Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
IMF Survey: Global Rules Make Financial System Safer to Sustain Growth
October 14, 2010
- Policymakers must address institutions "Too Complex to Fail"
- Cross-border solution for failed banks key issue
- Financial innovation should serve society overall
New rules to strengthen the global financial system are one way to boost economic growth in a fragile economic recovery, but how far regulation should go is still under debate.
Top officials and guests gathered in Washington to debate the hot topics of the day during the World Bank-IMF Annual Meetings (photo: IMF)
IMF Annual Meetings
As experts convened for seminars on the sidelines of the IMF and World Bank Annual Meetings, top practitioners and officials disagreed about the need for more or less regulation in the financial sector during the discussion on navigating the road ahead hosted by the IMF as part of its Program of Seminars in Washington, D.C. on October 9.
“The final objective is a financial system that will finance strong and sustained growth, but now I think the danger may be under regulation,” said José Viñals, the IMF’s financial counselor and director of the Monetary and Capital Markets Department.
Viñals said there is a lot to do be done on the regulatory front, since the new global rules on capital and liquidity, known as Basel III, will apply to traditional banks and not other types of financial institutions.
The Program of Seminars provides a forum during the Annual Meetings for the private sector, government officials, civil society, and staff from the IMF and World Bank to find solutions to the most pressing issues facing the global economy.
Raj Singh, chief risk officer for global insurance giant Swiss Re said there was a concern about over regulation, with implementation measures becoming more onerous and complex.
“The good news is we’re seeing pushing back and telling regulators maybe you’ve gone too far,” he said.
Regulatory reform
The need for regulatory reform received top billing in another seminar to identify structural reforms needed to boost growth and jobs. Sharan Burrow, general secretary of the International Trade Union Confederation, expressed frustration at the lack of “concrete proposals, except in the U.S.” to address a financial system which she viewed as being “too deregulated.”
Financial sector reform is the top priority for the advanced economies, according to IMF chief economist Olivier Blanchard, who was also a panelist at the structural reform seminar.
The key is finding the right balance so that regulation does not interfere with sustained growth.
Last week, the IMF said the financial sector remained the “Achilles’ heel” of the global recovery in its latest Global Financial Stability Report.
Too complex to fail the real issue
Since late 2009, the IMF has said the focus should be on whether a firm is too important or complex to fail, and its size—as well as its connections to other firms worldwide—are the conduits through which risks can be transmitted at lightning speed around the world.
The collapse of Lehman Brothers in September 2008 and the ensuing global economic crisis laid bare the previously unrecognized potential for one firm’s failure to cause devastating effects to both global financial stability and the world economy.
In order to tackle the challenges of financial institutions that are too-important-to-fail, policymakers must also strengthen the financial infrastructure and figure out how to resolve the failure of cross-border banks and other financial institutions with a global reach.
“If we don’t have cross-border resolution, we will never solve too-important-to-fail,” said Viñals.
Part of the solution is to move contracts that are traded off financial exchanges, known as over the counter derivatives, which are subject to domino like effects in the event of a financial crisis, when uncertainty forces banks and investors to call in their positions.
The solution is to move derivatives that can be standardized to Central Counter Parties (CCPs), which themselves may become too-complex-to-fail. Viñals said there is merit in central counter parties having access to central bank liquidity.
Need for stronger supervision
Supervision of financial rules is often overlooked in the debate, and Tan Sri Dato Zeti Akhtar Aziz, Governor of Bank Negara in Malaysia, favors a macro-prudential approach to financial stability and strong supervision to complement the regulations.
Randall Kroszner, a professor at the University of Chicago Business School and former member of the board of governors of the U.S. central bank, said there are strong incentives within the financial system to try and get around the regulations put in place.
“Fixing problems in financial systems is harder than in engineering systems, and a better analogy is probably warfare,” said Richard Bookstaber, a staff member of the SEC and former risk manager for JP Morgan. “When a valve in a nuclear power plant breaks, you replace it and the problem is fixed; but in a financial system markets try to find loopholes in regulation to exploit much as an enemy might probe for weaknesses in your defenses.”
Greece’s Finance Minister George Papaconstantinou (Photo: IMF)
Strong supervision and new regulations require political will, and earlier in the day, during the televised BBC Global Debate, Greece’s Finance Minister George Papaconstantinou said he thought “we’ve lost our nerve on this.”
The ultimate cost of the bailouts to the financial system has been borne by taxpayers around the world, and Vitor Constȃncio, vice president of the European Central Bank reminded the panel on The Financial Sector: Navigating the Road Ahead of the limits to taxpayers’ patience.
“Our democracies cannot really sustain the same sort of demand from public money to be put at risk as a response to a financial crisis,” he said.