Progress in Strengthening the Architecture of the International Financial System
The financial crises of the past few years exposed weaknesses in the international financial system, many of which relate to the increasing size and importance of large cross-border capital flows. These crises highlighted that globalization can bring risks as well as important benefits. In response, the international community has mobilized to strengthen “the architecture of the international financial system.”
This architecture is the institutions, markets, and practices that governments, businesses, and individuals use when they carry out economic and financial activities. Building a stronger, more stable international financial system will make the world less vulnerable to devastating financial crises, while allowing all countries to reap the benefits of globalization, with its demonstrated potential to spur economic growth and improve living standards.
Although some advances were made in strengthening the international financial system after the last major crisis (the Mexican peso devaluation of 1994/95), recent progress has been more rapid. Notable accomplishments, with an emphasis on the role of the IMF, are:
the gradual increase in the quality and candor of economic information that governments and other institutions are making available to the public;
the growing implementation of codes of good practices that are essential to a well-functioning economy; and
the creation of Contingent Credit Lines (CCL), an IMF facility that enables the Fund for the first time to lend preemptively to help prevent a crisis.
Key reports that comprehensively document the progress toward the strengthening of the international financial system—along with a “users’ guide” to the 35-plus proposals made by the IMF and the international community—are available at /external/np/exr/facts/arcguide.htm. The five major areas where the cooperative global efforts on reform have been concentrated are listed below. Many of these initiatives have implications for further strengthening IMF surveillance, the process by which the IMF provides its assessment and advice to member countries on their economies. Thus, reforming international financial institutions such as the IMF is part of the work in progress to meet the challenges of a rapidly evolving global economy.
The goal is to make timely, reliable data, plus information about economic and financial policies, practices, and decision-making, readily available to financial markets and the public.
47 countries now subscribe to the IMF’s Special Data Dissemination Standard (SDDS), which encourages member countries to provide detailed and reliable national economic and financial data.
In its surveillance of members’ economies, the Fund continues to actively encourage members to release Public Information Notices (PINs), which describe the IMF Executive Board’s assessment of a country’s economy and policies. Over 80 percent of countries now release PINs. Under a pilot project for the voluntary release of the staff reports that are the foundation of the surveillance process, almost one-third of member countries have published the reports.
In the use of IMF financial resources, the Fund similarly encourages members to release details of the policies the member will follow to restore economic stability under its IMF-supported program, and about 90 percent of members now release this information. The Fund also releases the key points of Executive Board discussions of those programs.
2. Developing and Assessing Internationally Accepted Standards
Adherence to international standards and codes of good practices helps ensure that economies function properly at the national level, which is a key prerequisite for a well-functioning international system.
In consultation with others, the IMF has developed standards or codes of good practices in its main areas of responsibility: the Special Data Dissemination Standard; the Code of Good Practices on Fiscal Transparency; the Code of Good Practices on Transparency in Monetary and Financial Policies; and guidelines concerning financial sector soundness (see below).
Other standard-setting bodies are working on developing, strengthening, and disseminating international standards in the areas of accounting and auditing, bankruptcy, corporate governance, securities market regulation, and social policy.
To help foster countries’ implementation of these “rules of the road,” the IMF has prepared experimental country case studies known as ROSCs (Reports on the Observance of Standards and Codes) that assess a country’s progress in observing internationally recognized standard and codes.
3. Financial Sector Strengthening
Banks and other financial institutions need to improve internal practices, including risk assessment and management, and the official sector needs to upgrade supervision and regulation of the financial sector to keep pace with the modern global economy.
The IMF and the World Bank have intensified and enhanced their assessment of countries’ financial systems through joint Financial Sector Assessment Programs (FSAPs), which serve to identify potential vulnerabilities in countries’ financial systems. A pilot program of FSAPs for 12 countries is almost complete. A further 24 FSAPs are planned for the coming year.
- With IMF input, the Basle Committee on Banking Supervision is addressing gaps in regulatory standards.
4. Involving the Private Sector
Better involvement of the private sector in crisis prevention and resolution can limit moral hazard, strengthen market discipline by fostering better risk assessment, and improve the prospects for both debtors and creditors.
Efforts at prevention must be focussed on the implementation of appropriate policies, strengthening of financial systems, and establishing a constructive dialogue with private creditors.
The Fund is encouraging members during periods of relative calm to put in place mechanisms that could help facilitate the orderly resolution of crises, including collective action clauses in contracts and contingent lines of credit.
When crises inevitably occur, it is important to maintain the involvement of private creditors. In some cases, it may be possible to rely on the catalytic impact of lending by the Fund or other official sources to persuade creditors to maintain exposure. In others, it will be necessary to use mechanisms such as debt restructuring to ensure that countries’ programs of economic adjustment are fully financed without excessive reliance on capital from official sources.
5. Modifying IMF Financial Facilities and Other Systemic Issues
The IMF created a new instrument of crisis prevention in 1999, Contingent Credit Lines (CCL). The CCL is a precautionary line of defense readily available to member countries with strong economic policies designed to prevent future balance of payments problems that might arise from international financial contagion. The IMF has undertaken a fundamental review of all of its non-concessional financing facilities to ensure that they meet members’ needs in a changing world economy.
The design of the CCL draws on the other major components of the reform efforts, creating further incentives for countries to adopt strong policies, be transparent, adhere to internationally accepted standards, and have a sound financial system.
Other initiatives to strengthen national and the international financial systems focus on helping countries to assess their external vulnerabilities and to choose appropriate exchange rate regimes.
More needs to be done to make sure that the global financial system provides a solid foundation for economic and human development. But it is fair to say that the way the world makes economic policy and does financial business is changing because of the reforms of the international financial system that are under way.