TWN Info Service on WTO and Trade Issues (July10/04)
12 July 2010
Third World Network

WTO holds first-ever "dedicated discussion" on financial crisis
Published in SUNS #6958 dated 5 July 2010

Geneva, 2 Jul (Kanaga Raja) -- Three years after the onset of the financial crisis that originated in the US and other world financial centres, and the massive bailouts at taxpayer's expense that ensued, the World Trade Organization held this week its first-ever dedicated discussion to examine the effects of the financial crisis and of rescue measures on trade in financial services.

The day-long discussion took place on Tuesday (29 June) at the Committee on Trade in Financial Services, under the agenda item of "Recent Developments in Financial Services Trade."

The unprecedented bailouts, involving unorthodox measures by central banks as well as direct injection of funds by government treasuries, involved not only financial firms - banks, insurance firms and others - but also various "consumer" credit and financing operations of automobile manufacturing and other corporations.

While some of the major developing countries had been pressing repeatedly for an in-depth discussion in the Committee on Trade in Financial Services (CTFS), the United States, European Union, Canada and other industrial countries have been resisting it.

While the WTO and the Secretariat, as well as the majors, have attempted to keep the trade organisation and the GATS out of the extensive discussions taking place outside, more recently, there have been some academic writings, as well as position papers at web-sites by activist civil society groups (like Public Citizen's Trade Watch), focussing on the connections between the financial crisis and the trade in financial services of the General Agreement on Trade in Services (GATS).

The decision to organize a dedicated discussion on the financial crisis and trade in financial services was the outcome of two proposals, the first by Argentina, Ecuador, India and South Africa, which formally put forward a proposal on 17 September 2009 (subsequently revised in November 2009), and the second by the United States that was put forward at the meeting of the CTFS on 4 February 2010 - when other members put forward a number of suggestions during the discussion at that meeting.

According to an informal note circulated by the Secretariat, topics suggested for discussion by Members included the following:

-- The effects of the financial crisis on the cross-border supply of financial services through modes 1 and 2, and sales and purchases of financial services through mode 3 (commercial presence);

-- The effects of the financial crisis on the operations of foreign and domestic financial service suppliers, including investment, employment, as well as product mix;

-- Whether these effects vary by product (e. g. Banking relative to insurance or securities; trade finance as compared to other banking services; marine, aviation and transport insurance versus other non-life services);

-- The effects of global liquidity conditions in the wake of the financial crisis on trade in financial services and the availability of trade financing;

-- The effects of government measures in support of the financial sector on trade in financial services, including competitive conditions and global financial stability; and

-- Possible systemic implications in terms of the GATS.

According to the informal note, the purpose of the discussion is to allow Members to exchange information and discuss their experiences, and to be informed about research conducted by other international organizations.

The discussion was divided into two segments, the first segment being devoted to presentations by international organizations having undertaken work in this area, such as the Bank for International Settlements (BIS), the International Monetary Fund (IMF), the Financial Stability Board (FSB), and the Organization for Economic Cooperation and Development (OECD).

The second segment was to be devoted to an exchange of information and experiences among Members on the issues outlined for discussion, as well as other topics of interest for Members related to the financial crisis, such as its implications for financial services trade and the Doha Round.

At a media briefing on Thursday, Mr Hamid Mamdouh, Director of the WTO Trade in Services Division, noted that this was the first real dedicated discussion of the financial crisis and trade in financial services in the WTO by a standing WTO body. The discussion was "extremely un-confrontational," said Mamdouh.

According to trade officials, some twenty developed and developing countries spoke during the discussions. Some had brought along capital-based officials.

Trade officials said that in their various statements, delegations focused on whether the financial crisis had - or had not - affected their financial systems and the types of actions that they undertook in response to the crisis.

In what seemed to be the Secretariat's interpretation of the discussions, Mamdouh said that in the deliberations in both the segments of the dedicated discussion, it was quite significant that "nobody at all saw that commitments under the GATS were among the root causes of the (financial) crisis."

The WTO official said: "We've gone over all the analysis that the experts delivered as well as the interventions and presentations by delegations. I think what was stressed was the importance of (a) strong, sound regulatory framework." And implicitly, according to Mamdouh's interpretation, (the stress was on) how important it was that the regulatory framework keeps being developed, adjusted and updated to stay in pace with innovation and competition in the financial markets.

In the interventions by Members during the discussion, he said that there were references made to possible distortions (arising out of the massive bailouts of financial institutions in the developed countries, particularly in the US and Europe). The point was made by some Members that bailouts were not necessarily neutral in terms of their effect on conditions of competition, he added.

Mamdouh further said that the counter-argument to that is that when governments face serious crisis, they resort to exceptions, and that this is why there is the "prudential carve-out". There is an exception provision for prudential regulations in order to protect the stability and integrity of the financial system.

(This Secretariat view of the "prudential carve-out" in the financial services annex of GATS, and the scope it provides for such government bailouts and interventions has been challenged in some recent academic writings, as well as by some civil society groups tracking these issues.)

Asked whether the issue of the implications of the financial crisis for the Doha Round was raised during the discussion, he said that this issue was not talked about.

Asked about the issues that were discussed, the WTO official said that the statements of delegations were mainly centred around their own experiences with the financial crisis, in how it affected their financial systems and what was done by them in response to the crisis.

A number of developing countries said that their financial systems were not affected in a serious way by the financial crisis. In terms of their experience with the financial system, many developing countries explained how their approach to sound regulation has helped them avoid the negative consequences of the crisis, Mamdouh added.

A developing country trade diplomat who attended the dedicated session told SUNS that the speakers made a compelling case about the competitive problems that were caused by the bailouts in the financial sector.

While it was not a confrontational session, the trade diplomat said that some of the speakers made a reference to the competitive distortions that were created as a result of the bailouts (of the troubled financial institutions by the developed countries).

For the most part, the trade diplomat said, many developing countries took the floor to explain how the financial crisis had affected them, and how they coped with the crisis. China made a proposal on how the financial sector relates to development.

According to the trade diplomat, the United States and the European Union (responsible for the bulk of the bank bailouts) tried to explain how their programmes worked. They also made a reference to why these programmes were needed. For the most part however, they concentrated on explaining how their programmes worked and how they were conducted.

The OECD, BIS, FSB and the IMF made presentations on the financial crisis. They highlighted the type of measures that they were taking and how the countries have reacted to those measures. They also talked about the bailouts that were provided by some countries, said the trade diplomat.

(The title of the presentation by the IMF was "Cross-cutting Themes in Economies with Large Banking Systems"; the title of the presentation by the FSB was on "Priorities on Global Regulatory Reform"; the title of the presentation by the BIS was "An Assessment of Financial Sector Rescue Programmes"; and the title of the presentation by the OECD was on "The Government as Guarantor of Last Resort: Benefits, Costs and Premium Setting Issues.)

The diplomat pointed out that there were no conclusions drawn by the Members at the end of the dedicated discussion.

In its statement at the Committee, India thanked the Secretariat for organizing the dedicated discussion.

Referring to the session earlier in the day, India said that it has heard from the experts about the huge size of the rescue packages in some of the countries and how provision of blanket guarantee transferred risks from the banks to the Sovereign, thus, in effect changing the condition of competition in favour of the weaker banks.

India said that in one of the presentations, it was pointed out how guarantees can introduce distortion in competitive conditions. "What is further worrying is the question raised in the presentation whether these guarantees can be fully withdrawn."

Thus, said India, there is a risk of perpetuating the distortion already introduced. "Distortions in condition of competition definitely have effect on trade in financial services. This is certainly not conducive to a level playing field and impacts adversely on provision of financial services from the suppliers in the developing countries."

According to India, "this supports the view of the proponents that we need to further examine the effect of these measures on trade in financial services in a more comprehensive manner to further improve our collective understanding of the crisis and its impact on financial services trade."

India echoed the views expressed by Argentina about the competition distortive effects of some of these measures.

On a separate track, India said that one of the lessons reinforced from the presentations, as referred to earlier by Pakistan, is that developing countries have to be cautious when looking at liberalization and expansion in financial services taking into consideration local conditions, development needs and priorities.

"Calibrated opening with effective regulation is probably the way to go as developing countries do not have the deep pockets to resort to large rescue packages in case of a crisis," said India.

A representative of the Reserve Bank of India (RBI), India's central bank, made amongst others some technical observations on the deficiencies of contemporary financial architecture, impact of global economic crisis on the Indian economy, salient features of Indian banks, and role of foreign banks in India during the crisis.

According to the RBI representative, foreign banks play an important role in the Indian financial sector. There are currently 34 foreign banks operating in India as branches. Their balance sheet assets, as on March 31, 2010, accounted for about 7.65% (9.03% the previous year) of the total assets of the scheduled commercial banks. In case, off-balance sheet assets are included, the share was 45.94% (50.5% the previous year). However, after credit conversion of off-balance sheet items, the share was 11.23% (13.77% the previous year) as at end March, 2010. The foreign banks saw a decline in their share of assets over the previous year because of contraction in lending in India during the global financial crisis.

The RBI representative said that the crisis has shown that in countries where foreign banks had a large presence and had also acquired a large share at the expense of domestic banks in the boom years, when the home countries were afflicted, the foreign banks had tended to substantially curtail their operations in or withdraw from the host country.

The Indian experience in this regard has been no exception, as the foreign banks had withdrawn substantially from the credit markets in India to the extent that year-on-year growth of credit was -7.1% (as on July 3, 2009) and -15.9% (as on October 9, 2009).

In India, the RBI official added, foreign banks not only withdrew from the credit market, they also hoarded liquidity with their Head Offices.

"The events have demonstrated that when a banking group gets into difficulty, liquidity which was believed to be available to the whole group can be hoarded' by the parent or, in some cases, seized by local authorities intervening to protect their own depositors," the RBI official added.

This is often exacerbated after the collapse of the group as liquid assets are retained within the parent either by the management of that firm or the actions of local authorities, which may be contrary to group assurances or even cross-border agreements and international obligations.

Therefore, there is an increasing realisation that there should be a calibrated approach in opening up of the domestic banking system to foreign banks. This may also call for some kind of limitation on the size of operations of foreign banks in terms of market share at a macro level.

In contrast to the global scenario, the RBI official said that India has by and large been spared of the global financial contagion. Even in the midst of the crisis, India's financial sector remained safe and sound and financial markets continued to function normally.

[In some of the comments in business sections, both in some leading Indian media and in US media like the New York Times, as well as in posts by specialists in some of the blogosphere sites (moderated by financial experts), it has been noted that in countries like India, the central bank, resisting pressures from the banking trade, have stricter regulations on bank credits. In India, for example, at an early stage, the RBI placed several restrictions on bank lending for buying land for housing etc.

[In the extensive discussions taking place in the United States, in relation to the financial reform legislation under way there, some of the leading economists like Paul Krugman and Simon Johnson have been focussing both on the strong regulatory framework and its enforcement, as well as separation of banking and speculative trade activities in the financial sector. There has also been focus on the issue of the absence of international agreements on financial institutions becoming bankrupt and how their assets are to be distributed among creditors, making it difficult to resolve problems arising out of failures such as that of Lehman Brothers.]

There are a variety of reasons for this, said the RBI official. In India, credit-derivatives market is in an embryonic stage; the originate-to-distribute model in India is not comparable to the ones prevailing in advanced markets; there are restrictions on investments by residents in such products issued abroad; and regulatory guidelines on securitization do not permit immediate profit recognition. Financial stability in India has been achieved through perseverance of prudential policies which prevent institutions from excessive risk taking, and financial markets from becoming extremely volatile and turbulent.

Though the Indian banking system remained stable during the crisis, there was adverse impact on the Indian economy, the official noted.

After clocking an average of 9.4% during three successive years from 2005-06 to 2007-08, the growth rate of real GDP slowed down to 6.7% in 2008-09. Industrial production grew by 2.6% as compared to 7.4% in the previous year. In the half year ended March 2009, imports fell by 12.2% and exports fell by 20.0%. The trade deficit widened from $88.5 billion in 2007-08 to $119.1 billion in 2008-09. Net capital inflows at $9.1 billion (0.8% of GDP) were much lower in 2008-09 as compared with $108.0 billion (9.2% of GDP) during the previous year mainly due to net outflows under portfolio investment, banking capital and short-term trade credit.

The expansion of trade in services has included not only cross-border trade but also foreign direct investment. Banks, for example, typically establish branches or subsidiaries within a host country. As a result, the RBI official said, the GATS covers foreign direct investment as well as cross-border trade. IMF research on the current crisis shows that larger stocks of debt liabilities and of FDI (foreign direct investment) in the financial sector are associated with worse growth slowdowns.

Countries with larger stocks of debt liabilities or financial sector FDI fared worse in the current crisis, whereas those with larger stocks of non-financial FDI fared better.

Under GATS, it is difficult to realize fully the benefits of liberalization of trade in financial services without free cross-border movement of capital. The GATS therefore contains certain provisions aimed at ensuring that a country does not apply restrictions on payments and transfers that would undermine its commitments to market access and national treatment.

The new findings of the IMF on FDI in financial services sector therefore sits oddly with the requirements of GATS for liberalization of financial services, stressed the RBI official. +