Speech

Remarks by Rodrigo de Rato, Managing Director of the International Monetary Fund, To the Frankfurt European Banking Congress

November 18, 2005

1. Thank you for inviting me to speak today. It is a pleasure to be here in this distinguished company.

2. In recent years there have been fundamental changes in financial markets. Non-bank financial intermediaries have grown dramatically at the expense of banks. Institutional investors are playing an increasingly important role in capital markets. Financial market innovation and integration are proceeding rapidly. Indicators that were once reliable are becoming ambiguous: for example, Alan Greenspan has recently suggested that the slope of the yield curve is no longer a useful gauge of the U.S. economy. And huge transfers of risk are taking place, not only between countries but also from financial institutions to other sectors. Substantial financial risk now lies with the household sector, to the extent that the household sector has become "the shock absorber of last resort." All of these developments have profound effects on modern economies.

3. The theme of this panel is shared responsibilities for financial sector stability. I would like to talk about the impact of the changes I've described, and also of globalization more generally, on the responsibilities of the private sector, of governments and of international financial institutions in promoting and protecting global financial stability. I should also emphasize that financial stability is not just important in itself, but because financial instability can have significant and adverse effects on the real economy. This is one reason why I am encouraging the IMF to deepen its knowledge of and engagement in financial sector issues. Globalization of financial markets has great potential benefits for economies, but also considerable challenges, and the IMF needs to be able to give its members good advice on how to maximize those benefits and minimize those risks.

4. The public sector, in which I include governments, central banks, financial sector supervisors and international financial institutions, have responsibilities in at least three areas. First, they must promote macroeconomic stability, at both the national and at the global level. Second, the public sector has to provide a supervisory and regulatory framework that is conducive to well-functioning and stable financial markets. Third—and this is perhaps the most difficult task—the public sector must understand the constantly changing world of international financial flows, be alert to possible sources of instability, and act appropriately to confront them. Let me take each of these responsibilities in turn.

5. At the national level, the responsibilities of governments and central banks for macroeconomic stability are clear. Governments must set fiscal policy in a responsible way. Central banks should keep inflation down, and should be predictable and consistent in their monetary management. And recently central banks all over the world have been doing a good job at this, growing in both independence and skill in combating inflation. But as monetary authorities focus on holding down inflationary expectations, it is particularly important that they give clear signals of their intentions, to avoid unnecessary volatility in financial markets.

6. At the global level, responsibilities are less clear, and too often governments point fingers at other countries to justify inaction in their own. As a result, while some tentative steps have been taken, much more needs to be done. This is of concern, because global imbalances have grown large, and there is a real risk of a disorderly adjustment to them. But there is also a large pay-off from action, and all of the actions that are necessary are in the interests of the countries that need to take them as well as in the broader international interest. Fiscal adjustment in the United States would make an important contribution to reducing global imbalances and would leave the U.S. fiscal system better placed to cope with the pressures of an aging population. European governments can promote better growth performance in their own economies and sustainable global growth by reducing the rigidities prevailing in labor, product and service markets. This would also improve their economies' resiliency to shocks, including a sudden unwinding of imbalances. In emerging Asia, there is scope for greater exchange rate flexibility and increased domestic demand. The recent moves by China and Malaysia toward greater exchange rate flexibility are welcome, and I hope the authorities will use the flexibility afforded by their new arrangements, and that other countries in Asia that have been allowing more flexibility in their exchange rates will continue to do so.

7. Obviously the IMF has an important role in advising our members on this, through our surveillance of individual countries' economies and our work on the global economy. In order to make our surveillance work more effective, we are taking steps to sharpen the focus of our policy advice, including by deepening our coverage of financial sector issues in Article IV Consultations. We also plan to enhance our monitoring of emerging market economies' vulnerability to crises and consider again the possible role of Fund financing commitments in crisis prevention. Our aim is to help all of our members deal with the most pressing issues of macroeconomic stability and the challenges of globalization.

8. The public sector's responsibilities for the supervisory and regulatory framework are well-understood, but in carrying out these responsibilities governments and central banks need to adapt as financial markets evolve. For example, as asset management companies, including hedge funds, grow further in significance, governments will need to go beyond banking and insurance regulation, and address new issues of transparency and disclosure and problems of conflict of interest. Regulators and supervisors also have to remain alert to contagion effects. The IMF has an role to play in advising on supervisory and regulatory frameworks, including through the Financial Sector Assessment Program. The FSAP has now become such an established and valued feature of the work of the IMF and World Bank that it's easy to forget that it seemed quite radical when it was first started. I am very pleased that so many countries—especially here in Europe—have now undertaken the FSAP. We will continue to refine the FSAP process to further enhance its usefulness to our members.

9. Monitoring the global financial system is perhaps the most difficult task for governments and for the IMF. But it essential that we understand the global asset allocation process and be able to detect potential problems that could lead to financial crises. Policy makers need to be able to assess the likelihood of abrupt changes in capital flows that might undermine the financing of payments imbalances or the stability of emerging market economies. And international organizations should try to develop radar screens that can show policy makers upcoming problems before they are imminent. I would like the Fund to step up its work in this area. In particular we need to integrate our work on financial markets more closely with our economic advice to individual countries. We also need to draw on knowledge gained through country surveillance and interactions with policy makers and market participants, including professionals like yourselves, to help us form a global view of financial market developments.

10. Let me turn now to the responsibilities of the private sector. These include sound risks management practices, due diligence, and professional credit and risk analysis. I would also highlight the importance of corporate governance, including checks and balances within institutions, not only in the banking sector, but also in the asset management sector.

11. This leads me to an area where governments and the private sector have a shared responsibility. As Pay-As-You-Go systems diminish in importance, defined benefit pension plans become rarer, and diversification becomes essential for individual savers as well as companies, so an education on financial markets, especially on the trade-off between risk and reward, becomes more important. But this education is not only the responsibility of governments. If they are wise, private companies will recognize that they also have a responsibility to educate their clients. If they do not, then losses are likely to be greeted not just with disappointment but with anger, which will inevitably translate into pressure for public intervention. There is a long history, in both the banking sector and more recently in the area of accounting standards of events that cause losses to the public triggering intervention by legislatures, and this might be of a form quite unwelcome to the private financial sector. Transparency, consumer education, and sound corporate governance are all in the interests of financial sector businesses as well as their consumers.

12. I want to end on an optimistic note, because I see a number of very positive developments in financial markets. I see strong efforts to improve risk management. I see increased efforts to transfer knowledge and strengthen corporate governance in the financial sector. I see welcome concerted efforts by the private and public sector to head off crises. And I see much promise in meetings like this one: in free exchanges of views between the public sector and private sector practitioners. Understanding of problems and consensus on action begins with such exchanges. So once again I am very pleased to be here, and I look forward to hearing your views.

13. Thank you very much.