The foundations of regulatory convergence and divergence between the Federal Reserve and European Central Bank.

Author:Lavelle, Kathryn C.
 
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  1. INTRODUCTION II. EXPLAINING TRANSNATIONAL POLITICAL DEVELOPMENT IN THE CONTEXT OF INTERNATIONAL FINANCIAL REGULATION A. Academic Approaches to Studying Political Development B. What is Transnational Political Development? C. Why the Study of Transnational Political Development Sheds Light on Divergence III. THE NATIONAL AND INTERNATIONAL POLITICS OF BANKING SUPERVISION IN THE EVOLUTION OF THE FEDERAL RESERVE SYSTEM A. The Context of the Creation of the Federal Reserve and Ambiguity in its Supervisory Powers B. The National and International Context of the Early Federal Reserve System C. The Federal Reserve as a Supervisor 1. International Negotiations Promote National Regulatory Coordination 2. International Market Pressures Erode Glass-Steagall IV. THE NATIONAL AND INTERNATIONAL POLITICS OF BANKING SUPERVISION IN THE EVOLUTION OF THE EUROPEAN CENTRAL BANK A. The Creation of the European Central Bank B. The European Central Bank and the Financial Crisis in Europe C. The European Central Bank as a Supervisor V. COMPARING THE ORIGINS OF DIVERGENCE IN BANKING SUPERVISION BETWEEN THE FEDERAL RESERVE AND THE ECB VI. CONCLUSION I. INTRODUCTION

    In the wake of the collapse of the U.S. subprime mortgage market after 2007-2008, the global economy experienced a series of financial crises that prompted calls for dramatic regulatory change of financial markets at both the national and international levels. Because the world's financial system is so integrated, coordination among states is critical to building a coherent framework of financial regulation. Yet, regulatory practices have subsequently diverged in several crucial areas, even among advanced, industrial countries that would benefit the most from coordinating financial regulation in order to support their substantial volume of trade and financial flows. Divergence is a problem because growing opportunities for regulatory arbitrage among market participants can destabilize the entire system as well as undermine the ability of financial authorities to supervise institutions and promote best practices worldwide, ultimately threatening economic growth and job creation in the industrial core of the world's economy. (1)

    Scholarship on regulatory divergence takes many forms. Within the discipline of political science, the subfield of international relations debates the problem of international regulatory financial coordination with an emphasis on international institutions--such as the Financial Stability Board (FSB), Basel Committee on Banking Supervision, International Organization of Securities Commissions (IOSCO), or the International Monetary Fund (IMF)--from the top down. (2) The subfield of comparative politics considers regulatory change from the bottom up, or within domestic institutions and their accompanying national political debates. (3) Similarly, work in the field of American political development points to the connection between crises and state building with an emphasis on the expansion of domestic administrative capacity and the growth of the welfare state. (4) Work on central banks focuses on the nature of their independence from political actors and their role in monetary policy. Such scholarship pays less attention to other policies and functions of these institutions, such as exchange-rate policy, financial regulation and supervision, and negotiating in international forums. (5) While this scholarship adds considerably to the discourse, a lack of a broad historical framework often leads to very narrow conclusions.

    The sources of regulatory convergence and divergence are both national and international in origin. Thus, it is more than a truism to state that national and international financial regulatory systems are complex, or that both national and international politics matter. This Article takes a different tack and considers transnational political development by comparing the internal evolution of two of the world's major financial institutions as they have responded to competing domestic and international pressures for regulatory coordination and divergence. (6) Specifically, it compares the growth of the supervisory functions of the Federal Reserve System, in connection with the end of the Glass-Steagall separation of commercial and investment banking functions in 1999, and the European Central Bank (ECB), with the establishment of the Single Supervisory Mechanism (SSM) in 2013. In short, this Article focuses on the dual national and international political configurations that made the growth of the supervisory operations of these two central banks possible. Moreover, it compares the internal institutional configurations that push and pull on convergence and render the process anything but static.

    The Article will proceed in five parts. Part II considers competing understandings of the role of national and transnational politics in banking supervision. Part III explores the history of bank supervision in the Federal Reserve System and its connection to international developments. Part IV explores the history of bank supervision in the European Central Bank and its relation to national and international affairs. Part V compares the two cases, and Part VI concludes by considering the configuration of political and economic institutions that affect the distribution of power in the polities in which each central bank is embedded--i.e. the United States and the Eurozone. (7)

  2. EXPLAINING TRANSNATIONAL POLITICAL DEVELOPMENT IN THE CONTEXT OF INTERNATIONAL FINANCIAL REGULATION

    1. Academic Approaches to Studying Political Development

      Traditional explanations for U.S. policy in the international sphere can be classified as system-centered, society-centered, or state-centered approaches. (8) System-centered approaches examine the attributes or capabilities of the United States relative to other countries; societycentered approaches take policy to reflect domestic political struggles among interest groups or parties within the United States. Statecentered approaches view foreign economic policy to be constrained by domestic institutional relationships that have persisted over time. In the area of monetary policy, some analysts assert that U.S. leaders have a relatively free hand in trade policy, because decisions are taken in the White House, Treasury, and Federal Reserve, where they are insulated from societal demands. (9) Joanne Gowa utilizes a logic of collective action wherein different issues connected to monetary policy determine different incentives for group activity across each of them. (10) Other approaches, such as the literature on varieties of capitalism, consider the organization of the market, relations between firms, and interactions between social partners. (11) The literature on ideas considers the ideational policy frameworks that inform the actions of policymakers. (12) Most authors, such as Lucia Quaglia, take a multi-level institutionalist approach that engages the complexity of history. (13)

      Theorists debate the degree to which the United States or EU sets the pace for transnational regulatory coordination. Most approaches to international relations concur that the Basel Committee is an important site for the coordination of financial regulation in the absence of a true global regulator and that the United States plays a key role. (14) For Simmons, the dominant financial center innovates and other regulators then confront incentives to emulate or diverge from new arrangements. (15) Drezner argues that the United States and EU prefer to raise financial codes and standards to decrease the level of financial instability, protect domestic investors, and improve the functioning of capital markets. (16) They use club intergovernmental organizations to establish global financial regulations like the Basel Committee on Banking Supervision (BCBS) to promulgate common regulatory standards in an effort to avoid the cost of bailing out the private sector in a financial crisis. Singer models the 1988 Basel Accord as an exemplar for other industries wherein unelected regulators, having authority delegated from legislatures, created a new form of global governance. (17) Regulators are caught between the regulated industry's stability and competitiveness and the international competitive constraints that push against higher levels of regulation. This literature lacks an understanding of how these regulators emerged from individual state political development in the United States or from political development in the EU.

    2. What is Transnational Political Development?

      While much of the field of American political development has made important contributions in the study of welfare policy and administrative capacities, (18) little scholarship has explored the institutions that regulate finance, nor their connection to international developments. Work on the EU has focused on only one institutional aspect of central bank governance--central bank independence and its effects on monetary policy. (19) In addition to overlooking important central bank policies, the work overlooks the differences in the nature of the timing problem and its connection to transnational pressures. (20) When institutions are built that attempt to address the need to rebuild confidence in the financial intermediaries within the existing regulatory structure, political actors play different roles depending on their connection to domestic and international circumstances. In later phases, the existing bureaucracy itself becomes an actor as agencies compete for influence and politicians pursue electoral goals in the executive branch and legislature. (21)

      The term "political development" has many meanings. "National political development" refers to the historical processes wherein political actors forge administrative capacity in a given area. In Stephen Skowronek's landmark analysis of this process in the United States, state capacity grew out of institutional...

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