The Private Sector in a Strengthened Global Financial System -- Remarks by Michel Camdessus
June 8, 1999
As prepared for deliveryRemarks by Michel Camdessus
Managing Director of the International Monetary Fund
at the International Monetary Conference
Philadelphia, Pennsylvania, June 8, 1999
I am very pleased to participate in this International Monetary Conference, which provides such a valuable opportunity for dialogue among key players in the financial sector. At a time when global financial reform is at the top of national and international agendas I value greatly this chance to interact with leaders of the banking world, since some of the most challenging issues relate to the role of private creditors as we work together to achieve a more secure global financial system. I also find it especially appropriate that the chairman of the Conference this year is Mr. Yoh Kurosawa, whose bank, the Industrial Bank of Japan, has been at the forefront as Japan has begun to implement its banking reforms. Undoubtedly we wish every success to your efforts and those of the wider banking sector in Japan.
The last decade has seen a remarkable step forward in the evolution of financial intermediation. Global markets have become increasingly integrated while investment and saving behavior is changing worldwide, as we can see from proliferating securities markets, diverse financial institutions and instruments, and large flows of foreign investment and cross-border lending. This is the "upside" of globalization, for in such circumstances saving and investment can be allocated most efficiently. The "downside" was illustrated in the past two years by the succession of crises that shook several emerging market economies directly, and threatened many others with contagion.
Against that backdrop what is the global outlook now? Certainly, the worst of the current emerging markets crisis seems to be behind us. In Asia, the countries at the heart of the crisis are close to or even past the turning point: Korea in particular is seeing an upturn in activity. Latin America, in the past few months, saw a rebound in investor confidence, and there is some evidence that the slump in activity may have been less than expected, particularly in Brazil. The policy dialogue in Russia began to move forward again and we hope that the new government will steadfastly implement the program undertaken by its predecessor.
Yet any optimism needs to be heavily seasoned with realism at this point, since many challenges and questions remain. In the near-term, can the United States, the powerhouse of the global economy for the past several years, avoid hitting the capacity constraints that might renew fears of inflation? How soon can Japan expect to see the long-awaited and expected recovery? Can Europe revive its economic expansion? And will the emerging markets be able to revive growth and sustain sound macroeconomic policies while undertaking the structural reforms that many need?
More generally, can this tentative recovery be extended into a new era of high-quality global growth, in which the emerging markets will play a dynamic role once again? That will depend not just on skillful macroeconomic management but also on whether the international community can advance convincingly with the challenge, on which it has embarked, to overhaul the architecture of the international financial and monetary system.
In the few minutes at my disposal today, I shall not attempt to give you a comprehensive presentation of all that is being done in the way of systemic reform, since I understand that many aspects of this are being covered in your other conference sessions. Instead, I shall approach the question with a particular focus on the role that can be played by the private sector, and its relationships with the public sector and the international agencies.
In the debate on system reform, no topic has proved more challenging than the question of how to "involve the private sector in forestalling and resolving crises". If there is any characteristic that distinguishes this series of crises from others, it is the prominence of the private sector-financial institutions and corporations-on both the creditor and debtor sides of the equation. Therefore any solutions-whether it is the short-term resolution of the immediate country crises, or the forward-looking proposals that seek to reduce the frequency and severity of crises in future-will have little value if they do not factor in the private sector.
Inevitably, early attention has focussed on the resolution of crisis. The severity of the situation demanded immediate response, but this was a new breed of crisis for which precedents were relatively limited. Therefore we have in effect been developing a substantial body of "case law" based on the different experiences in each case. If there is one clear lesson to emerge from the experience it is that the diversity of country situations means that there is no "silver bullet", no "one-size-fits-all" solution. The circumstances and workouts of debt in each of the major crisis countries during the past two years have differed substantially-from the concerted rollover of a large volume of short-term debt in Korea, to the consultative approach adopted by Brazil, even though there was no intention and no need to consider debt restructuring. In Thailand and Indonesia different approaches were taken again, but in all of these cases the cooperative approach stands in sharp contrast with Russia's recourse to a disorderly suspension of debt service.
More recently attention has focussed on a group of countries in which obligations to external bondholders, pose an important issue: notably Ukraine, Romania, and Pakistan. These cases all raise important issues for the role of crisis resolution, and I shall return to this shortly.
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If we are to build a more durable, integrated international financial system, the foundation for successful crisis resolution should exist long before crisis strikes. Quite simply, it should consist of the market structures, practices and relationships that exist under normal conditions. We need to foster a mature market, which is based on stable relationships among players that rely on enlightened self-interest, and in which official involvement can be limited to establishing strong legal, regulatory and supervisory frameworks.
What should we expect from the players, regulators, and supervisors in this market? As I review some of these expectations, I think you will quickly recognize that I am calling for good governance, transparency and cooperation.
I. Let us first think of the responsibilities of debtors. At the top of the list, clear and unambiguous, is the principle that contracts must be honored. I will emphasize this at every opportunity, since it is the very foundation of the successful operation of mature markets. I also stress it because of the concerns raised by some that the proposals for involving the private sector implicitly encourage countries to abrogate their commitments. Quite the contrary, we want to ensure that obligations are honored.
If there is an equivalent singular responsibility of governments, then it is the obligation to pursue the macroeconomic policy objectives of stability and growth within a transparent economic and financial policy framework, including the dissemination of comprehensive, accurate, and timely data.
Other obligations involve elements of a shared responsibility, led perhaps by either public or private sector, but calling for extensive cooperation and consultation:
A strong legislative framework-including a workable bankruptcy law-and an independent judicial system;
Adoption and adherence to internationally accepted standards of disclosure and governance. Even if some of these standards are still "work-in-progress", there are many that can be adopted already;
The development of a robust regulatory and supervisory framework for the financial sector;
Policies and practices that promote sound debt management and the high-frequency monitoring of private external liabilities, a key aim of which should be to avoid excessive short-term debt.
II. How can creditors, in other words the private sector-and their governments-contribute to a better system?
The first area is risk assessment and risk management. You do not need me to tell you that investment of any kind involves risk, carrying with it the obligation to develop adequate techniques and practices for assessing, pricing and managing risk. Many investors have taken substantial losses in the past two years, and are increasingly interested in and capable of differentiating among countries. But investors would do well continually to keep their practices under review, and national regulators should ensure that this happens.
Second, creditors can play an important role in encouraging adherence to internationally organized standards. Not only should they themselves expect to adopt them-for instance by attaining high standards of disclosure-but they can also encourage borrowers to adopt good practices by factoring this into their investment and pricing decisions.
Third, creditors should accept that national authorities need to adapt the principles and standards that support their regulation and supervision of national financial systems. One practical suggestion, which has gained widespread support, is to reflect more adequately the risk of lending to emerging markets by increasing the risk weights assigned to short-term lending in the balance sheet of creditor banks under the Basle Core Principles. On this, we welcome the consultation document released by the Basle Committee last week. More generally, the activities of offshore funds, and highly leveraged institutions--including hedge funds and the similar operations of other financial institutions-and the role of short-term credit, will be the subject of studies by the recently established Financial Stability Forum.
Fourth, private creditors can help-and in a few cases already are helping--countries to preserve their foreign exchange liquidity when there is a threat of contagion by establishing contingent financing arrangements that can be activated if crisis looms. But for such mechanisms to be fully effective, I would underscore that creditors must be prepared to be steadfast, continuing to support the arrangements even when external financing pressures develop.
Fifth, since cooperation is vital, debtors and creditors need to establish and maintain good lines of communication during normal times. Some recent cases of debt workouts-for instance Indonesia-have pointed to the importance of timely and effective consultation among debtors and creditors. Here countries may consider emulating Mexico's practice, established after the 1994/95 crisis, of regular consultation with international financial market participants, and Brazil's consultative approach to its creditors in the context of securing a voluntary rollover of interbank and trade related credit lines.
III. How can the IMF contribute? Less than two months ago the Fund took a highly innovative decision, which will enable it to offer financial resources to support crisis prevention, through the mechanism known as Contingent Credit Lines. These lines are designed to help countries that are in a relatively strong situation-with sound macroeconomic management, strong financial systems, and making progress in applying internationally recognized standards-withstand the pressure on their balance of payments that might arise from a sudden loss of confidence through contagion from developments elsewhere.
This will not divert us from our traditional activities. Indeed since the first line of defense in preserving the stability of the international financial system will always be our bilateral and multilateral surveillance, it is important for us to strengthen this function. And indeed, we are broadening the coverage of our surveillance:
our consultations with members now routinely encompass financial sector issues, in collaboration with the World Bank and other agencies; and
in a very recent innovation that constitutes a key step in promoting transparency, we have begun to develop approaches that will promote the dissemination and application of standards and codes of good practice.
We continue to update the technical assistance and training we offer to help countries build up their institutional capacity to manage their economies and to handle changes in their financial systems. And we continue to offer financial assistance to countries that have encountered balance of payments difficulties and are taking active steps to overcome the underlying causes of the imbalances.
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Of course, occasionally crises will occur and, we need to be ready with measures to assist in their resolution. This requirement entails a delicate balance among the objectives of preserving countries' market access in normal times, ensuring equitable treatment of creditors if crisis strikes, and avoiding debtor and creditor moral hazard. We should approach this task by seeking market-based and market-friendly solutions. To this end, let me suggest two yardsticks that will help to evaluate any proposals:
Measures to reduce vulnerability to crisis should promote the efficient operation of capital markets in normal times, including due attention to the management of risk.
Measures intended to resolve crisis should not have the perverse effect of precipitating them. In other words, if measures are introduced that are seen by creditors as locking them in once crisis has developed, then they may become hyper-sensitive to market volatility, even if that volatility is the result of contagion, and not precipitated by domestic economic weakness.
The complexity of the issues arises because workable arrangements must consist not only of ex ante measures that are ready in case the threat from contagion develops. They should also offer mechanisms-or at least some principles-for resolving "extreme situations", where crisis has deepened to such an extent that normal payments can no longer be sustained.
Among ex ante measures-I have already mentioned this as a preventive tool-are contingent financing arrangements from private lenders that could be an early recourse if crisis develops. This is one of the few ideas that can actually be said to be in place and workable, even if it is on a modest scale; three countries-Argentina, Indonesia, and Mexico-have concluded such arrangements. Other ex ante mechanisms have been suggested, and even if these do not stand up well to the two yardsticks I have mentioned, I have no doubt that markets and debtors can, in time, develop more.
One issue that is attracting considerable attention at present is the question of bondholder claims. In a number of recent cases, where it has not been feasible to address the developing crisis by mobilizing new resources, the question arises whether sovereign bonds should be included in comprehensive debt restructuring. For the time being, this is a question that, in view of the diverse situations of debtors, will have to be approached on a case-by-case basis. Broadly speaking, bondholders must be viewed as a category of investors at par with others, needing to assess and price risk, and who, just like other creditors, cannot expect public or official money to shield them from adverse outcomes. But of course, no debtor would wish to take default lightly, since, no matter how careful an approach is taken, debtors will perceive that their credibility has been undermined and investors' confidence shaken. However, investors and debtors may have to accept that in extremis, a country may have no orderly way out of the crisis other than a comprehensive debt restructuring that includes bonds.
These issues again highlight the critical importance of debtors and creditors maintaining a dialogue, that is established in good times, and is sufficiently robust to continue through periods of stress. Given the very large number of creditors that now typify many emerging market situations, one promising avenue is to introduce collective action clauses into new bond contracts. Rescheduling could then take place with the consent of a majority of creditors rather than requiring unanimous consent as currently is the case in most contacts. This is a relatively innovative approach that may well require industrial country borrowers to lead the way, an issue that is currently under consideration.
We must recognize that there may be a few instances in which, despite good faith efforts by countries to reach agreement with their creditors, agreement cannot be secured and default cannot be avoided. In such cases it will be important to reestablish normal relations as quickly as possible: debtors should seek to reestablish good faith negotiations with their creditors promptly, but they should be able to do so without finding that the process is blocked by a handful of dissident creditors. This has raised the questions whether and how the international community might introduce a temporary stay on legal action by creditors during the negotiations between a country and its creditors. One option is to reach agreement on an interpretation or an amendment of Article VIII 2b of the Fund's Articles of Agreement to allow it to declare such a stay. This suggestion has proven quite contentious and consensus is not yet in sight.
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I have covered a number of rather technical topics today in response to the question that forms part of your conference title-"Can we strengthen the architecture?"-which includes the need for some grand design. But in closing, I would leave you with the thought that many of the steps that the international community is undertaking to strengthen the international financial architecture, if viewed piecemeal, could be seen as quite unremarkable. But when viewed together and, if implemented wholeheartedly by all concerned-debtors and creditors public sector and private sector-they will add up to a formidable change in the functioning of international financial markets and the global economy as a whole. And our success in achieving this transformation will depend on an approach based on cooperation and dialogue.