Speech

Stable and Efficient Financial Systems for the 21st Century: A Quest for Transparency and Standards -- Address of Michel Camdessus

May 25, 1999

Mr. President, Distinguished Colleagues, Ladies and Gentlemen,

The last decade of the 20th century has seen a remarkable step forward in the evolution of financial intermediation. Investment and saving habits are changing worldwide—as we can see from proliferating securities markets, diverse financial instruments, and large flows of foreign direct and portfolio investment. These have been—and have all the potential to be much more—essential instruments of this explosion of international transactions of the last 15 years, a major component of globalization with all its opportunities and risks. During the last two years we had a vivid illustration of these risks and of the virulence of the crisis which is the other side of the glittering promise of globalization. The worst of this crisis being now over, and being a member of the team of firemen who had to contain and extinguish them and at the same time being active in the workshop where the new architecture of the international monetary and financial system is being designed, I believe that I can perform no better service this morning than to bring you up to date about the work governments and financial institutions are undertaking to adapt this system to the globalized world of the 21st century. I would be delighted if this could be of some help for you to better identify the broad framework in which your ambitious but indispensable efforts for establishing a stable and efficient financial system could find their full efficiency.

I am immensely grateful to the organizers and particularly to Michel Prada, the Chairman of your Technical Committee, for providing me with the opportunity so symbolic of the need for this new world for stronger link among international agencies in general, and between the IMF and the standard-setting agencies in particular. I will restrict myself to identifying the key elements of this new architecture and to providing you with a few preliminary reflections on what could be our interaction in the future.

As the world emerges from a period of intense turbulence, what kind of economic and financial system can we expect to develop?

The emerging markets crisis revealed deficiencies in the international financial system both on the debtor side—in the national policies and institutions—as well as on the creditor side, notably in the capacity of investors to undertake adequate risk assessment and of supervisory authorities to monitor properly their activities. The cost of it was high: the most severe worldwide crisis of the last 50 years. Was that a reason to abandon globalization with all its promise for a more prosperous world, in favor of the old models of protectionism and state intervention? There was, on the contrary, a very broad consensus for embarking on a major and immediate cooperative effort simultaneously to contain the crisis—a task now well advanced—and to reform the "architecture" of the system. This had to entail in reality a very profound change in what has been the relationship among governments, banks, and enterprises in promoting economic development during the last 30 or 40 years. The emerging consensus reaffirms a world economy based on free market mechanisms—on open trade and capital movements—buttressed by sound national financial systems and by good public and corporate governance. This would be a system that fosters the private sector—both domestic and foreign on a truly equal footing–as the primary source of investment and growth. It would require establishing an arm’s length relationship between governments and markets, neither too close nor too distant. It is a partnership that demands good governance, transparency and disclosure of information, and a respect for standards and codes of good practice that are consistent across countries.

Investors should be able to assess risks realistically, and operate within a clearly defined, but not oppressive, framework of laws and regulations. And, even if it almost goes without saying, a consistently stable macroeconomic framework will be asine qua non for national and global stability. All countries must compete for excellence in their macroeconomic and financial policies—not to mention the special responsibilities of the G-7; we know too well now the systemic cost of a serious crisis in a middle-sized economy as Thailand. It would also be a world that benefits from the existence of international institutions with well-defined, but constantly evolving, mandates that promote the smooth functioning of markets and economies, and as far as the IMF is concerned, could strengthen and, if needed, broaden further its surveillance to better promote the stability of the global system.

In other words, this crisis is obliging us all to imagine new ways in which economic dynamism and financial stability should be reconciled in the future. This is what the so-called new architecture is all about. Let me tell you about the four domains where we see progress, and where conceptual and practical work is no doubt still required.

I. There is a strong consensus for making transparency the "golden rule" of the new international financial system. On that I can be very brief, merely to underscore that it is absolutely central to the task of civilizing globalization. In fact, improving transparency lies at the heart of many elements of the debate. A lack of transparency has been found at the origin of each recurring crises in the emerging markets, and it has been a pernicious feature of the "crony capitalism" that has plagued most of the crisis countries and many more besides. Markets cannot work efficiently, and they will remain vulnerable to instability in the absence of adequate, reliable, and timely information from all quarters. Here IOSCO has been on the forefront, not only developing principles for the securities markets, but also working together with other agencies, for instance the IASC (International Accounting Standards Committee), to develop proper accounting and disclosure rules. But the world was very far removed from this! So it may seem like a very tall order to change the culture and attitudes of many decades. But in fact considerable progress is being achieved in defining new standards and establishing new practices. We are at the point now where—let me be a little bit impertinent—central banks no longer compete on their reputation for secrecy—but instead on transparency—and the IMF will be invited soon to establish transparency reports.

A second domain where major efforts are deployed with a particular sense of urgency and where public and private forces must join hands is in preventing and resolving crisis. This is a must, of course. We no longer want to see in this globalized world innocent bystanders paying suddenly for the mistakes of others. But this is the most complex area of the debate, and although considerable headway has been made, there is still some way to go. The focus should be on preventing crises. Just as the public sector is being asked to adapt its culture, so too the private sector will have, I think, to increase its own transparency, to use internationally accepted standards, to promote an arm’s length relationship with government, and, as far as financial institutions are concerned, to have a much more careful evaluation and management of their risks, while developing a more mature partnership with their clients. This should lead, when crisis does strike, to an active contribution to their resolution. In the past two years, we have all learned from the experiences of involvement of the private sector in a number of country crises, such as Korea, Thailand, Indonesia, and Brazil. In moving forward, we need a creative approach that draws on a mature partnership between the public and private sectors.

On the public side, this effort expected from the private sector should be accompanied by powerful interventions to help contain the crisis, re-establish confidence, and provide the countries with the temporary financing that they may require during the phase of adjustment and reform. You recognize here a contribution orchestrated by the IMF. The four countries I have just mentioned are, I think good examples of this kind of post-crisis international support. But more innovative and more promising is the IMF’s recent decision to contribute to the prevention of crisis through a new mechanism, the so-called Contingency Credit Lines (CCL). Why this new instrument? The past two years have confronted countries with situations where contagion is such that they can encounter severe external financing pressure even when they have basically sound economies. This new mechanism, approved about a month ago, represents a substantial change in the way in which the Fund interacts with its members and the global financial community; it shifts the emphasis from curative medicine to preventive medicine. Existing IMF facilities help countries that are in a weak condition and experiencing an actual balance of payments need—because of policy shortcomings or adverse external developments. By contrast, the CCL is designed to help countries that are strong—with sound macroeconomic management, strong financial systems, applying internationally recognized standards, and having established responsible relationships with their international creditors—withstand the pressure on their balance of payments that might arise from a sudden loss of confidence caused by the contagion from crises in other economies. In such cases the amount of the support of the IMF would have no rigid pre-determined quantitative limits.

Other initiatives are also being considered to help the orderly workouts of crises if they do occur. These could entail introduction of collective negotiation clauses in bond contracts and definition of appropriate arrangements in extreme situations for allowing a stay to be organized to help creditors and to arrange orderly workouts in their mutual interest.

A third domain where we are actively working to establish a proper balance is in the fundamental question of the freedom of capital movements. Here we must reconcile a freedom from which many countries have benefitted so much, with the precautions needed to preserve stability. The breakneck pace of development of the international financial markets during the decade preceding the Asian crisis raised questions about the appropriate approach to the liberalization of the capital account, and, of course, we have learned many lessons from the emerging markets crisis.

Recognizing that de facto capital liberalization is under way—and without doubt potentially most beneficial—are we prepared to accept a haphazard, piecemeal and potentially volatile process, or should we try to manage the process in a way that increases economic stability and growth? This calls for a judicious approach on the part of both debtor and creditor nations. Debtor nations will need to satisfy two prerequisites: one, a sound, internally consistent macroeconomic framework; and two, a robust financial system with sound institutions and a good regulatory and supervisory framework. It is easy to imagine that these conditions cannot be met overnight in many countries. This means that creditor nations and institutions need to pay attention to assessing and managing risk. Of course, it is the investor who has the primary responsibility for assessing risk. But regulators in the industrial countries need to ensure that financial institutions participating in the global financial markets are subject to appropriate safeguards.

Should there be a formalized institutional approach to capital account liberalization? In Hong Kong, at the IMF Annual Meetings in 1997, the international community, through a statement of the Interim Committee, declared that "[it] is time to add a new chapter to the Bretton Woods agreement". The Fund’s Executive Board was invited to propose "an amendment to the Fund’s Articles of Agreement that would make the liberalization of capital movements one of the purposes of the Fund, and extend, as needed, the Fund’s jurisdiction through the establishment of carefully-defined and consistently applied obligations regarding the liberalization of such movements." It is significant that this statement was made after the crisis had begun to emerge and it is even more striking that, as the full scale of the crisis became evident, how few countries reversed direction. Although it was understandable that the crisis made the international community think twice before proceeding, I believe it is now time for momentum to be re-established. The reason is simple: as confidence returns to world markets and financial flows are starting to grow again, undoubtedly new forms of innovation will take place. It is vital that these next stages of integrating global financial markets take place within the framework of "carefully defined and consistently applied obligations" rather than accepting the risks of a return to the piecemeal approach of the past decades. We need a constructive means of helping countries that wish to access capital markets, do so in a way that protects their stability and economic security. This is the work we will try to advance this summer.

This objective will be made much easier to reach by what I see as the fourth domain where a consensus is clearly crystallizing and where our cooperation will be important—the need to establish at the international level the discipline that has progressively come to prevail in domestic markets. It was time to admit, as a matter of fact, that governments had not devoted enough attention in order to secure such a civilized environment. In the international markets we were already living in the 21st century but with an absence of universally accepted rules and standards that was reminiscent of the domestic environment that prevailed at the end of the 19th century in the industrial countries. Messrs. Bill Gates, George Soros, and others were operating internationally in a framework that was not far from the one described by Balzac and Zola in my own country at the end of the last century. No wonder that a number of countries hesitated to expose themselves to such a risky environment. This had to be corrected.

Consequently, tremendous effort is under way to establish standards and codes of good practice at the international level that build on and offer the potential to globalize the standards that exist within the most advanced nations. New standards are being defined and existing ones refined. The IMF has been formulating standards or codes of good practice for governments in its core domain of responsibilities, which are already well advanced or being implemented. Many agencies, several of which are represented here today, have been working to develop standards in their areas of expertise: accounting, auditing, corporate governance, payment and settlement systems, insurance, and bankruptcy. ¹ IOSCO has been in the front rank. It was among the first agencies to make a concerted response to the crisis, rapidly bringing to completion in Nairobi last September a set of "Objectives and Principles of Securities Regulation" that provide a pragmatic launching pad for national regulators to establish codes tailored to their own countries. What is more, the objectives on which those principles are based—protecting investors; ensuring that markets are fair, efficient and transparent; and reducing systemic risk—can serve as a guide for all of us working on standards and codes of good practice.

In the critical area of financial sector strengthening, the IMF and the World Bank are cooperating closely to help promote stronger financial systems, based on the internationally accepted Basle Core Principles. But there is scope for even deeper international cooperation, and the Financial Stability Forum that has just been established to encourage dialogue among the many relevant national and international agencies will make an invaluable contribution.

II. This is the domain where the perspectives for the expansion of our cooperation in the near future are the most promising. Let me provide you with a few preliminary thoughts about it.

What are the implications for the IMF? Our activities are being affected in some quite profound ways. At one level, we have been asked to take the initiative to define standards in three areas:

• First, the Fund began to formulate standards for data dissemination shortly after the onset of the Mexican crisis. These are now fully operational, and the more demanding Special Data Dissemination Standard (SDDS) has now been adopted by about one-quarter of the membership, the large majority of those countries participating in capital markets.

• Second, in April 1998, the Interim Committee adopted a Code of Good Practices on Fiscal Transparency. Since then, we have made this code operational through the preparation of an implementation manual and development of a questionnaire that a number of countries are now using to assess the transparency of their fiscal systems.

• Third, the Fund—working together with the BIS, a representative group of central banks, the World Bank, and the OECD among others—has prepared a draft Code of Good Practices on Transparency in Monetary and Financial Policies. The unusually broad participatory approach ² used in this case will continue through consultations with the public and other agencies, with a view to finalizing this code before our Annual Meetings in September. We are grateful to IOSCO for its contribution during the preparation of this code, and we hope to draw on expertise again as we develop a supporting document to this code.

Looking to the future, new priorities are emerging for the Fund. With many agencies now preparing or updating their standards, principles, and codes of good practice, the attention is shifting to the high challenge of implementation. There are no special difficulties within the domain traditionally covered by the IMF surveillance, but the question arises beyond that as many agencies do not have the capacity to conduct the country-by-country consultations that will be necessary. Although the Fund does not yet have the expertise to assist in implementing many of the new standards, it turns out that it is in a unique position to contribute to their dissemination and with the help of the standard setting institutions, to contribute to their implementation. The Fund’s mandate enables it to have regular—usually annual—contacts with all member countries for policy discussions. This has led to a number of calls for the Fund to use its surveillance to play a significant role in encouraging the implementation and monitoring of observance. But for that we will need your cooperation.

The precise mechanics of this have yet to be worked out, but it will clearly build on the experience that we will gain in implementing the standards that are the direct responsibility of the Fund (data dissemination, transparency in fiscal, monetary and financial policies). It will also build upon the collaborative approach with the World Bank under the Financial Sector Assessment Program that we have recently formalized. Another proposal is that countries should prepare "transparency reports". In a first experiment, three countries—Argentina, Australia, and the United Kingdom—have volunteered transparency reports, each with a quite different character. We will continue to work with our members on this most promising avenue.

A further reason for the Fund to become involved in encouraging and assessing the implementation of standards arises from the important adaptation in our functions that follows from newly-established Contingency Credit Lines. Among the five criteria for access to the CCL is the country’s "progress in adhering to relevant internationally-accepted standards" and clearly judgment calls will have to be made by the Fund.

In executing these new tasks, it is quite evident that the IMF will have to enhance and supplement its in-house expertise by relying heavily on the skills, resources, and advice of the many agencies engaged in defining standards. But, even more, we would look to the standard-setting agencies to play an active role in developing methodologies for assessing observance of their standards. We shall have to develop with IOSCO and organizations like it a high degree of collaboration. As we proceed, the most pressing needs will be for technical assistance in countries adopting new standards, and the human resource constraint may well be the largest challenge we face, since in some areas, there are simply not enough people with adequate skills to go around. An uncommon degree of cooperation among the many international bodies and national agencies is now essential to meet this challenge.

I believe we are here at the beginning of one of the most difficult aspects of reforming the international financial architecture. The standards and principles now being formulated at the international level must be turned into more precise standards in individual countries and implemented systematically. This will be a technically complex, time-consuming, and at times even politically sensitive task. The challenge for the international community is to ensure that the benefits for all countries are evident and substantial. A firm start has been made, but our journey together will be long, indeed. We must make it a success.

¹In addition to the work underway by IOSCO on securities markets standards are being prepared or updated by: the Basle Committee on Banking Supervision on banking; the International Association of Insurance Supervisors (IAIS) on insurance; the International Accounting Standards Committee (IASC) and the International Federation of Accountants (IFAC) on accounting and auditing; the United Nations Commission on International Trade Law (UNCITRAL), the World Bank, the IMF, and the International Bar Association on bankruptcy; the OECD, World Bank and the BCBS on corporate governance; and the Committee on Payment and Settlement Systems (CPSS) on payment systems. This work is summarized in the IMF publication, Experimental Case Studies on Transparency Practices: Developing International Standards-Progress Report.

² Public comment is being invited on this code, which may be viewed on the IMF ’s website at http://www.imf.org/external/np/mae/mft/index.htm. Comments are invited by June 15.