IMF/JSA Regional Conference on Banking Supervision
Opening Address by Naoyuki Shinohara
Deputy Managing Director
International Monetary Fund
February 9, 2011
As prepared for delivery
1. Good morning, ladies and gentlemen. It is a pleasure to be back in Japan and an honor and privilege to be able to welcome you to the inaugural IMF/JSA Conference on Banking Supervision and Regulation. I would like to express the IMF’s immense gratitude to the Japanese Ministry of Finance for its support for this conference, and to the central banks and financial supervisory agencies for enabling your participation.
2. This conference is a great opportunity to demonstrate the spirit and practice of technical assistance that has been provided through the JSA—the Japan Administered Account for Selected IMF Activities—in conjunction with the IMF’s Monetary and Capital Markets Department. Over the next two days, we hope to foster a fruitful exchange of ideas, experiences, and best practices relating to banking oversight. The IMF resident advisors on banking supervision—based in four Asian countries—will present their experiences in promoting effective banking supervision and regulation at the ground level. In turn, you—the participants—have agreed to share your insights into issues that currently dominate the international financial reform agenda. We would like to thank you in advance for your active participation.
3. It is almost impossible to overstate the importance of our conference topic—Banking Supervision and Regulation—particularly in the Asia Pacific region, where capital inflows have been fuelling significant increases in asset prices in some countries. It is important to note that Asia’s financial systems have proved to be more resilient than that of advanced economies, which remain fragile and subject to significant downside risks. However, while the Asia Pacific region remained largely unscathed during the recent global financial crisis, it is critical not to become complacent. Measures proposed under the G20 reform agenda will be instrumental in supporting Asia’s economic growth and addressing new risks to the region’s financial systems.
4. This conference will focus on three essential elements of financial sector oversight, including (i) measures to strengthen regulatory capital, (ii) banking supervision, and (iii) new approaches to systemic risk monitoring.
- First, I would like to elaborate on the need for strengthened regulatory capital, which has emerged as one of the preeminent issues of the post-crisis era. Last year, the Basel Committee on Banking Supervision (or BCBS) reached broad agreement on the new capital, liquidity and leverage requirements, which represent the core of the reform package known as Basel III. The proposed measures are aimed at significantly enhancing the quality and quantity of the regulatory capital base and the risk coverage. The BCBS, in conjunction with the Financial Stability Board, is also developing measures to enhance the loss-absorption capacity of systemically important banks through new policy tools such as capital surcharges, contingent capital, and bail-in debt.
- Second, this conference will focus on supervision. As the international regulatory framework changes, supervisors will play a crucial role in implementing the new rules. National supervisory structures may have to be strengthened through new institutional arrangements. Supervisors will also have to step up their cross-border cooperation to improve joint-monitoring of key risks in the financial system.
- Third, we will discuss new approaches to systemic risk monitoring. The recent financial crisis has highlighted the need for improved macroprudential frameworks aimed at identifying, monitoring, and managing systemic risk in the financial sector. While there is broad agreement on the overall strategic direction, policy makers have yet to develop a commonly accepted range of policy instruments and institutional arrangements that will allow them to implement their improved macroprudential policies. The recent BCBS agreement on “countercyclical capital buffer”—based on reciprocal arrangements between countries—marked an important first step towards cross-border macroprudential provisions.
5. We look forward to receiving your views on this important reform agenda—including possible concerns about the appropriateness of the proposed measures. Some supervisors in the Asia Pacific region may have wondered why their financial systems should bear the burden of additional regulation, which they believe is largely aimed at addressing shortcomings in the banking systems of advanced economies. When the recent global financial crisis hit this region, many Asian banks were considered well-capitalized under the Basel II capital rules. These banks had sufficient buffers to withstand the spillover shocks that reverberated through this region. Moreover, Asian financial institutions—unlike many of their peers in developed economies—had largely refrained from investing in sub-prime and structured credit products. This does not mean, however, that Asia should become complacent. The new international regulations will become a global standard and Asia cannot afford to be left behind if it wants to compete on an equal footing. Furthermore, as Asia develops and deepens its capital markets, progress on financial sector reform is necessary to address new risks.
6. Many of these concerns stem from the fact that new international regulations are necessarily based on compromise solutions.. The proposed Basel III regulations are a case in point. While the proposals constitute a significant improvement over the pre-crisis status quo, more work is needed in the longer term. For example, the quality and comparability of capital across countries could have been defined in a clearer manner. In addition, the new prudential rules under Basel III will not be fully implemented until 2018. Such a long phase-in period will place an additional onus on supervision to become more intensive and intrusive to prevent a new cycle of excessive risk taking by institutions with weak capital. Clearly, many policy choices still lie ahead—nationally and internationally—which require further refinements and collective efforts to keep the reform agenda on the right path.
7. Policymakers here in Japan will, no doubt, carefully consider how to implement the new regulations in the domestic financial sector. The Japanese banking system has already increased its capital buffer, but banks continue to face several challenges, such as declining core profitability and still-elevated domestic and global macro-financial risks. I would like to highlight three specific issues:
- First, Japanese banks have sought to strengthen their capital base mainly by issuing common shares, which will help increase their core and Tier 1 capital ratios. Yet, given existing risk exposures and the new regulatory capital requirements, banks may need to further increase their capital buffers. At the same time, with outstanding loans falling across the banking system and thin interest margins, it is important that Japanese banks seek to raise their core profitability by diversifying their revenue sources.
- Second, there have been continuing concerns about the quality of Japanese banks’ loan portfolio, including loans to small and medium-sized enterprises (SMEs). Full credit guarantees provided to SMEs during the height of the global crisis have complemented the financial intermediation process of private financial institutions, but are set to end in March this year. With SMEs in general still suffering from high indebtedness and low profitability, Japanese banks will need to strengthen their risk management of SME finance, including adequate provisioning against the prospect of potentially high non-performing loans. At the same time, SMEs are vital to Japan’s economic growth, and Japanese banks need to play an important role in the efficient allocation of resources through proper assessment of the creditworthiness and growth potential of SMEs. This said, a fundamental improvement of banks’ overall asset quality requires a sustained recovery of the economy as a whole.
- Third, the Japanese banking system is facing a number of external downside risks, including a possible global economic slowdown stemming from European sovereign debt problems, a possible slowdown in US growth, and a potential reversal of property boom in emerging markets, such as in China. Such external shocks could affect equity and foreign exchange markets, and could weigh heavily on Japan’s economic growth prospects.
8. The uncertain external environment facing policymakers in the Asia Pacific region underscores the need for renewed vigilance. Since the Asian financial crisis more than a decade ago, many financial systems in this region have seen remarkable progress and stability. Asia’s policy makers and supervisors have drawn the appropriate lessons from their own, painful experiences—helped, in some cases, by the IMF’s technical assistance. We believe that this region now has an opportunity to make another regulatory quantum leap that will help bolster its financial stability and economic growth in the years to come.
9. If you will allow me, I would like say a few words about the IMF’s technical assistance mandate and the indispensable partnership between the IMF and the JSA.
10. As you know, the IMF has three core mandates, including surveillance, financial assistance, and—of course—technical assistance, or TA. Under the TA program, member countries can receive advice and training aimed at strengthening their human and institutional capacity. They can also use TA to help design and implement effective macroeconomic and structural policies. All this is particularly relevant for low-income and lower-middle income countries, which account for three-quarters of the IMF’s TA expenditures/projects.
11. It is worth noting that there is a strong historical connection between the TA program and the Asia Pacific region: the IMF began providing TA in the early 1960s, in response to requests from newly independent nations in Africa and Asia. Since then, the program’s scope and significance has grown substantially. The 1990s proved to be a particularly challenging period, because of the sharp increase in demand for TA from countries facing financial crises.
12. Traditionally, TA has been provided in areas such as fiscal policy, monetary policy, financial systems, legislative frameworks, and macroeconomic and financial statistics. Of course, the program continues to evolve as member countries reassess their policies and strategic objectives—ranging from debt reduction to the adoption of international standards and codes. TA experts have recently stepped up their efforts to help countries build capacity in financial risk modeling and stress testing.
13. Of course, further growth in our TA program cannot be sustained unless we have appropriate funding. TA work and training accounts for a quarter of the IMF’s annual operating budget, but the program also relies on significant external financing from bilateral and multilateral donors, including the JSA. In 2009, external financing accounted for more than two-thirds of the IMF’s TA delivered in the field. Donors will continue to play an invaluable role, and we are grateful for their cooperation and commitment. Their financial support will help us improve the effectiveness and sustainability of our expanding TA program.
14. To be clear, without the JSA’s generous funding, technical assistance—particularly in the Asia Pacific region—would not exist in its present form. Through the JSA, launched in 1990, Japan has become the largest single contributor to the IMF’s TA and training activities, accounting for more than a quarter of total external TA financing received by the IMF in 2009. Some 124 member countries, as well as the seven Regional Technical Assistance Centers and seven IMF regional training centers, have benefited from JSA-funding
15. The distribution of JSA funding across TA areas is quite wide ranging, with fiscal and monetary policies accounting for, respectively, 40 percent and 27 percent in 2009. Within the monetary policy category, banking sector oversight accounted for the largest share.
16. Enhancing banking supervision in selected ASEAN countries—including Cambodia, Indonesia, the Philippines and Vietnam—has emerged as a JSA theme, reflecting the JSA’s efforts to generate cross-border TA synergies. Today’s conference is a natural extension of this pragmatic approach. IMF resident advisors have led TA activities in these four countries, which had previously received significant JSA-funded TA on a wide range of bank supervision topics. We would like to think that the resilience of their respective banking sectors during the recent global financial crisis stems in part from their progress in banking reform supported by our TA program.
17. Finally, I would like to express a most heartfelt thank you to the Japanese government, on behalf of the IMF, for its unequivocal support for the IMF’s TA program. I would like to take this opportunity to wish you all a productive and informative conference.