Financial Stability Board: How it Works

What Is the Financial Stability Board (FSB)?

The FSB is an international body established to oversee and make recommendations for maintaining the health of the global financial system. The FSB will get much of the credit if that system remains relatively stable. However, should a crisis arrive, it will take the blame for not helping its member nations avoid what was coming.

Key Takeaways

• The FSB’s initiatives are meant to bolster financial stability worldwide.
• It promotes cooperation among 24 domestic finance authorities and global watchdogs.
• Partnering with global entities, such as the International Monetary Fund and World Bank, is part of its work to preserve financial stability.
• In recent years, the FSB has focused on the risks coming from digitalization, climate change, and changing interest rates.

Formed in April 2009 as the successor to the Financial Stability Forum, the FSB’s mandate was broadened over the former, given the crises of the period, which had the global financial system teetering near collapse. It monitors the global financial landscape, works to identify systemic vulnerabilities, and recommends ways to mitigate these risks. The FSB coordinates the efforts of 24 national financial authorities and international standard-setting bodies to coordinate regulations and react to challenges. The financial system is an area where success requires much cooperation, given how intertwined each part is with all others.

A pivotal aspect of the FSB’s role is developing regulatory and other financial policies with its members, including watchdogs from the major world economies and international organizations. Through its outreach and discussions with and among stakeholders, the FSB recommends ways to avoid the next financial crisis. Its initiatives cover a wide range of financial institutions and markets, including the nonbank financial intermediation sector, to address potential sources of systemic risk. It also works to make the global financial system more resilient.

History and Background of the Financial Stability Board (FSB)

The FSB was established in April 2009 in response to the global financial crisis of 2008. The crisis exposed the need for a more effective international organization to oversee and guide the global financial system since its predecessor, the Financial Stability Forum (formed a decade earlier), proved it wasn’t up to the task because of the events of 2008.

The financial crisis was a devastating global event that sent shock waves through the world’s economies. It began with the collapse of the U.S. housing market, fueled by risky lending practices and complex financial instruments. This triggered a cascading series of failures in major financial institutions, freezing credit markets and threatening a complete meltdown of the global financial system. The results were a severe worldwide economic recession, massive job losses, and the erosion of the income and savings billions needed to put food on the table and prepare for the future. It revealed the interconnectedness of the global financial system and the lack of coordination among international regulators caught flatfooted as the dominoes began to fall in 2008.

As a result of the efforts of the G20 group of finance ministers and central bank governors, the FSB was given an expanded mandate to identify and address systemic risks. The board was created out of necessity—major institutions would have challenged its broader scope and powers a few years before—and aimed at preventing future catastrophes by identifying major vulnerabilities, sparking global regulatory cooperation, and developing better standards for the financial sector.

Today, the organization serves as a forum for national monetary authorities, such as central banks and finance ministries, and international standard-setting bodies, like the Basel Committee on Banking Supervision, to collaborate on developing and implementing effective regulations, standards, and policies for the financial sector.

The FSB’s Responsibilities

The FSB is tasked with enhancing global financial stability by identifying and addressing systemic vulnerabilities within the financial system. It’s tasked with bolstering the strength of international financial markets by crafting and carrying out regulations, supervision, and other aspects of the financial sector.

Here are some of the major responsibilities assigned to the FSB:

• Monitoring and assessing vulnerabilities in the global financial system
• Promoting coordination and information exchange among authorities responsible for financial stability
• Advising on and monitoring best practices for meeting international regulations and standards
• Undertaking joint strategic reviews of the policy development work of international standard-setting bodies
• Setting guidelines for and supporting the establishment of supervisory bodies for systemically important cross-border financial institutions.
• Report annually on the enactment of the Basel III banking sector accords

In its role as a global coordinator, the FSB brings together national financial authorities and international standard-setting bodies to promote international financial stability. This has brought a greater focus to the need for standardized financial practices worldwide since a crisis in just one part of this global system can suddenly impact the livelihoods of people a world away.

Key Initiatives

The FSB acts like a global seismograph, feeling around for subtle tremors that could soon mean a massive financial earthquake like the 2008 crisis. But it’s also the seismologist who looks at the data and suggests new construction rules after running simulations on how specific areas and institutions can handle different forms of stress—or if they’ll quickly buckle with the slightest shift in the ground. Thus, it does more than try to predict coming disasters; it works with its partners to prevent small cracks in the financial system from becoming major chasms.

The FSB is best known for its work on behalf of the Basel III reforms. These measures aim to safeguard the banking sector and the broader economy from severe crises by improving regulations and standards and reducing systemic problems and incentives for large financial institutions that could cause them to put the wider economy at risk.

Here are more of the FSB’s major duties, divided by the work of its different parts, summarized in this table and detailed more below.

Identifying and Addressing Vulnerabilities: SCAV

The FSB’s Standing Committee on Assessment of Vulnerabilities (SCAV) focuses on identifying risks in the global financial system before they become crises.

SCAV receives data and reports from international financial institutions and securities regulators to analyze them and monitor for potential risks. The committee’s work highlights the potential for international spillovers across financial systems, which are often challenging to address in a domestic or regional context. Internally, SCAV debates and assesses the seriousness of different risks to the financial system, all to draw advice it gives the FSB and others on policy actions needed to address the risks it finds.

The Analytical Group on Vulnerabilities, a standing subcommittee that provides data research for analyzing new and evolving risks, supports the SCAV’s work. The SCAV also collaborates with the International Monetary Fund to conduct early warning exercises, which examine less likely but potentially systemically disruptive risks.

In recent years, SCAV has looked to clarify how regulators communicate with one another—not a minor problem if it means overlooking potential crises. This has meant getting financial institutions worldwide on board with a common terminology and taxonomy for discussing risks and vulnerabilities.

Developing International Standards and Policies: SRC

The FSB’s Standing Committee on Supervisory and Regulatory Cooperation (SRC) serves as the FSB’s “eyes and ears,” monitoring the financial landscape for emerging risks and systemic vulnerabilities. These include those stemming from new financial products, cross-border activities, and the nonbanking financial sector. The SRC also acts as a hub for international cooperation, bringing together regulators and policymakers for coordination. The SRC comprises senior representatives from FSB member countries and international standard-setting bodies like the Basel Committee on Banking Supervision.

Basel III wouldn’t exist without the FSB. Born out of the 2008 financial crisis, it aims to prevent a repeat disaster by demanding that banks hold more high-quality capital and “rainy day” funds while limiting the risky debt they take on.

Here are some of the main elements of Basel III:

1. Higher capital requirements: Banks must hold more and higher quality capital to absorb losses and reduce the risk of insolvency. This includes additional capital buffers during good times to draw on in periods of stress.
2. Leverage ratio: A non-risk-based leverage ratio to restrict the level of leverage banks can take on.
3. Liquidity standards: Basel III introduced liquidity coverage and net stable funding ratios to ensure banks have enough liquidity to withstand short-term and long-term stress.
4. Counterparty credit risk Includes measures to tackle outsized hazards from derivative transactions, including higher capital requirements for exposure to central counterparties.

Monitoring the Effects of Reforms: SCSI

The FSB’s Standing Committee on Standards Implementation (SCSI) keeps tabs on how new agreed-upon international financial standards and regulatory reforms are being put in place. Here are some of its activities:

Identifying inconsistencies: The committee reviews compliance while also analyzing differences in implementation among member nations to spot potential inconsistencies or loopholes that could undermine global stability.

Peer reviews: The SCSI conducts rigorous peer reviews to assess a country’s adherence to international standards. This involves in-depth analysis and feedback to promote continuous improvement. These reports on specific countries are publicly available on its website.

Reporting: The committee reports regularly to the FSB on the progress and challenges of member countries in how they are carrying out reforms. These reports help guide FSB policies and decisions.

Policy development: The SCSI also proposes policies and frameworks to boost global compliance with the FSB’s standards.

Future Challenges and Priorities

The global financial system faces challenges that include inflation and tightening financial conditions in many parts of the world. “The outlook for financial stability remains challenging,” Klaas Knot, chair of the FSB, said in February 2024. “Global economic growth, while modest, has been steady amid a swift transition to higher interest rates and in the face of geopolitical uncertainty.” While there have been signs that inflation was easing, he said, “caution is warranted.” He suggested that the problems of the international financial system’s need to be on guard against significant risks have not gone away. “The evolving landscape also highlights the financial system’s vulnerability to rapid shifts in the digital age and the pressures from high-interest rates meant to combat inflation,” Knot said.

The FSB’s medium-term goals include bolstering public-sector backstop funding, implementing better resolution options when policy disagreements arise, and examining the impact of social media and digital innovation. Another goal for the FSB is to improve the resilience of the non-bank financial intermediation sector. Knot said these are among its main goals in the mid-2020s:

1. Determine what went wrong during the March 2023 banking problems and find ways to prevent similar issues in the future. This includes examining how social media and digital technology affected the collapse of Silicon Valley Bank.
2. Ensure non-bank financial companies (like investment funds) are better prepared to handle financial risks and have enough money available if many want to withdraw their funds simultaneously.
3. Keep a close eye on how crypto assets, tokenization (turning assets into digital tokens), and artificial intelligence affect financial stability. The FSB will be publishing public reports on each of these.
4. Ensure its members follow the rules and guidelines for crypto assets and stablecoins (a crypto asset that keeps to a fixed value).
5. The FSB is also designing an incident reporting exchange to standardize information requirements and enable financial institutions to report events to many authorities more quickly.

Who Hosts the Financial Stability Board?

The Financial Stability Board is hosted by the Bank for International Settlements.

What Is the G20 and What Is Its Purpose?

The Group of 20, also called the G20, is a group of finance ministers and central bankers from 19 of the world’s largest economies, including those of many developing nations, and the European Union. It promotes economic cooperation among its member countries.

Who Is the Chair of the Financial Stability Board?

Klaas Knot, president of De Nederlandsche Bank, is the chair. This role calls on Knot to be the principal leader and representative of the FSB. He also sets the board’s agenda, presides over its meetings, and guides the FSB’s strategic direction. The chair is typically a senior official from a member institution and is appointed for a three-year term.

What Is the FSB Plenary?

The plenary is the Financial Stability Board’s main decision-making body, comprising senior representatives from each of its member institutions. It meets to set strategy and priorities for the board.

The Bottom Line

The FSB is a major actor in maintaining global financial stability. It steers international cooperation among financial authorities and standard setters to mitigate vulnerabilities and improve regulations over banks and other financial institutions. The FSB’s work encompasses a wide range of financial issues, including those related to systemically important financial institutions, shadow banking, new financial technologies, and the effects of regulatory reforms.

Read the original article on Investopedia.