Financial Reform - Making the Human Rights Case

27 January 2010

By Mary Dowell-Jones, Research Fellow at the Human Rights Law Centre, University of Nottingham

In announcing his financial reform proposals last week, US President Barack Obama pledged: “never again will the American taxpayer be held hostage by a bank that is too big to fail.

This commitment underlies his proposals for regulatory reform of Wall Street, including:

  • Limiting bank size;

  • Banning commercial banks from engaging in proprietary trading; and

  • Forbidding commercial banks from owning, investing in or sponsoring hedge funds or private equity.

Although positive steps, does the President’s plan address many of the wider and more fundamental problems that led to the credit crisis?

Preventing future massive build ups of risk right across the world’s financial structures must be a central objective of regulatory reform efforts both for financial stability and for the protection of human rights. Existing regulation facilitated the concentration of enormous levels of risk in the world’s financial architecture by allowing the financial industry, rating agencies and regulators to systematically underestimate and downplay it.

It is not clear at this stage that the President’s proposals will have much effect in tackling this problem. They may simply result in moving risk around. Proprietary trading - when banks trade their own money purely for profit rather than providing any type of service for clients - played only a minor role in the credit derivatives mania and massive build up of leverage and inter-locking credit-related exposures that made the system so vulnerable.

Though shifting proprietary trading from commercial banks to other actors may help protect depositors’ money from risky trading, it will make little difference in terms of the overall risk in the financial system. Limiting bank size may similarly merely shift risk to other players, rather than removing it from the system.

The fact is that we no longer face the problem of a few huge global banks that are too big to fail. The globally-integrated financial system itself is now too big to fail.

AIG was neither a commercial nor an investment bank, but was still bailed out with over $170 billion of taxpayers’ money because not doing so could have had wide-ranging consequences. The system has become so complex and overlapping that the risks of cascading failures once one major financial entity fails are too daunting to contemplate. This was clearly demonstrated by the consequences of Lehman’s failure. Should Wall Street ever face the brink of bankruptcy again, it is difficult to believe that the US Government would not step in to provide some type of support because neither the US economy nor the world can afford to see Wall Street fail.

Bank for International Settlements. But what principles and values are informing these and other efforts?

Numerous voices have highlighted how the ongoing economic crisis has had enormous implications for human rights worldwide. These voices have urged that greater attention be given to human rights obligations and standards, in particular to principles of accountability, transparency and concern for the most vulnerable, as part of regulatory reform efforts. But this assumes a conceptual bridge has been built between international human rights obligations that governments have freely accepted and the more technical aspects of financial regulation that profoundly influence the way the financial system behaves. Has such a bridge been built? The answer is no.

At this stage, the language of human rights obligations and responsibilities adds little to complex financial issues like the management of risk and capital adequacy. Yet its clear these issues have wide-ranging implications for human rights. An essential challenge for the human rights community is to build deeper understanding and specialised technical competency around these complex financial issues in order to more actively engage in policy debates on their implications for the poorest of the world’s people. In order to hold the financial system effectively to account, it is necessary for human rights activists not only to catalogue impacts, but also to contribute to detailed discussions on financial reforms.

"Protect, Respect, Remedy" [28 pages] framework put forward by UN Special Representative for Business and Human Rights, John Ruggie, can be realised.

It is not enough to call on States to carry out their obligation to protect human rights from abuse by companies that they regulate. There is also a need to determine how States and financial entities can best ensure human rights obligations and responsibilities are implemented in a workable way within the technical framework of the modern finance system.

Existing initiatives like the Principles for Responsible Investment, a project of the UN Environment Programme’s Finance Initiative (UNEP-FI), and other ventures like the Extractive Industry Transparency Initiative (which aims to root out corruption), and the Equator Principles (which deal with project finance) are important steps in engaging the financial sector directly on specific issues. But they are limited in scope and do not address many important issues such as capital adequacy, trading strategies, the use of leverage and risk management, all of which are fundamental to the workings of the international financial system and can potentially have wide-ranging impacts on individuals, communities and nations.

Putting the international financial system on a more economically and ethically sound path means we must tackle all of these challenges. Acknowledging the links between the regulatory architecture and human rights is only the first step in fixing the problem.

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