Transcript of a Press Briefing on the International Monetary Fund’s Global Financial Stability Report

By José Viñals, Financial Counsellor and Director of the Monetary and Capital Markets Department, with Jan Brockmeijer, Deputy Director, Monetary and Capital Markets Department, and Peter Dattels, Chief of Global Market Monitoring
April 20, 2010
Washington, DC

Webcast of the press briefing Webcast

MR. MURRAY: Good day. I am William Murray, Chief of Media Relations at the IMF. This is our latest briefing on the Global Financial Stability Report. It is live and on the record. Journalists are here at IMF Headquarters and watching via our online Media Briefing Center. Welcome.

José will have some brief opening remarks, which we will make available at the conclusion today, and then we will take your questions. José.

MR. VINALS: Thank you very much, Bill, and good morning to you all. Let me begin with our overall assessment of global financial stability.

In this edition of the report, we find that risks to stability have eased. The policy stimulus enacted at the height of the crisis has provided substantial support to financial institutions and markets, and underpinned the global economic recovery. This has helped to improve a broad range of risk indicators and financial institutions.

Yet risks remain elevated. Global financial stability has not been secured as the recovery is still fragile and the repair of consumer and financial balance sheets is still ongoing. Furthermore, there are concerns over rising sovereign risks related to the build-up of public debt that need to be carefully monitored and addressed.

Turning now to the banking system, the news is encouraging, as improving economic and financial market conditions reduce expected write downs. Our estimate of global write downs for banks has improved by around $500 billion, from $2.8 trillion to $2.3 trillion, and two thirds of these estimated write downs have been realized so far. Additionally, banks' capital ratios in Europe and in the United States are stronger, as banks have raised capital and enjoyed a temporary boost in earnings.

However, this improvement in the aggregate picture masks pockets of weak banks with smaller capital buffers, with high risks of further asset deterioration, and that display chronically low profitability due to overcapacity in the financial system. Moreover, banks around the world now would face significant funding challenges amid a wall of maturing debt, including almost $5 trillion coming due in the next three years.

As a result of these ongoing pressures in banking systems, the recovery in credit is likely to be slow, shallow, and uneven. Credit capacity would continue to be weak as capital markets only partially offset weak credit growth from banks. Moreover, ballooning sovereign borrowing needs and low credit supply could potentially lead to higher interest rates or less credit availability for the private sector.

Let me now turn to the issue of sovereign risk. Following the crisis, the substantial increase in public debt and sharply higher sovereign risks are the most important challenges we flag in our report. Although much attention has been paid to Greece in this regard, fiscal concerns are not confined to one country. In particular, the average debt-to-GDP ratio of the major advanced economies is nearing its highest level since the Second World War without experiencing a world war.

Indeed, the credit spreads of sovereigns have already widened in some economies as longer run fiscal solvency concerns have been telescoped into short-term funding strains. Worries about default risks have risen and could undermine financial stability, especially if sovereign shocks are transmitted across borders or to banking systems.

Now I would like to turn to emerging markets and the challenges associated

with strong portfolio capital inflows into these economies. Clearly, the recovery in portfolio flows after their sharp collapse during the height of the crisis is a welcome development, but for some countries there is a risk that the volume of these flows may become "too much of a good thing."

Historically, a combination of strong capital inflows, asset price increases, and credit accumulation have led to serious financial imbalances. Currently, we do not observe excessive credit or asset valuations system wide. However, some hot spots have emerged, exhibiting elevated credit growth or asset prices.

So, what are our key policy messages? We have four.

The first is that careful management of sovereign risks is essential not only for the sustainability of public finances, but also for financial stability. Policymakers must develop and communicate credible plans for achieving medium-term fiscal sustainability, combined with stronger fiscal institutions and improved public management frameworks, as well as other measures to mitigate the transmission of sovereign risks through financial channels.

Failure to take timely action to reduce sovereign risks could extend the crisis into a new phase, as we begin to reach the limits of public sector support for the financial system and the economy.

The second policy priority is to ensure a smooth deleveraging process that results in a safer, competitive, and vibrant financial system. Rebuilding capital buffers and securing stable funding for banks are necessary to provide adequate credit supply to support the recovery. Nonviable banks should be resolved swiftly and viable ones restructured to ensure that, once public support measures are removed, a healthy core of viable financial institutions remains. In the interim, policies may still be needed to sustain an adequate flow of credit to the private sector, including support for safe securitization and a careful exit from extraordinary monetary and financial support measures.

Our third policy message relates to capital inflows. Policymakers in countries receiving strong capital flows will need to employ a wide range of tools to address the risks of rapid asset price increases and credit accumulation. Macro policy adjustments and prudential measures are the main lines of defense. In some circumstances, temporary capital controls could also be considered. However, in all cases, an effective policy response must take a medium-term view to preserve the benefits of globalization, while ensuring lasting macroeconomic and financial stability in the liquidity-receiving countries.

Our last, but by no means least, policy message is that we need to continue pushing for policies and reforms that establish the basis for a safer, competitive, and vibrant financial system. On the regulatory front, there are a host of initiatives under way to improve capital and liquidity buffers, to enhance risk management, to address procyclicality, to reduce the likelihood and costs of the failure of systemic institutions, and to strengthen market infrastructures. What is important now is that these initiatives are agreed and then implemented in a timely, effective, and—very importantly—internationally consistent manner.

In conclusion, in spite of recent improvements in the outlook and the health of the global financial system, stability is not yet assured. If the legacy of the present crisis and emerging sovereign risks are not addressed, we run the real risk of undermining the recovery and extending the financial crisis to a new phase.

We can avoid this outcome with appropriate policy actions to restore the health of sovereign balance sheets and financial institutions. This must be accompanied by the regulatory reforms needed to move to a safer and more resilient global financial system. So, in conclusion, now is the time to ensure stability and to promote reform.

Let me conclude here. My colleagues and I would be happy to take any questions that you have. Thank you.

QUESTION; I want to start with Spain, if I may. You have this very interesting Appendix in the study on the banks in Spain and the savings banks. It is very technical, and I wonder if you could help me a little bit to understand it.

The message that I got from it is that you are pointing out some weaknesses in the savings banks, in the cajas. You mentioned that they may need 17 million euros in new capital if the crisis worsens. I wonder if you could explain a little bit how could they get that money. I mean, there are these legal limits to what they can do and how they can obtain capital, whether you are looking at the government or how can that issue be resolved.

Thank you.

MR. VINALS: Let me just go into answering your question. I think that the main message of this analysis that we do of some specific banking systems is to, in the case of Spain, for example, say that the system is fundamentally sound, that for the most part the banking system is fundamentally sound, but there are some pockets of weakness that need to be addressed.

The analysis that we do in Spain shows that, under a baseline scenario, the capital needs of commercial banks or savings banks to address the potential forthcoming losses linked to the deterioration of asset quality, nonperforming loans, and so on, that these needs are very small. It is 1 billion euros, American billions, for commercial banks, which is a very small quantity compared to the 99 billion euros of tier capital that they have, and 6 billion for savings banks, which is also very small compared to the $78 billion of Tier 1 capital that they have.

We also run an adverse scenario and in that adverse scenario, again, the numbers for commercial banks are very small. The numbers for savings banks are a little bit higher, 5 billion for commercial banks and 17 billion for savings banks.

Now, we think that these numbers are manageable; for the commercial banks, there is absolutely no problem to absorb those. For the savings banks, because these may be a little bit higher relative to the capital they have, around 20 percent, there are other things that need to be done. In Spain, there is the FROB, which is precisely the fund for restructuring that was set up by the authorities to deal with these situations.

So, this is the time to use this vehicle which has been designed precisely to help the country restructure, be able to absorb these sort of expected losses, and then through a restructuring of the savings banks, to come out with a more consolidated savings bank sector that can provide support to the economic recovery once it gets under way.

So, the message there is that the problems are manageable but that the institutions need to make use of this FROB that has been designed. In that regard, it is very important that, in Spain, where cajas have a very strong link with regional local governments, that there is a unity of action in doing whatever is best for the national financial system. That would be very important, because that would be also what is best for the national economy and the general interest of their citizens.

QUESTION; Good morning. Would you identify Brazil as a hotspot regarding the capital flows, and would you recommend some kind of capital controls in Brazil, especially now that the central bank is poised to raise the interest rate?

MR. VINALS: Well, in the analysis that we have provided in the report, when we talk about hotspots, we talk about places where we see significant overvaluation in asset prices or residential real estate, equities, bonds, etc. The case of Brazil does not stand out in our report as one case where these problems are very large.

We think that there is some degree of slightly higher-than-average or historical average or equilibrium values for equity prices, but this is not something which is very far from these averages. The Brazilian authorities have already introduced some measures in terms of controls on capital inflows, so we do not have anything further to recommend to the authorities in this regard.

MR. MURRAY: I am going to turn to the Media Briefing Center. This is a question related to what is described as major economies' fiscal issues and financial stability.

With so many major economies needing fiscal retrenchment at the same time, how should policymakers try to calibrate that? Is there a risk to financial stability in having such a synchronized fiscal tightening cycle?

MR. VINALS: This is something which undoubtedly will need to take place over time. This is not something that is going to be done at once. This is part of a plan that in some economies will start next year. For those other economies which are more pressured by markets and the potential loss of reduction of market confidence, this is something that will have to be undertaken much sooner this year.

This is something which is going to take place over time. We think that it is fundamental that these policies to ensure the sustainability of public finances are undertaken in a timely manner in order precisely to avoid undermining global financial stability. So, we think that they are a must. If undertaken in a sufficiently careful manner and gradual manner, these should not lead into problems on the financial stability front. On the contrary, it would help on that front, as I have said.

QUESTION: I do not know if your analysis for the international financial system includes in the worst scenario the possibility that Greece has to restructure its debt.

MR. VINALS: Well, our analysis signals risks to financial stability, but our scenario is precisely that, if adequate policy action is taken, these tail risk scenarios could be avoided and should be avoided. I think that it is very encouraging that the Greek government is in the process of taking measures to reduce their fiscal deficits going forward and that this has been done within a cooperative dialogue with the European authorities, the European Central Bank, and the IMF.

So, we think that conditions exist precisely to effectively address the public finance problems in Greece in order to make sure that the right scenario turns out and not the wrong or very-difficult-to-swallow scenario. So, I am fully confident that this is going in the right direction.

MR. MURRAY: This is a question from the Media Briefing Center regarding sovereign debt levels. A reporter is asking for you to recap the main risks, given the current sovereign debt levels. His question is, What is the main risk of the higher sovereign debt levels for the stability of the international financial sector?

MR. VINALS: Well, if somehow these fiscal problems are left unaddressed, the main risk is that they can undermine global financial stability insofar as financial market investors may have doubts about the long-term solvency of public finances. This is something which, as I said during my introductory remarks, may telescope into funding strains.

That is something that would push up interest rates for the private sector. Also, for governments, this would further complicate the debt dynamics and would not allow the private sector to get credit on the terms that they need for the recovery. So, the risk is that you would extend the financial crisis going forward and that you would undermine the recovery.

Again, this is what makes us say that appropriate action to consolidate public finances through credible, well-designed, medium-term fiscal consolidation plans to improve public debt management by increasing wherever possible the maturity of the debt and taking some of the measures to reduce any potential spillovers of the fiscal situation on the financial system are the right measures precisely to contain and mitigate these risks.

QUESTION: We are talking about financial stability and I want to ask you something about Goldman Sachs. Do you think that the Goldman Sachs case can be any risk for financial stability and open maybe a new phase of the crisis? Do you think maybe that from Goldman Sachs we can have a new push for financial reform?

MR. VINALS: Well, let me not comment on the specifics of this case as it is still in process and the discussions are going on, and it is all very recent. I think that what this case highlights is that we live in a world where there are lots of derivatives, and derivatives are not very easily understood. So, it is very important that an effort is made to enhance the transparency in the derivatives market, that every effort is made to increase the information available to investors, and that appropriate action is taken to enforce these ideas.

If we talk about derivatives, let me just also take the opportunity to stress a very important message in our report, which is that going beyond issues which have to do with consumer protection and investor protection, I think it is very important that we take the steps to make market infrastructures safer and, in particular, to make derivatives safer. As you know, the total volume of derivatives in the world is about $600 trillion.

One thing that we are advocating in the report is that it would be very important that these derivatives are cleared through central counterparties and that many of these derivative contracts are adequately collateralized precisely to reduce risks. So, these are policies that we stress very much, because this would be like firewalls which prevent problems in any particular financial institution from spreading. I am not talking about Goldman; I am talking in general terms.

Lehman Brothers, for example, would not have had the same impact if we had had this more solid market infrastructures to trade derivatives, because many of these derivatives contracts would have been put either onto organized exchanges or cleared through central counterparties, and that would have provided a lot more resilience to the international financial system.

QUESTION: I just wonder if you could address the priorities on the financial reform agenda. Is there a concern that the discussions about the bank tax will kind of distract from so-called Basel III capital and liquidity ratio standards?

Thank you.

MR. VINALS: I do not think so. These are discussions that are going to be held in Washington in the meeting of the G-20. The proposals for the reform of Basel II to increase the capital and the liquidity buffers of banks is something which is well underway. Now, regulators are in the process of calibrating the economic impact, the impact on the banking system and on the economy as a whole of various possibilities concerning the ratios for capital and liquidity.

So, this is all well under way, and I do not think that having a discussion on financial taxation issues would be a distraction. I think that these issues have to be looked at as different parts of an overall package, because the Basel capital and liquidity buffers are fundamental to prevent crises while the idea behind the financial taxation, financial levies—different people have different terminologies—is that it is something that, while it should be designed to be consistent with good risk management on the part of institutions, it can be helpful to address the costs of financial crises by making the industry pay for the costs of resolving banking failures so that if an institution fails, it would be the industry which will absorb these losses in terms of the costs of resolution, and so on.

So, I think that they are directed at different things and I think that both can be discussed without one undermining the other.

MR. MURRAY: We are going to turn to the Media Briefing Center again. This is a question regarding funding pressures faced by banks. Could you discuss the pressure banks will face on funding? Are you saying that banks may shrink because revenue streams will not return to pre-crisis levels?

MR. VINALS: The funding pressures that banks are going to be facing over the next couple of years, this year and the next couple of years, have to do with the fact that during the crisis banks had to issue shorter-term debt because markets, investors were not willing to accept longer-term debt.

Now, this debt is now coming to maturity, so banks will be facing $5 trillion refinancing needs over the next 36 months. That is the important thing, and that would happen at a time when public debt issuance would be significantly higher than has been the norm in the past, and also, at the same time, as monetary and financial support would be gradually withdrawn by the authorities and the central banks in the exit strategies that they are implementing. That would make it more challenging for banks to secure funding, so it is very important that they take any opportunity that they can in order to lengthen the maturity of their debt.

MR. DATTELS: As part of the debt management strategy, what we are advising is that governments should issue, to the extent possible, to the longer tenors, which would leave a more room for banks to fund themselves in the one- to five-year area. It is also a focus of this report, that deleveraging is shifting from the asset side to the liabilities side of bank balance sheets. For that reason, weaker institutions need to be addressed so that overcapacity in the system is reduced in order to prevent pressures for competition for stable funding sources from driving up deposit rates and again putting pressure on intermediation and reducing, ultimately, the capacity for extending credit. So, these strategies are coordinated as part of ensuring a smooth deleveraging process.

MR. MURRAY: We are going to just take a few more questions and then wrap this up. Are there any more questions in the room or I can turn to the—we are all set? Okay.

This is a question [on the Media Briefing Center] regarding the sovereign debt restructuring mechanism.

In 2003, the IMF unsuccessfully came up with a proposal for a sovereign debt restructuring mechanism. With exploding state debt, the topic is hot again. Is there or will there be a new proposal for an SDRM? Does it play any role in the Annual Meeting?

MR. VINALS: And the answer is, in my personal opinion, no.

MR. MURRAY: Thanks. On that, I think we will wrap this up unless there is a last question in the room. No?

Thank you very much: José Viñals, Jan Brockmeijer, and Peter Dattels, and thank you all here and on the Media Briefing Center for joining us. Any follow-up questions, send an e-mail to Thanks.


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