come from closed “club” model of its origins and of the possibility for greater accountability of international regulation. In contrast to Barr and Miller, Claessens, Underhill and Zhang (2008: 320) argue that the private sector began to play an even bigger agenda-setting role than in the past. The input-side during the formulation of the Accord was highly exclusionary. Powerful private interests had more access to the policy process than developing countries. They claim that the Institute of International Finance (IIF) remained the principal interlocutor, despite of the consultation rounds. Moreover, most of the comments in the consultation process came from financial institutions in Europe and North America and to a lesser extent from developing country financial institutions or from other interested associations (Claessens, Underhill and Zhang, 2008: 321; Claessens and Underhill, 2010: 114). Blom (2011: 133) categorized the responses on the second consultation document and

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on the third consultation document during the negotiations of Basel II. He found out that during the second consultation round 70% of the responses came from private financial actors and during the third consultation round 66% of the responses came from private financial actors.

In June 2004 a new framework was published after six years of intensive preparation (BCBS, 2016b). The aim was to provide an overall framework for risk assessment and risk management (Peihani, 2015: 149). Basel II comprised of three pillars: first of all, minimum capital requirements, which sought to develop and expand the standardized rules, set out in 1988. Secondly, a supervisory review of an institution’s capital adequacy and internal assessment processes. Thirdly, effective use of disclosures as a lever to strengthen market discipline and encourage sound banking practices (BCBS, 2016b). The formal implementation would commence at the end of 2007, but the implementation phase was difficult to manage for a lot of countries. The outbreak of the global financial crisis overlapped with the programmed phase-in of Basel II. At that moment, Japan was the first and only G10 country claiming to have fully implemented all pillars of the Basel II Capital Accord (Blom, 2011: 135).

Reactions to the new Accord were predominantly critical. Claessens and Underhill (2010) claim that Basel II has emphasised improved facilitation of market processes instead of containment of the systemic risks (133). Also Blom argues that Basel II entails a shift towards a more private nature and towards less stringent governance (Blom, 2011: 135). Danielsson et al. (2001: 3) argue that Basel II failed to address many of the key deficiencies of the global financial regulatory system and even created the potential for new sources of instability. A few examples they give in their research consider the fact that the proposed regulations fail to consider that risk is endogenous and that the proposals will exacerbate the procyclicality of the financial regulation and negate the fact that financial regulation should reduce the likelihood of a systemic crisis. As a consequence, the proposals can have destabilizing effects and thus harm the global financial system. Claessens, Underhill and Zhang (2008) distinguish between winners and losers as a result of the Accord. Small banks and banks from developing countries can be considered as the ‘losers’: they will have a competitive disadvantage due to the Basel II regulation. Moreover, the impact on developing countries would be detrimental: there will be an adverse effect on the external financing prospects for developing countries. Seabrooke (2006: 148) agrees with the former scholars that developing countries are the losers of this Accord. As a consequence, he questions the legitimacy of the global financial order. Winners are the large, advanced banks, which is not surprising as they had more access to the decision-making process than other actors (Claessens, Underhill and Zhang, 2008).

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3.4. Basel III Accord

As before mentioned: Basel II had several shortcomings. One of the many defects of the Basel II framework was the incentive for banks for off-balance sheet activities (Blom, 2011: 194). Moreover, it failed to understand adequately the risks stemming from complex financial products and securitisation. And, during the crisis, the Basel II models failed to recognize systemic risks: the focus was too much on market-based risk management (Persaud, 2009). Before the crisis these shortcomings had become already apparent. But, the crisis amplified the feeling that the Basel Accords needed to be revised and strengthened (Nørholm Just, 2014). Public opinion radically changed against the banks due to the severe consequences of the financial crisis. This caused a shift in power and preferences: the political pressure to prepare new financial regulation increased. Consensus arose among policymakers that a new approach to capital regulation was essential for the future of the international financial system (Lall, 2013: 625). Another consequence of the crisis was the extended membership of the BCBS to all G20 members. Nevertheless, the negotiations for the Basel III framework were already in their end phase when these members could join. Therefore it can be doubted if the new BCBS members have had a significant impact on the Basel III accord. Accordingly, interactions between the BCBS with private financial institutions are still frequent and pervasive, which alleviates the purpose of the extended membership (Underhill, Blom and Mügge, 2010).

Negotiations on Basel III started in 2008 (BCBS, 2016b). The years that followed were full of discussions between public officials and private actors about the flaws of the Basel II framework and about the measures that should or should not be taken and the phase-in time of these measures. In January 2009, the BCBS published two consultative papers outlining its proposed ‘enhancements’ to Basel II. The measures of Basel III aim to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, to improve risk management and governance and strengthen banks’ transparency and disclosures (BCBS, 2009d; BCBS, 2009e). Again, the BCBS provided consultation rounds to enable stakeholders to comment on the proposed regulation, which provided access for lobbying. As a result, the comment process has been dominated by the financial industry, lobbying for less tough regulation (Chalmers, 2017). From the 274 comments on Basel III, 230 came from industry players (BCBS, 2009c). Therefore many IPE scholars argue that the committee was still inappropriately influenced by the industry it was supposed to regulate (Tsingou, 2008; Underhill and Zhang, 2008; Baker, 2010).

Reactions to the Basel III Accord were wide-ranging. The financial sector articulated their worries about the new framework. Many banks wrote in comment letters to the consultation documents that the new measures would be detrimental to the real economy (BCBS, 2009c). For instance, Howard Atkins, CEO of Wells Fargo, writes in a comment

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letter that the proposals require financial institutions to hold too much capital, which will be threatening for national economies and an impediment to economic growth (Atkins, 2010). Bankers their attention was also focused on slowing down the implementation of more stringent requirements. The British Bankers Association warned regulators that implementing tougher requirements too fast could lead forcing banks to reduce lending, and thus contribute to a double dip recession (Financial Times, 29 June 2009). The IIF published a report on the new Accord claiming that a 2 per cent increase in overall capital requirements would cut cumulative economic output by 3.1 per cent in the Eurozone, the US and Japan by 2015. Moreover, nine million jobs would disappear during the process (IIF, 2010). But there were also other voices that claimed that the new regulations were, again, no fundamental rethink of the system. Lall (2012: 626-627) argues that the proposals have fallen short of their creators’ aims. He claims that large financial institutions were able to regain control of the Basel process due to early participation in the regulatory process and due to the fact that economic growth increased again in 2010, what weakened public demand for change. Moreover, Blundell-Wignal and Atkinson (2010: 16) argue that the fundamental problems of the global financial architecture are still not addressed in the Basel III Accord. Underhill (2013: 586) agrees with the previous scholars and adds that institutional innovation at the level of global financial governance has been minimal so far.

Finally, the agreement of the BCBS was formalised by the G20 summit in Seoul on 11-12 November 2010. In December 2010, the enhanced Basel framework was published. It extended the framework with some innovations like a countercyclical capital buffer, which places restrictions on participation by banks in system-wide credit booms with the aim of reducing losses in credit busts. Furthermore, a minimum liquidity ratio, the Liquidity Coverage Ratio (LCR) was included in Basel III. This should provide enough cash to cover funding needs over a 30-day period of stress, and a longer-term ratio, the Net Stable Funding Ratio (NSFR), intended to address maturity mismatches over the entire balance sheet (BCBS, 2010). The measures of the Basel III Accord represent a fundamental overhaul for banking regulation. But, the BCBS noted that they “will put in place appropriate phase-in measures and grandfathering arrangements in a way that it does not impede the recovery of the real economy”. The strengthened definition of capital will be phased in over five years: the requirements were introduced in 2013 and should be fully implemented by the end of 2017 (ibid). The BCBS closely monitors the implementation of the Basel standards. In the last monitoring report the majority of the countries adopted most of the regulation. However, the report stated that more attention should be devoted to adopt the rules concerning risk-based capital (BCBS, 2017).

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3.5. Summary

As explained in this chapter, private influence seems to be dominant through the negotiations of all the Basel Accords. The legitimacy and accountability of the BCBS are frequently disputed. Many recall that the BCBS is an unaccountable institution with illegitimate rulemaking processes due to the limited input of stakeholders and superior influence of the financial industry (Zhang and Underhill, 2008, Lall, 2012, Claessens and Underhill, 2010). Peihani (2015) provides as example the private meetings the BCBS organizes with industry representatives and regulatory officials to discuss possible new regulation. These meetings happen behind closed doors. In the last couple of years more civil society associations have requested to be given similar access to BCBS meetings. However, to date there has been no occasion for civil society participation in such meetings and no sign that the BCBS is going to change this precedent (Peihani, 2015: 154). In the following chapter the influence of the private sector that may have played a role during the negotiations of the last Basel Accord will be tested.