A. The Mandate: Financial Modernization

1. Why is financial modernization important?
Financial modernization, through its interventions to improve the market outcomes of financial intermediation, makes the benefits of a strong and stable financial sector accessible to all its potential users, be they companies or households. In other terms, financial modernization distributes the dividends of financial stability to the population at large. It helps fulfill the promise of “finance for growth and equity”.

2. How does financial modernization relate to financial stability?

A 2006 speech by the European Central Bank Vice President explores at length the interface between financial stability and financial efficiency, recognizing their interrelationship and specific angles. An influential World Bank policy research paper published in 2006 argued to embrace financial efficiency considerations, pointing out that “the emerging policy issues in Latin America have much less to do with financial stability and convergence towards international standards and codes, and much more to with completing financial markets in small economies in the context of globalization”. Its conclusion was that “the dominant policy paradigm is ill-suited to provide guidance vis-a-vis the big emerging issues. We emphasize the need to take a fresh look at the evidence, improve the diagnoses, revisit expectations, and revise the paradigm”.

3. Why is financial modernization so challenging to pursue?

While pursuit of financial stability is facilitated by well-developed “standards and codes” prepared by the international financial regulatory community which focus on a small set of key prudential parameters, financial modernization embraces a very large range of potential interventions that make the interface between supply and demand of financial services smoother. It requires profound and detailed understanding of how markets work (and how they are likely to react to new regulations) and intense coordination among a plurality of stakeholders, including various line ministries and Parliaments, to identify the most appropriate policy intervention, to prepare a feasible recommendation and finally to enact market-building reforms.

Former Vice Chairman of the Federal Reserve Board Roger Ferguson argued in a March 2006 speech for “a middle ground in which markets are allowed to work and develop and in which policymakers work hard to understand new developments and to help market participants see the need for improvements where appropriate”.

B. The Instrument: A Public-Private Partnership

4. Why is a public-private partnership necessary for financial sector modernization? What are its risks and benefits?

Successfully tackling market frictions requires a detailed technical understanding that market participants are uniquely positioned to provide to authorities – hence the idea of a public-private partnership for financial modernization. But there is another important angle to the partnership: it is the matter of the sheer volume of market frictions that need to be fixed to improve market outcomes. Only through “safe” outsourcing of preliminary analytical and reform option identification to the private sector, can a usually overstretched public sector process the large number of regulatory and legislative changes that are necessary to make markets work better. The public-private partnership, therefore, helps also to deal with the issue of the “volume” of reforms – in addition to the issue of “quality” of reforms, if it is supported by an efficient Technical Secretariat, as experimented by the Convergence Program.

The risks of a public-private partnership are those, well-known, of capture on one hand and of lack of reform follow-through on the other hand. This only magnifies the importance of the “operator”, or Technical Secretariat, of the public-private partnership.

C. The Need for a Catalyst

5. What is the rationale for official institutions to catalyze public-private cooperation?

The President of the European Central Bank, Mr. Trichet, articulated the case for public sector catalytic intervention as one reacting to coordination difficulties by market participants: “Responsibility for promoting financial integration chiefly lies with financial institutions themselves which should exploit the framework promoted by public authorities. This is also dependent on the ability of the financial industry to coordinate its members effectively. We see the fostering of collective action on the part of the private sector to overcome possible coordination problems as a very important contribution by public authorities”. In many emerging and developing countries, coordination mechanisms within the private sector and between the latter and authorities have considerable room for improvement.

6. Why was the Convergence Program needed to catalyze financial modernization?

Two years of extensive discussions with both authorities and market participants in South-East Europe and careful assessment of local reform dynamics led to the overwhelming conclusion that country stakeholders did not have the coordination capabilities, analytical methodologies and enactment support discipline to inject energy into a sustainable financial modernization program – and that they sincerely wished they would acquire them.

7. Are there other examples of financial modernization catalysts?

As mentioned earlier, in the European Union the European Central Bank sees as part of its mandate to catalyze both private sector coordination and public-private cooperation to reap efficiency gains from the Single Financial Market. However, in other jurisdictions there is less clarity about relevance and feasibility of this role, even if potential benefits from fulfilling this function would be considerable. The Convergence Program represents therefore an innovative attempt to structure role and functions of a financial modernization catalyst for countries whose financial modernization opportunities are left significantly unattended because of coordination and cooperation failures.

8. Should SPI Platforms be promoted by the international community?

Prevailing institutional arrangements in many emerging, developing and transition countries make it difficult to pursue financial modernization in a systematic fashion and at a scale that is commensurate with its potential benefits for the economy. The case for a catalyst is overwhelming, as in the EU with the ECB. Whether the international public and business community plays a direct catalyst role or helps a local institution emerge as a catalyst depends on country circumstances, the fact remains that international expertise and funding support can deliver very large public gains in addressing the following challenges: a) To break public-private coordination and cooperation failure that hold back efforts to increase financial intermediation efficiency; b) To create a domestic institution with the single undivided goal of catalyzing financial modernization; c) To promote strengthening of local management and analytical capabilities.

D. Implementing the Public-Private Partnership

9. How can an SPI Platform be launched to support a public-private financial modernization partnership?

As in all new initiatives, an institution or a leader needs to come forward to articulate a vision, rally the partners around it and take principal responsibility for the implementation of a public-private partnership for financial sector modernization. In short there is no partnership without a catalyst. The catalyst of a public-private partnership for financial sector modernization could either a public institution, be it the Central Bank or the Ministry of Finance, or the Banking Association or even local civil society such as a think-tank. In case local conditions are not conducive to the complex dynamics of public-private cooperation and/or the potential catalysts perceive they lack the recognition and resources to play the catalyst function, an external player may be needed to play this role – most preferably on an interim basis. The Convergence Program has prepared an SPI Platform Toolkit to enable the European Banking Federation to assist its Associates in Eastern Europe become the champion of public-private dialogue.

10. A Technical Secretariat supports the activities of the public-private financial modernization partnership, organized around the SPI Platform concept. What is its basic philosophy?

The SPI Secretariat houses two fundamental capabilities: a) strong analytics to create consensus; and b) relentless enactment focus. Both are necessary to support the reform identification, preparation and enactment phases. The functions of the SPI Secretariat reflect the lessons learnt from analyzing the set-up of successful reform teams in several emerging market countries as compiled in a Note prepared by the World Bank in 2008. The Delivery and Reform Group created by UK Prime Minister Tony Blair is another interesting reference for a similar mandate in a reform-driven government.

The basic philosophy of the SPI Secretariat must be one of creating a uniform “problem-solving” methodology that the financial community can adopt to tackle the myriad of reform opportunities that will need to be undertaken overtime to improve the efficiency of the financial sector. Recognizing the difficulty to predict the direction, specific nature and number of future reform opportunities, it is vital that the SPI Secretariat develops scalable problem-solving methodologies that could be applied by many reform teams under limited supervision in unrelated sectors in pursuit of financial modernization goals. The EU Better Regulation, as implemented by the Convergence Program, is a good example of a methodology that supports large-scale reform efforts.

11. What are the economics of an SPI Platform? How much does it cost and what are its outputs?

Depending on country circumstances, an SPI Platform can be operated by a very small SPI Secretariat, consisting between two and four staff, also on part-time basis. Its activities can be calibrated so that its operating costs represent a very small fraction of the financial benefits that accrue to the economy (and market participants).

E. The SPI Platform Impact

12. How does the SPI Platform governance contribute to effective public-private cooperation?

Constitutionally, SPI Platform partners choose together the issues to be tackled and commit themselves to evidence-based dialogue and consensus-driven solution-searching. Practising a collaborative approach through transparency and integrity builds trust between public and private sector stakeholders and goes a long way towards creating public legitimacy in the public-private dialogue, as recommended by the OECD’s Principles for Transparency and Integrity in Lobbying. The outcomes are better regulatory production, less adversial relationship between regulated parties and regulators, and more efficient use of civil society expertise in activities that have a higher likelihood to influence policy actions.

13. How can an SPI Platform evolve overtime?

For the SPI Platform to be seen as the manifestation of a viable public-private partnership for financial modernization, it has to govern its activities with clear rules. It should be anchored in a local institution with a mandate that is compatible with the SPI Platform activities and namely the production of financial reform proposals conducted and executed under public-private governance. Typically this could be a think-tank or another not-for-profit institution. Also a banking association could house SPI Platform activities, provided they are conducted under a transparent and robust public-private governance framework. A good example is provided by Patti Chiari (“Clear Agreements”), Italy’s financial consumer protection initiative housed in the Italian Banking Association with strong independent governance.

14. Can an SPI Platform wither?

The fate of the SPI Platform is directly linked to the reform commitment of the local community. As programmatic and participatory approaches are powerful instruments to drive ambitious reform programs, the SPI Platform may weaken as a result of the authorities’ inability to translate SPI Platform outputs into timely legislative and regulatory initiatives. It may also weaken because of less energy injected in SPI Platform analytical activities. In some instances, this may be connected with resistance to adopting evidence-based solution searching methodologies. As mentioned earlier, the SPI Platform is a powerful instrument to inject transparency and integrity in policy dialogue activities.

F. Looking Forward

15. What are the prospects for the financial modernization agenda?

They are encouraging, by all means. For example, the Making Finance Work for Africa initiative calls for comprehensive financial sector policies at the country level coordinating and catalyzing financial development activities by Government, private sector players and donors. “Strategies should be based on trust between regulators, policy makers and the private sector, and public-private partnerships should be encouraged”. In this context, Nigeria is planning an ambitious Financial Sector Strategy 2020 initiative. Also Rwanda experimented a large public-private Financial Sector Development Strategy. After the crisis, financial modernization will become an even more compelling political necessity. Governments will need pro-actively to take measures to ensure that financial intermediaries support the needs of the real economy – while avoiding the imprudent behaviors of the past.

The Convergence Program prepared a Note, released in February 2009, which advocates tackling financial crisis response through the twin track of financial stability measures and financial modernization reforms. The latter are essential to attenuate the negative impact on growth of the former.

16. How will future financial modernization needs be met?

Much of the demand for financial modernization advisory services will be met by professional firms that, after developing public sector practices in addition to their private sector practices, will start exploring selling their advisory services at the intersection of both markets. For instance, Ernst and Young is already monitoring this market through its Donor Dynamics magazine. A December 2008 McKinsey Quarterly article also analyzed how executives should engage with regulators. Reputable institutions, such as the International Institute of Finance, have also embraced the discipline of a responsible attitude in public-private dialogue, informed by “Better Regulation” methodologies in this document.

In parallel, as donors realign their activities away from single projects to programs, strengthen their coordination to help countries implement their own strategies, and place greater importance on growth of local management and analytical capabilities, they will have stronger incentives to replace the present donor-based and –driven technical assistance delivery channels with new tools, more cost-efficient, more collaborative and with higher sustainable impact characteristics.

Very soon, demand for financial modernization assistance and supply of advisory services will inevitably converge around the areas explored by the pioneering Convergence Program. Whether the institutional arrangements which countries will choose carry the SPI Platform label or not, the World Bank and Italy’s Ministry of Economy and Finance will be entitled to cash a large moral dividend of their foresighted investment in how to tackle financial modernization.

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