Press Release No. 10/376

Press Release: IMF Urges More Comprehensive Reform of the Global Financial System

October 3, 2010

Three years after the onset of the financial crisis, IMF analysis finds that there is much left to be done to build a global financial system that can provide a lasting foundation for stable and sustainable economic growth. While current reforms are moving in the right direction, the Fund’s latest Staff Position Note, “Shaping the New Financial System,” finds that many difficult decisions lie ahead―both at the national and international levels―which are both urgent and challenging.

While the crisis has provided the impetus for a major overhaul of the financial regulatory system, the IMF paper warns that “prompt progress by the international community is essential to reduce the likelihood and impact of another crisis, and to alleviate regulatory uncertainty.” Just as the international community came together at the start of the crisis, so there needs to be a global effort to design reforms that are “nationally relevant and internationally consistent.”

“No other financial crisis since the Great Depression has led to such widespread dislocation in financial markets, with such abrupt consequences for growth and unemployment, and such a rapid and sizeable internationally-coordinated public sector response. Behind this response was the acknowledgement that these costs have been imposed partly as a result of systemic weaknesses in the regulatory architecture and on the failure of supervisors to rein in excessive private sector risk taking.”

“Comprehensive reform, once agreed and implemented in full, will have far-reaching implications for the global financial system and the performance of the world economy.”

At this stage, policies need to address more than just the risks posed by individual banks, but also the risks from non-banks and the financial system as a whole. The recent proposals of the Basel Committee on Banking Supervision represent a substantial improvement in the quality and quantity of bank capital, but these tougher standards apply only to banks and not to nonbank financial institutions.

A fundamental principle underlying the analysis is that the private sector and the corrective influence of market discipline plays an important role: “It is not up to the regulators to ‘build’ the financial system, but to influence its direction by providing appropriate rules and incentives,” IMF experts emphasize.

The following five goals are identified by the IMF as key priorities in the reform agenda:

1) Ensure a level playing field in regulation. Global coordination is needed to promote the benefits of global finance; foster competition; and minimize regulatory arbitrage.

2) Improve the effectiveness of supervision. Stronger supervision is necessary if a new cycle of leveraging and excessive risk taking is to be prevented. Supervision needs to be more intensive and intrusive, as well as more focused on cross-border exposures.

3) Develop coherent resolution mechanisms at the national level and for cross-border financial institutions. Given the global reach of financial institutions, an enhanced cross-border resolution framework that eliminates moral hazard while preserving financial stability is needed. The first step is to focus on making this operational among a small set of countries that are home to most cross-border financial institutions, particularly to address the problem of “too important to fail.”

4) Establish a comprehensive macro prudential framework. Micro prudential regulations designed to improve the resilience of individual institutions must be complemented with effective macro prudential regulations that strengthen the resilience of the financial system. This will require indentifying, monitoring, and addressing systemic risks generated by individual firms and collective behavior.

5) Cast a wide net. Reforms must address emerging exposures and risks in the entire financial system, not just banks. There is a danger that riskier activities and products will migrate to less regulated or un-regulated segments of the system.

This IMF Staff Position Note is part of the Fund’s ongoing efforts to promote a global approach to regulatory reform, spot trends in the financial system that have important implications for policy, and to examine the interaction with macroeconomic policies for more effective measures in the future.

Governments should put in place supervisory and regulatory frameworks that deliver a safer and efficient global financial system. “Global regulatory reform should remain a top priority,” the staff note concludes.