Speech

Remarks by Rodrigo de Rato, Managing Director of the International Monetary Fund, on his Acceptance of the Club Financiero Génova Award

March 30, 2007

As Prepared for Delivery

1. Thank you very much. I am honored that you have chosen me to receive this award. And thank you for those very kind words.

2. Let me take advantage of this occasion to share my perspective on the global economy and on financial markets. I have the opportunity to lead the International Monetary Fund at a time when the world is changing in important ways and the Fund must adapt to these changes. Over the past 18 months we have been developing and implementing a new Medium-Term Strategy for the International Monetary Fund, with the aim of helping our members address the challenges of 21st century globalization.

• We are strengthening the foundations of Fund surveillance—our monitoring of the global economy and our discussions on the economies of individual Fund members. This is the core business of the Fund and a unique service we provide for all our members.

• We are assessing whether our tools for crisis prevention and response are the right ones.

• We are making changes in the way we work on low-income countries, to sharpen our focus on areas where we can make the greatest contribution to helping low-income countries make progress toward meeting the Millennium Development Goals.

• We are updating the Fund's governance structure, with the aim of increasing the representation of countries whose economic weight has increased in recent years, while also protecting the voice and representation of low-income countries.

• And we are making changes in the way the Fund operates, streamlining our work and reducing our expenditure in real terms, and are considering changes to our income model, to make sure that the Fund has the resources to carry out our mandate.

3. All of these changes are needed to make sure that the Fund continues to be relevant and that we provide the best services we can for our members. They are needed because the world is changing vary rapidly, and in many ways. I'd like to talk today in more detail about one aspect of these changes that is taking place in the financial markets. This is the transfer of financial risks from financial institutions to a broad base of individuals. Of course, there is a sense in which individuals have always been at risk, since as citizens and members of society their fortunes rise and fall with the economy. But individuals are increasingly taking on financial risks much more directly. There are several ways in which this is happening.

• First, borrowing by individuals and families is much higher than in the past, and their obligations to service this borrowing have grown correspondingly, as a share of income.

• Second, the role of banks has changed. Many banks no longer hold the bulk of the risk on the loans they make. Instead, banks transfer and diversify credit risks to other banks, insurance companies, mutual funds and hedge funds. This trend has been facilitated by the rapid growth of securitization of assets of all kinds: from mortgages to credit card loans, from corporate loans to aircraft leases.

• Third, the role of the financial intermediaries that are taking on the credit risk has changed. Where insurance companies and pension funds once held the risks themselves, the rise of non-guaranteed insurance savings products and the decline of defined benefit pension plans mean that individuals and households are becoming the ultimate holders of risk in the system in a much more direct way than in the past.

Each of these developments carries both benefits and risks. Let me take each in turn.

4. The broadening of credit brings with it opportunities that reach many more people than in the past, for example opportunities to finance a house or to develop a business. The downside is that people sometimes take on too much debt. We are seeing the effects of this in the United States at the moment in the distress of financial markets arising from the troubles in the sub-prime mortgage sector. And this distress has its counterpart in hundreds of thousands of stories of individual distress felt by overstretched borrowers. But the problem is not confined to the United States. The introduction of new and more complex financial products around the world suggests there is a need for regulators to look closely at lenders' underwriting standards and for borrowers to educate themselves in the risks that they are taking.

5. Turning to the position of savers, the changing role of banks results in corresponding changes to the risks that other institutions and individuals face. The growth of credit risk transfer instruments, and the structured credit products that go along with them, has allowed banks to make loans and then transfer and diversify the associated credit risk to other institutions. Loan securitization—the issuance of securities backed by loans—has similar effects on the transfer of risk.

6. Both of these developments can be seen as enhancing financial stability, since they serve to disperse risks to a more diverse set of investors such as bondholders, pension funds, life insurers, and hedge funds. But there are also other consequences. For example, we do not know how vulnerable the credit risk transfer or securitized loan markets are to a potential loss of liquidity if the credit cycle turns down sharply and defaults become more common. There may also be an increased risk of spillovers between markets.

7. Risks are also being transferred from insurers and pension funds to individuals and families. For example, the shift from defined benefit to defined contribution pension plans has placed more direct responsibility on households to manage investment portfolios and related risks. Such schemes allow individuals to build portfolios that better fit their needs and capacity to bear risks, but individuals must also absorb market and other risks, especially longevity risk, more directly.

8. One implication of the shift in the location of risk is that regulators and supervisors need to take the new reality and the new vulnerability of savers into account. Another implication is that individuals and families need to take more responsibility for managing financial risks themselves. Therefore, they need to be educated consumers of financial information. Evidence from all around the world suggests that this is not happening at the moment. Let me give a few examples:

• Only 30 percent of those surveyed in the United Kingdom can correctly calculate simple interest rates, and only 44 percent reported a basic knowledge of pensions in 2004;

• 47 percent of workers in the United States who have no savings still report themselves confident that they will have enough for retirement.

• A majority of French households consider themselves to be ill-equipped to choose an investment strategy;

• 65 percent of Dutch households are unable to provide any estimate of their pension income on retirement;

9. Leadership is needed from governments, the private sector, and regulatory authorities to remedy this situation. Governments can encourage the teaching of financial literacy in schools and provide counseling services, especially for low-income groups. They can also promote better default options in pension schemes, such as automatic enrollment in life-cycle investment plans, rather than money market accounts. This would give people a simple and reasonably conservative option for saving for retirement, while giving people who want to save at different rates or take more risks the option of doing so. The private sector can provide more targeted products with transparent fee structures. And, as neutral—and hopefully trusted—sources of advice on financial matters, regulatory authorities can coordinate the efforts of other parties and can publicize the best sources of advice on financial planning.

10. The International Monetary Fund also has a role to play, especially in identifying and assessing global and cross-border financial risks, which is another aspect of financial education. To meet this challenge, we are intensifying our efforts to integrate our financial sector work, including on capital and financial markets, into our economic analysis. In our monitoring of individual countries' economies, we are enhancing the analysis of financial sector vulnerabilities and ensuring that this is reflected in our macroeconomic analysis and policy advice. In our monitoring of the global economy, we are devoting more attention to understanding and identifying the linkages between the financial sector and real economy.

11. In this area, there is much for the Fund—and for others—to do, and much for the Fund—and for me—to worry about. But there are also times when it is good for people to stop worrying for a while, even the Managing Director of the International Monetary Fund. And this is a good time and place for that. It is a pleasure to be back in Spain. It is a pleasure to be with so many old friends today. And it is pleasure and a privilege to accept this award from you.

12. Thank you very much.