In promoting global financial stability, the Basel Committee for Banking Supervision appears to have stumbled.
Banking systems in Russia, Korea, Thailand, Indonesia, and Brazil have run themselves into the ground during the last five years, borrowing billions of dollars from the West to finance loans that had little chance of being repaid.
Meanwhile the Japanese have crippled their economy by allowing poorly capitalized banks to keep bad loans on their books.
The result: a global financial crisis and emerging credit crunch that rocked the U.S. stock markets and prompted some analysts to predict that the United States will join the rest of the world in a recession next year.
Yet the Basel Committee, an offshoot of the Basel, Switzerland-based Bank for International Settlements, was strangely silent during the half decade leading up to the crisis, doing little to bolster bank supervision in these countries or enforce international capital accords.
"It has always been very reactive to crises," said Gary N. Kleiman, president of Kleiman International Consultants Inc., Washington. "Before the crises occurred in emerging markets, there wasn't much attention paid to developing countries."
It wasn't until the fall of 1997-more than a month after the Thai financial crisis exploded-that the Basel Committee started moving, apparently realizing the severity of the crisis facing developing countries.
The group adopted core principles for effective banking supervision, which cover everything from capital requirements and risk management to enforcement powers and on-site exams.
The guidance, however, came too late. Within months Korea and Indonesia were engulfed in banking crises and Latin American banks were on the brink of collapse.
Some observers argue that Basel could have at least muted the severity of the global financial crisis if it had pushed for better supervision and higher capital requirements in the early 1990s, when these economies first opened up to significant financing from the West and were experiencing double-digit growth.
"They should have done this 10 years ago," said Bert Ely, president of the industry consulting firm Ely & Co. "This has always been a problem."
There is no way to know if the crisis could have been averted-or even lessened-if the Basel Committee had played a more forceful role in persuading countries to impose tougher bank regulation.
Yet many, including Federal Reserve Board Chairman Alan Greenspan, have argued that strong bank supervision may prevent minor economic troubles from exploding into a financial crisis.
"Experienced bank supervision cannot fully substitute for poor lending procedures, but presumably it could encourage better practices," Mr. Greenspan said at a Federal Reserve Bank of Chicago conference in May. "Apparently even that has been lacking in many countries."
For the past year, Basel has been trying to change that reality.
Besides core supervisory principles, the group released risk management guidelines for electronic banking in April, year-2000 guidance in July, and recommendations for bolstering internal controls, increasing transparency, and reducing operational risks in September. On Oct. 14 it proposed guidance on when banks should be required to charge off bad loans.
Its new chairman, Federal Reserve Bank of New York President William J. McDonough, also has announced plans to overhaul risk-based capital rules within a year.
Recognizing that even more needs to be done, on Dec. 1 Basel and the Bank For International Settlements chartered the Financial Stability Institute, which is responsible for promoting better oversight of global banking, capital, and insurance markets.
"There is a general view around the world that the key to preventing the types of crises we had in the past is to strengthen the financial sector," said John G. Heimann, chairman of global financial institutions at Merrill Lynch & Co., who will become the institute's chairman Feb. 1.
These steps represent a sharp change from the group's work earlier this decade, which focused almost exclusively on derivatives, managing market risk, and securities settlement systems. These are all areas of concern to large Western financial institutions, but have little bearing on banks in developing countries.
Despite its apparent shortcomings, the Basel Committee has received little adverse publicity while the International Monetary Fund and World Bank have been hammered by critics.
Federal Reserve Board Gov. Roger Ferguson said it is unfair to hold Basel responsible for the banking crises. "I wouldn't tar them with that brush," Mr. Ferguson said.
The blame, he said, lies with bankers who did not understand how to manage risk and did not disclose the true health of their businesses. All the guidance in the world from international regulators would not have mattered, he said.
Eugene A. Ludwig, the former Comptroller of the Currency who is now a vice chairman at Bankers Trust Corp., said few regulators in the early 1990s thought that troubles in Thailand and Indonesia could threaten industrialized countries.
Instead, they feared a derivatives crisis or similar trading debacle, which meant the Basel Committee never focused on emerging markets, he said.
"The centrality of emerging banking systems by hindsight seems obvious," Mr. Ludwig said. "But there were very few people with that much foresight."
Others argue that Basel's structure makes it impotent during boom times. Because Basel requires agreement from all its members before it may act, tough measures are hard to adopt during good times.
"The politics of attempting to govern banking systems around the world when they seem to be totally robust seems to be impossible," said Karen Shaw Petrou, president of the industry consulting firm ISD-Shaw Inc.
Even when standards are adopted, Basel is dependent upon voluntary compliance by sovereign countries, said George Kaufman, a professor at Loyola University and co-chairman of the Shadow Financial Regulatory Committee, a group of academicians, lawyers, and bankers that scrutinizes regulatory policy.
"Enforcing recommendations in other countries is extremely difficult unless you send in the Marines," he said. "The best you can do is exert moral pressure."
Mr. McDonough, Basel's chairman, acknowledged as much during a news conference in October. "The pressure on bankers to run safer and sounder banks has to come from their depositors and shareholders," he said. "Supervisors can give a nudge, but at the end of the day, it is (up to) the bankers themselves."
Mr. McDonough declined to be interviewed for this article, but Christine M. Cumming, a New York Fed senior vice president and one of Mr. McDonough's top international banking aides, said Basel has been "fairly aggressive" in providing guidance. "Its timing has been decent," she said.
The demands on bank regulators in developing countries exploded exponentially as their markets opened to foreign capital, she said. "As they have deregulated and become exposed to more influences from abroad, that creates new kinds of risk in the financial system," she said.
Basel needed time to react to these changes, Ms. Cumming said. Also, the group does not want to be so aggressive that it becomes the international arbitrator of credit decisions.
"You don't want to say this group of regulators are going to decide where the capital will flow in the world," she said. "I think that's a mistake."
Others argue that the Basel Committee was effectively barred from focusing on developing countries until 1996 when the G-10 countries-the major industrialized nations that created the supervisory committee- expanded its jurisdiction.
"Without a mandate from the G-10 governments, there was absolutely no way for the Basel Committee to be involved," said Daniele Nouy, general secretary of the Basel Committee, which is the top staff job. "We were not making rules for the planet. That would have been impossible."
Mr. Kleiman, the international consultant, said the problem is far deeper than a lack of authority. He argues that the Basel Committee is still missing the boat on developing market issues because it does not consult nearly enough with regulators in these countries.
"You should reformulate the Basel Committee by adding developing countries or create a new group that includes them," he said.
Yet others argue that the Basel Committee needs more powers to enforce its directives. For instance, without enforcement powers, Basel could not prevent Japanese banks from skirting risk-based capital rules with impunity for the past decade, Mr. Ely said.
Recognizing these weaknesses, some researchers advocate an international central bank, which would combine the functions of the IMF and Basel Committee.
David Marshall, a researcher at the Chicago Fed, has proposed such an international lender of last resort. Countries that agree to supervision by the lender would have a guaranteed source of liquidity during financial panics.
Countries that reject outside oversight would be denied access to the funds and would be less likely to receive significant credit from foreign banks, which would view the country as a far riskier bet than neighboring nations that agreed to international oversight.
"If you are going to provide a safety net for these countries, then you need an appropriate regulatory apparatus for controlling risk," he said. That includes the power to examine banks on-site and close poorly capitalized institutions, he said.
"The purpose is to avoid having an undercapitalized bank continue to function while a series of stopgap measures are taken but nothing gets done," he said.
Giving Basel-or a similar entity-enforcement powers, however, could destroy the organization, warned Susan Krause, senior deputy comptroller for international affairs at the Office of the Comptroller of the Currency.
Basel "is an extremely effective mechanism as is," she said. "It could not continue to be effective and relatively efficient in that role if it tried to move into enforcement."