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Was the creation of the Financial Stability Board last year a bloodless coup by the world’s central bankers? A repeal of the US Declaration of Independence?

Extreme theories have been provoked by a body with just 20 staff. The FSB, set up in April 2009 by the world’s top 20 economies in response to the financial crisis, already wields significant influence. In its first year, its small, unelected group of officials, little known outside financial markets, has wielded tremendous power in reshaping how banks work. US Treasury Secretary Timothy Geithner describes it as “in effect, a fourth pillar of the architecture” of international cooperation alongside the IMF, the World Bank, and the WTO.

It’s still a work in progress. The FSB’s broad license to roam across long-established regulatory fiefdoms has sparked inevitable power struggles with other regulators. Emerging states in Asia could clash with older forces, Europe and the United States. It’s not even clear that the FSB will have the backing to push reforms through in the future. So far, it doesn’t even have its own budget or office, let alone any binding powers.

Despite all that, its reach is remarkable. “The FSB is now like a roof over all the global standard setters,” a European member of the FSB says.

Officially, the FSB’s role is to keep an eye on potential weaknesses in the financial system, and to encourage the world’s regulatory bodies to share information about how they address those problems.

One early achievement has been to speed up agreement on tough new rules about the amount of capital that banks must hold. Basel III, as the rules are known, will force some banks to raise extra capital in the markets as a buffer against the kind of liabilities the crisis has foisted on taxpayers.

Unveiled in a draft version in December and set to be formally approved by G-20 leaders gathering in Seoul later this week, the new rules replace an accord known as Basel II, which took a decade of haggling.

“Without the apparatus of the FSB, the Basel reform would never have gone through at the speed it has,” says David Green, a former Bank of England and Financial Services Authority official.

But the FSB has its sights set on much, much more. Its charter says it can undertake “any other task agreed by its members in the course of its activities and within the framework of its charter.” Though it was set up by, and continues to be beholden to the G-20 group of countries, the FSB has a degree of independence.

How does it work? The official at the head of the FSB is a European central banker: Mario Draghi, the 63-year old head of the Bank of Italy. A former vice president at Goldman Sachs, Draghi’s a banker through and through. He chairs quarterly meetings of G-20 central bankers, financial supervisors and treasury officials. Countries can send ministry representatives but not politicians. The idea is that while the FSB’s main actions may be directed by politics, the rules of the global financial system should be above them.

As well as pushing along Basel III, the FSB has started working on a list of “systemically important financial institutions” or SIFIs — the 30 or so biggest banks in the world whose failure could destabilize the broader financial system. It hopes to force even tougher capital requirements on those institutions deemed “too big to fail.” It’s also devised global principles to rein in excessive banker pay.

The FSB has also set out ideas for ways to account for the risks inherent in derivatives positions: The trades which nearly blew up the likes of US insurer AIG and are typically carried out on a bank-to-bank basis, so they can remain hidden from regulators. It has made recommendations to reduce markets’ blind reliance on the credit rating agencies, which were blamed in the subprime crisis for stamping AAA on products that were cocktails of toxic debt.

It’s also examining ways to coordinate the supervision of financial institutions internationally — so banks can’t arbitrage the rules between countries. It’s working on handling the risk of collapse by a globalized bank affecting economies of countries where it has subsidiaries.

And, perhaps most ambitiously of all, it’s examining ways to prevent risk-taking players from evading regulation by presenting themselves as being active in some other segment of the financial services sector — a problem known as “shadow banking.”

Success in even one or two of these areas would be a revolution in global finance, but many obstacles remain. For one, the FSB has an incredibly diverse membership. Built on its predecessor, the Financial Stability Forum, a loose-knit group of officials from the world’s seven leading economies, the FSB also includes Brazil, Russia, India and China.

The FSB represents over 80 percent of the world’s financial activities, which gives its new rules a better chance of global success. But its powers are actually limited: It can make recommendations, but these must be endorsed by the G-20. It cannot approve rules that are binding on G-20 countries, and instead relies on “peer reviews” that “name and shame” laggards who don’t implement them. Regulators say that even though this process hints at the FSB’s weaknesses, it amounts to something of a revolution in financial regulation. “It can’t roll out the tanks across the lawn. It works on peer pressure,” says one European regulator.

Some officials have complained that the FSB’s political masters in the G-20 will curtail its independence, enabling it to be hijacked to serve the interests of the G-20’s most influential states. But people close to the FSB say that countries such as China and Brazil are increasingly powerful. “The idea that India, China and the other emerging markets are going to accept everything the Western world dreams up is finished,” a European official with knowledge of the FSB says.

One Asian regulator says the United States and the European Union are still the main shapers of new rules — for now. “What the Asian countries now have is a veto say. The newer entrants are not shaping the rules until they find something they don’t like and just block it,” the Asia-based regulator said, referring to China’s move early on in the crisis to stop richer countries from publishing a blacklist of tax jurisdictions that won’t share information on tax dodgers.

Another problem is that the FSB is in a race. Past crises have often been followed by a frenzy of rule-making activity. Over time, though, momentum can slow down. “The FSB is a work in progress but it’s not entirely clear a work in progress to what,” says Nicolas Veron of Brussels-based research organization Bruegel.

Agreeing on Basel III in such a short time was a major feat, but it will be harder to secure global agreement on steps to make safe the world’s “too big to fail” financial institutions.

The Seoul summit was at one stage meant to agree on a package of measures to beef up Basel III for the SIFIs, but has failed to get beyond broad principles. There is no consensus on whether such big lenders should face capital surcharges, because emerging markets say their banks don’t need extra safeguards.

The FSB’s independence from its political masters will be tested next year, when it may publish names of countries that won’t cooperate in sharing supervisory information according to standards set by the IMF and IOSCO. If it pushes ahead with that plan, the move would extend the FSB’s influence to more than 100 countries, including offshore havens. Some G-20 countries will also be on the “blacklist” unless they change their ways in time.

The FSB’s fate will also hinge on keeping US backing for the broader G-20 process, whose summits provide detailed conclusions that map out its work and lend it authority. A G-20 process mired in spats between China and the United States over currencies, coupled with Congressional gridlock in the wake of US midterm elections, could leave the FSB sidelined once its current work winds down, regulators say.

If that happens, what once seemed to some Americans like a threat to democracy would boil down to little more than a political PR stunt, leaving taxpayers the world over exposed to the risks run by the banks to which they entrust their wages.

 
Huw Jones covers European regulatory issues and global rulemaking bodies for Reuters.