Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
IMF Survey: IMF Engages Middle East Policymakers on Financial Reform
July 16, 2010
- New financial regulations will need to be internationally consistent
- Strong supervision must be intrusive
- Reform should take into account the region’s vulnerability to commodity cycles
There should be stronger cooperation among supervisory authorities throughout the Middle East and Central Asia region, the IMF said at a high-level seminar on financial sector regulatory reform in Beirut.
Oil company worker in Kazakhstan, a country in the region that experienced banking sector difficulties during the crisis (photo: Oleg Nikishin/Getty Images)
FINANCIAL SECTOR REFORM
“If you look at what went wrong in the advanced economies, it is that consolidated supervision failed and there was not enough cooperation between the supervisors of different countries where the banks operated,” José Viñals, Financial Counsellor and Director of the Monetary and Capital Markets Department at the IMF, said at a press conference following the July 12 event.
Fostering greater cooperation and better communication among financial sector supervisory authorities—within a country and cross-border—in good times is crucial, he said, because that can help stop problems from developing during bad times.
The conference “Reshaping International Financial Regulation—Implications for the Middle East and Central Asia Region” brought together senior policymakers from the region and representatives from international financial institutions. The meeting generated a lively discussion on the region’s experience during the crisis and on lessons that could inform the financial sector regulatory reforms currently under consideration by the Group of Twenty (G-20) industrial and emerging market countries.
Crisis impact contained
Banks in the Middle East were less affected by the crisis than their counterparts in advanced economies: they were more focused on traditional lending and savings and generally less integrated into global financial markets, so contagion was lower. Many of the region’s governments also enacted prompt and forceful policies, which helped contain the impact of the crisis.
“This region has a long history of banking, and banks are doing relatively well,” said Adnan Mazarei, Assistant Director of the IMF’s Middle East and Central Asia Department.
But the crisis has brought to light some old shortcomings, including excessive dependence by banks on name lending (a regional practice whereby loans are extended to influential business families on the basis of their name) and inadequate supervisory powers to take early remedial action. Addressing these problems requires improved regulation, but also hard-nosed supervision, Mazarei noted.
At the seminar, participants discussed several global regulatory initiatives currently under way, some of which are especially relevant to the Middle East and Central Asia region:
• Reducing cyclicality in financial markets. This reform is particularly relevant for Middle Eastern financial sectors that are vulnerable to swings in oil prices and capital inflows. In these countries, financing exuberant demand for real estate and equity during the 2003-08 oil price boom created vulnerabilities. The subsequent sharp decline in asset prices resulted in large losses for many banks and possibly excessive caution in extending credit even for potentially sound projects. While good macroeconomic policies—such as using counter-cyclical fiscal policies—should be the first line of defense, the prudential policies being considered in the global debate could help commodity exporters and others exposed to capital flows. These tools, such as capital, liquidity, and provisioning requirements, could be used to encourage financial institutions to build buffers in good times to be drawn down in bad times.
• Establishing stronger liquidity standards. It is crucial to ensure that financial institutions build adequate liquidity buffers. Many emerging markets have seen episodes of rapid credit growth not matched by rising stable retail funding. Banks turned to foreign funding sources, and several systems were hit hard when these were not rolled over. Financial institutions thus need to build adequate liquidity management systems and buffers.
• Strengthening supervision of systemically important financial institutions. A few countries in the region host banks that appear large relative to the ability of authorities to provide support. The crisis has brought to light the risks posed by systemically important financial institutions in advanced economies, and global regulators are debating ways to counteract these risks. Options include imposing a capital surcharge, demerging riskier activities, or developing “funeral plans,” whereby a bank continuously satisfies its regulators that any failing part can be separated from the parent structure and resolved in an orderly fashion.
• Improving bank resolution frameworks. One important step would be to implement a more comprehensive legal framework that is dedicated to government intervention in financial institutions and provides for speedy restructuring options, both locally and across borders.
Swift action needed
Many of these reforms were discussed in the IMF’s latest update to its Global Financial Stability Report, released July 8 in Hong Kong SAR. The report cited the need for countries to augment their macroeconomic and prudential policies to reduce their vulnerability to a sudden stop or an excessive buildup of credit or asset prices, ensure that banks have adequate capital buffers, and resolve uncertainty about the risk exposure of banks.
The report also calls for financial regulatory reform efforts to move more quickly, as uncertainty surrounding a final set of reforms is making it difficult for banks to take business decisions and constraining their willingness to lend.