Governance of the Financial Services Industry

Governance of the Financial Services Industry

Introduction

Financial services occupy a uniquely powerful position in all monetized economies. Firms and individuals engaged in financial services are responsible for allocating a society's resources to the most economically profitable activities. Because judgments of profitability may (and often do) clash with government policy priorities or broad social norms, domestic financial services are highly regulated in almost all jurisdictions. The recent expansion of financial services firms to achieve near-global scale has been accompanied by multilateral efforts to regulate them. In many respects, the financial services industries are at the leading edge of both contemporary processes of globalization and the emerging principles of global governance.

Normative Regulation of Financial Services

Financial services have been regulated as long as there have been formal commercial codes. A section of Hammurabi's Code (c. 1700 BCE) was apparently dedicated to the regulation and documentation of commercial lending (though only a fragment, paragraph 100, has survived). The Laws of Manu (c. 1500 BCE) specify allowable rates of interest and are sophisticated enough to allow the rollover of debts that cannot be paid in full while specifically prohibiting the capitalization of accrued interest, which must be paid before the rollover can be completed (chap. VIII). Table III of Rome's Twelve Tables (451-450 BCE) details procedures for keeping collateral, maximum rates of interest and a thirty-day grace period for repayment.

Religious regulation has long complemented or supplanted civil regulation of financial services. Medieval Catholic prohibitions against usury retarded the development of financial services in Europe. Major medieval commercial centers had municipal banks to provide weight verification and safe storage for gold and silver coins, but held deposits for safekeeping, rather than to make loans. Municipalities and churches also participated in official pawnbroking to provide for emergency financial needs. By the beginning of the Renaissance, moneylending families such as the Medici and Fuggers had learned to circumvent medieval rules on usury by disguising loans as bills of exchange, embedding interest payments in the exchange rates used to convert currencies. Although moneylending in contravention of religious prohibitions of usury was common in much of Europe by the seventeenth century, modern fractional reserve banking did not emerge until the foundation of the Bank of Scotland in 1695.

Religious norms in many majority-Muslim countries today continue to retard financial development. Muslim shari'a law typically prohibits lending at interest, but not financial participation in business investment. Thus, in shari'a-compliant commercial lending, banks take equity stakes in the success or failure of the businesses to which they lend. Shari'acompliant mortgage loans are structured as lease-toown agreements: the lender legally buys the house and then rents it to the borrower. The borrower gradually pays the lender the purchase price of the house; when the original purchase price is fully paid, legal ownership is transferred. A major emerging area in the asset management industry is the provision of shari'acompliant investment funds, which make unleveraged equity investments in firms that do not engage in activities that shari'a law ...