A key report commissioned by the European Union wants more powerful financial supervisors _ both within Europe and globally _ to monitor the banking industry and avoid a repeat of the crisis that has derailed the global economy.
The report, published Wednesday and written by banking experts, will fuel debate on overhauling the financial system within the European Union. It will also likely lay the ground for talks at the London G-20 summit in April, where industrialized and developing nations will seek a way out of the financial turmoil.
French banker Jacques de Larosiere, the chairman of the expert group, said EU banking supervision was "seriously fragmented" and needed better risk management, more transparency and more coordinated oversight.
The Larosiere report says Europe should set up a new EU-wide supervisor to oversee risks and give early warnings, but that individual banks should continue to be looked after by strengthened national regulators.
It also calls for the International Monetary Fund to set up a global early warning system to flag problems _ and says countries should have to answer publicly when they fail to follow IMF advice on fixing them.
Banks doing business in poorly regulated states _ such as tax havens _ should have to put aside more capital if supervisors in those countries won't cooperate with others, it says. That could limit investment _ and possibly strangle _ financial services in such countries.
In Europe, the report says national banking supervisors need to have their powers boosted so that they can sanction banks that don't comply with rules. It calls for stronger coordination between EU supervisors and 'colleges' of supervisors to police each major crossborder bank.
Larosiere said it would have been "unrealistic" for one EU-wide supervisor to police banks, saying it "would not necessarily prove effective" and would not be accountable to taxpayers.
He also said it had "little prospect of being accepted" by EU nations. Britain has long opposed any EU agency patrolling its banking sector.
Instead the report foresees a European Systemic Risk Council to pool information on financial stability and issue risk warnings. That would be chaired by the European Central Bank president and would be fed information from all financial regulators in the 27-nation bloc.
On the global level, the report says so-called 'Basel' banking rules need to be changed urgently to tighten standards for risk and liquidity management. Capital requirements should be raised and banks urged to build up buffers against risks. Stricter rules should also cover off-balance sheet investment.
It demands that groups that issue securitized investments keep a portion on their books to keep them from reselling bad risks on to others. It also calls for simplifying and standardizing over-the-counter derivatives _ such as the credit default swaps that insure investors against a borrower's inability to repay a loan.
Regulation also needs to cover the 'shadow' banking system, such as private equity funds and hedge funds that do not report regularly on their dealings, the report says.
It also recommends overhauling the bonus system for traders, asset managers and executives to reward them over several years _ covering both good and bad times _ and reflecting actual performance instead of their outlook. It says supervisors should oversee a company's bonus scheme to check that it doesn't encourage excessive risk-taking.
Risk management within banks should always be independent, with risk managers holding a "very high rank in the company hierarchy" and companies relying on their own due diligence _ not that of external credit rating agencies _ before making investments.
The Larosiere report says regulators got it wrong before the financial crisis by paying too much attention to individual financial firms and not enough to trends sweeping the entire sector that sparked the turmoil.
Supervisors did not ask for information on how much debt was building up _ and when they did get it, they either didn't understand it or didn't share it with other EU nations or with the United States.
Even when problems started to surface, no action was taken and the few warnings that emerged "were feeble anyway," the report says.
It sharply criticizes the new forms of finance that fed a banking boom over the last twenty years. It says securitization _ the slicing up and repackaging of debt _ failed in its aim to spread risks evenly across the banking sector because no one knew if risks had actually been shared out.
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