In most parts of the world today (except perhaps in India, where optimism about the benefits of unregulated financial markets still seems to dominate over the undisputable evidence of their many fragilities) most policy makers talk about imposing regulations on the financial sector. Of course, the events of the past two years in the world economy, and particularly in the core capitalist countries, have brought this about, for it is quite a change from the earlier presumption of ''efficient markets'' that led to widespread lifting of controls and shift to ''self-regulation'' in the financial sector.

In the United States, President Obama recently unveiled a set of proposals to control and regulate the activities of both bank and non-bank financial players. In the UK, the Governor of the Bank of England has been talking about the need to break up banks that are ''too big to fail''. In many developed countries, public outrage generated by the economic destruction caused by finance is now being expressed as animosity against the large bonuses that are still being paid out to finance professionals.

The proposals that are now being considered, not only by the Obama administration in the US but also in Europe and elsewhere, include limits on the activities of particular types of institutions, trying to limit bank size and ensuring that derivatives trading occurs only in regulated exchanges with clearly specified margin requirements, rather than in over-the-counter (OTC) transactions that are completely unfettered.

These are all important and necessary changes. In fact, it is clear that without such changes, the economies of the core capitalist countries - and therefore the world economy - will continue to lurch from crisis to crisis, necessitating ever larger bailouts and leading to even greater damage to the citizenry. But the question is, are they feasible at all given the legally binding commitments made with respect to financial services liberalisation by the US and several other WTO members?

A relatively little known aspect of the General Agreement on Trade in Services (GATS) is the implication that this agreement - and various elements of it and a related Understanding signed by some members - affects the ability of countries to regulate financial services. While GATS is still the most flexible of the various Uruguay Round WTO agreements, in that it is based on a request-offer process in which individual countries can determine the extent and pace of liberalisation in particular sectors and modes, there are some important caveats.

It is true that, as for all other services, member countries are required to provide their own GATS schedules of financial services commitments. However, the Annex on Financial Services already makes some crucial limitations on countries' ability to be flexible on these commitments. The Annex applies to all WTO member countries, irrespective of the extent to which they have individually or collectively decided to make liberalisation commitments in financial services.

The section on domestic financial regulation in the Annex makes the following point: ''Notwithstanding any other provisions of the Agreement, a Member shall not be prevented from taking measures for prudential reasons, including for the protection of investors, depositors, policy holders or persons to whom a fiduciary duty is owed by a financial service supplier, or to ensure the integrity and stability of the financial system. Where such measures do not conform with the provisions of the Agreement, they shall not be used as a means of avoiding the Member's commitments or obligations under the Agreement'' [emphasis added].

So, if countries have already made commitments to allow certain kinds of financial activities of foreign financial institutions, they cannot impose any prudential regulations (even when they are necessary for the stability and viability of the system) if they run counter to such commitments! What this means is that much of the regulation now being considered or proposed in developed countries would run counter to this provision in the Annex to GATS. Any such regulation could be opposed by another member country whose financial firm is affected by such rules. Given the cross-border proliferation and complex entanglements of financial institutions, it seems to be almost inevitable that such challenges will occur.

It gets even worse. The organisation Public Citizen in the US, which has done a lot of work on the implications of the GATS on financial regulations (http://www.citizen.org/documents/PrudentialMeasuresReportFINAL.pdf) notes that the financial services liberalisation commitments that have already been made are apparently irreversible under various GATS rules. This makes new regulations that are required to deal with finance today next to impossible in strictly legal terms.

The GATS Market Access rules (contained in Article XVI(2) of the GATS text) prohibit government policies that limit the size or total number of financial service suppliers in ''covered sectors'', that is those in which liberalisation commitments have been made. So if countries have already committed to certain kinds of deregulation, they cannot easily undo them, even in relation to critical issues like bank size. Under the same rules, a country may not ban a highly risky financial service in a sector (i.e. banking, insurance, or other financial services) once it has been committed to meet GATS rules.

The case law on this matter is disturbing to say the least. A WTO tribunal has already established the precedent of this rule's strict application: the US Internet gambling ban - which prohibited both US and foreign gambling companies from offering online gambling to US consumers - was found to be a ''zero quota'' and thus violating GATS market access requirements. This ruling was made even though the US government pleaded that internet gambling did not exist when the original commitment was made, and therefore could not have been formally excluded from the commitment list!

For the 33 countries that have signed on to a further WTO ''Understanding on Commitments in Financial Services'' in 1999, the situation is even more extreme. These 33 countries include almost all the OECD members, as well as a few developing countries like Nigeria, Sri Lanka and Turkey. This Understanding established further deregulation commitments by specifying a ''top-down'' approach to financial liberalisation, which means that sector is by default fully covered by all of the agreement's obligations and constraints unless a county specifically schedules limits to them.

For the US, UK and the other 31 countries that have signed on to the Understanding, there is effectively a standstill on further financial regulation of any kind: ''Any conditions, limitations and qualifications to the commitments noted below shall be limited to existing non-conforming measures.'' And there is no possibility of any kind of ban on specific financial products that are deemed to be too risky like certain derivatives, etc. because the signatories to the Understanding have promised to ensure that foreign financial service suppliers are permitted ''to offer in its territory any new financial service.''

What all this means is that most of the new reform proposals for the financial sector in the US, the UK and other major capitalist countries, are effectively illegal given their GATS commitments. This has huge implications for other countries, since the extent of financial entanglement is such that all of us will be affected by the volatile functioning of unregulated financial markets. And since GATS rules tend to prevent any backtracking on liberalisation commitments that have been made, it means that developing countries like India need to be doubly careful before making any commitments.

While this situation may appear to be bizarre and even incredible, it is a real comment on the immense political and lobbying power of finance. Most of these specific financial agreements were signed without the knowledge of either the political groupings or the public at large in the countries concerned. For example, in the US, congressional process is required to vet international economic agreements, but this did not occur in the case of the Understanding on Financial Services.

Obviously, these GATS rules are now completely out of date and constitute a major constraint on necessary reforms in the financial sector. There are two possibilities in such a context. First is that such rules get more or less ignored and become a bit like the ''Maastricht rules'' for European economic integration, which tend to be more honoured in the breach, especially by large countries. The second is that the GATS itself - and specifically these provisions - gets renegotiated, eliminating all these provisions which demand and insist on comprehensive financial deregulation even when it is irrational and socially undesirable.

In either case, change is going to require political reconfiguration of the power of finance. At present, it looks like this will happen only with more extensive crisis - which unfortunately is also only too likely to occur.

February 8 , 2010.