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 LONDON, Oct. 27 /PRNewswire/ -- A thorough global reorganization of financial regulation could be an important ingredient in relieving further the present financial crunch in the United States, and possibly in several other major countries as well, Dr. Henry Kaufman stated here today.
 Lately, Dr. Kaufman said, there has been some progress toward financial rehabilitation. "We are past the worst of the financial crunch, especially in countries like the United States where the emergence of a steeply-sloped positive yield curve has allowed financial institutions to rebuild their earnings without taking on additional credit risk.
 "Nevertheless," Dr. Kaufman commented, "large numbers of financial institutions, whether in the United States, Japan, the United Kingdom, Canada, Australia, or Scandinavia, are incapacitated and cannot be dynamic lenders once global business activity tries to move ahead. This can only diminish the prospects for satisfactory economic growth over the near term."
 Speaking before the 17th Annual Conference of the International Organisation of Securities Commissions, Dr. Kaufman said, "The global reorganization of the regulatory structure could play a vital part in getting a satisfactory worldwide business expansion going." He is president of Henry Kaufman & Company, Inc., a New York-based international money management and economic consulting firm.
 Global Regulatory Issue Has Broken Out of Technical Confines
 In his talk, entitled "Fundamental Precepts Guiding Future Financial Regulation," Dr. Kaufman pointed out that this global regulatory issue, mainly the domain in the past of the regulators, lawyers, accountants, and relevant financial institutions, has burst out of technical confines for three reasons -- the occurrence of a number of highly-publicized scandals in which the role of financial regulators has sometimes been criticized; the continued volatility of financial markets, which raises questions about market participants' behavior, along with the influence of new types of financial instruments and computer-driven trading techniques; and the blaming of regulators for inordinate laxity during the excesses in the 1980s who, then, overcompensated by forcing institutions to tighten lending standards excessively.

Regulatory Structure Can't Cope with New "High Tech" Finance Mishap
 Looking ahead, Dr. Kaufman noted that "events have proved that the existing structure of financial regulation has been inadequate to avert a truly powerful shock to the financial system . . . we also have reason to doubt that financial regulation as it is now organized and implemented will be adequate to deal with the potential fall-out of some unforeseen mishap arising out of the new world of 'high tech' finance -- the as-yet not fully understood and untested area of immense off-balance sheet exposures, whether taking the form of swaps, options, futures, or their many complex permutations." International Agenda for Regulatory Reform for New U.S. Administration
 Once a new American Administration is in place in Washington, Dr. Kaufman declared, a feasible international agenda for financial regulatory reform could include six elements:
 -- Building on the spirit of the successful Bank for International Settlements (BIS) agreement on capital requirements for commercial banks, there needs to be a meaningful effort to bring together banking, securities, and insurance regulators to reach agreement on standards -- accounting standards, disclosure standards, and trading standards. "At the present time," he said, "there are large differences from country to country."
 -- There needs to be a serious effort to extend regulatory coverage to those financial institutions that are now effectively unregulated, such as finance companies. "Otherwise, competitive realities will eventually lead to a shift of business away from the regulated entities, and the safety and soundness of the financial system will suffer."
 -- Regulatory oversight of securitization needs to be clarified, and reformulated regulatory structure will have to bring securitized credit more explicitly under oversight responsibilities. While securitization, a controversial subject, has made a major positive contribution by transforming the assets of financial institutions into more marketable and there more liquid investment instruments, it has introduced new forms of risk which has resulted in sizable losses to investors who did not fully appreciate the risk.
 -- Capital standards, where there is a promising beginning, needs further work. There has to be a common approach, as already recognized by leading regulatory officials, to evaluating market risks and the risks associated with off-balance sheet activities.
 -- With the continuing consolidation of financial institutions, there will inevitably need to be international agreements on the investment powers of universal banks and the potential for undesirable conflicts of interest as more financial institutions play the dual roles of lender and shareholder.
 -- The greater internationalization and complexity of finance cannot be dealt with reasonably and in a timely way without an ongoing institutional capability. "I have long believed," Dr. Kaufman stated, "that the most promising approach would be to establish a new international institution -- a Board of Overseers of Major International Institutions and Markets -- which would consist of central banks, other governmental agencies and members drawn from the private sector. It should be empowered to set mutually acceptable minimum capital requirements for all major institutions, to establish uniform trading, reporting and disclosure standards for open credit markets, and to monitor the performance of institutions and markets under its jurisdiction." Sharply Increased Credit Availability and the Swing from Binge to Crunch
 Noting that financial innovation, formal deregulation and the financial entrepreneurship which they bred had both good and bad consequences, there was one incontestable effect: They drastically increased the availability of credit, particularly to borrowers that used to be considered relatively high credit risks.
 "Reflecting a combination of competitive exhilaration spawned by the lure of high fees, inept credit judgments, over-optimistic economic assumptions, and sometimes outright fraud and criminality," Dr. Kaufman declared, "entrepreneurially driven financial institutions plunged ahead on a lending binge of unprecedented scale, concentrated in commercial real estate and land but extending also to highly leveraged corporations and even household finance."
 Conditions, he said, swung inexorably from credit binge to financial crunch as economic assumptions turned faulty, many loans went sour, and still others remain in great difficulty.
 The United States, Dr. Kaufman added, perhaps suffered the worst of both binge and crunch, with bad loans nearly bringing down an entire industry -- the savings and loan associations -- while numerous banks, insurance companies, and finance companies even now continue to struggle with impaired financial conditions brought about unwise lending and investment decisions. "The repercussions of credit immoderation will weigh on the financial system and, indirectly, on the prospects for economic revival for some time to come."
 While the managements of failed or troubled financial institutions necessarily deserve the lion's share of the blame, "financial regulators can be held accountable for not stepping back and calculating the risks that were collectively being loaded onto the financial system at large as a result of the rapid, overconcentrated growth of credit by financial institutions taken as a group.
 "Indeed, who else other than those responsible for identifying and limiting systemic risk are in a position to take such a 'macro' point of view?"
 Ten Fundamental Precepts to Guide Future Financial Regulation
 Long arguing for a serious effort to reform in a fundamental way the bizarre system of financial regulation the nation has stumbled into, Dr. Kaufman said the need now is to step back and focus on a number of precepts of financial regulation that need to guide the discussion before anybody's detailed recommendations for regulatory improvement can be properly evaluated. The ten precepts Dr. Kaufman set forth are:
 First, in financial regulation there is a fundamental choice between regulated and deregulated financial markets which most countries resist making. Regulated markets mean, he said, that the authorities bear some responsibility for the mistakes or misfortunes of the financial institutions that they regulate. Market discipline plays some role, but effective market discipline is foreclosed for institutions "too-big-to- fail" or politically connected. By contrast a true system of deregulated markets means letting losses fall where they may. Market discipline is taken seriously. "Where are we today?" Dr. Kaufman asked. "I know of no country where a true system of deregulated financial markets now exists. What we have instead is a patch work" of detailed regulation coexisting uneasily with judgmental supervisory oversight, with large areas escaping both.
 Second, thoroughgoing deregulation is impractical and even the most free-market oriented governments will flinch from its consequences. "The only time a 'too-big-to-fail' doctrine can be safely discarded and the uncompromising market discipline of a pure deregulated market can be accepted is when all large institutions are too strong to fail. But the only way that can be achieved is through close, ongoing official oversight - - - The logical corollary is that the more free enterprise- oriented a country is, then the greater the role of official supervision of financial institutions will be in such a country."
 Third, in a world of increasing financial consolidation large financial institutions must purse a higher code of conduct in their business activities. "Essentially, consolidation requires that the largest financial institutions be viewed increasingly in a manner analogous to public utilities, and less like ordinary business enterprises."
 Fourth, financial market participants will always push risk-taking to the marginal edge, unless specifically prohibited from doing so and carefully examined. "At the marginal edge of risk-taking where competition is least," Dr. Kaufman pointed out, "profit margins are highest, fees are most lucrative, and ancillary business is easiest to line up. In largely deregulated markets, the structure does not provide a safe haven where relatively secure profits can be made. Instead, deregulated financial institutions face intensified competition in core businesses and are under greater pressure to move toward the marginal edge. By comparison, in more regulated financial markets, protected segments are carved out that allow the average regulated financial institution to earn nice rates of return without stretching."
 Fifth, deregulated financial markets, by going quickly to the marginal edge of risk-taking, will exaggerate the credit cycle and the business cycle. "This was brought home graphically," Dr. Kaufman said, "in the 1980s through the overlending to the energy sector following the second oil shock and then in the worldwide commercial real estate lending boom. The common denominator is that there becomes a community of interest linking incentives that motivate the borrower with those that motivate the credit provider. An excellent illustration: The astonishing growth of floating rate financing and the development of interest rate swaps which enable a marginal credit to stay in the market longer than would otherwise be the case."
 Sixth, overregulated financial markets face the danger of bureaucratic inertia which also has the potential to magnify economic and credit cycles. Bureaucratic dynamics being what they are, Dr. Kaufman pointed out, the natural tendency is to question new lending in areas where past loans have already encountered difficulty, while blessing rapidly growing areas of lending where economic conditions are presently favorable.
 Seventh, the regulatory response to new financial techniques and instruments tends to be desultory.
 Eighth, financial deregulation and innovation complicate the task not only of regulatory agencies but also of the monetary authorities. Stabilization through modifications in monetary policy becomes more difficult. From a cyclical perspective financial innovation that, on the face of it, would seem to be a neutral factor for monetary policy turns out to be a factor reducing the effectiveness of monetary policy through the cycle.
 Ninth, the present system of financial regulation is distinguished by overregulation of minor matters, especially at the level of the individual institution, and insufficient attention to weaknesses of potentially systemic importance.
 Tenth, the international dimension of financial institutions is growing and will be increasingly difficult to deal with effectively without greater global harmonization of regulatory, accounting, disclosure and trading standards and practices.
 -0- 10/27/92
 /CONTACT: Charles Brophy, 212-922-0900, for Dr. Kaufman/ CO: ST: IN: FIN SU: ECO

KD -- NY082 -- 5456 10/27/92 13:28 EST
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