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IMFSurvey Magazine: In the News

IMF Outlines Dire Consequences if World Fails to Act on Banks

Trade and industrial activity is falling sharply around the world because of the crisis and faltering consumer confidence (photo: Newscom)

Global financial crisis

IMF Outlines Dire Consequences if World Fails to Act on Banks

IMF Survey online

February 7, 2009

  • Restoring confidence key to recovery
  • Governments must intervene to cleanse bank balance sheets
  • Further action needed to restore demand, revive trade

IMF Managing Director Dominique Strauss-Kahn pressed governments around the world to act urgently and decisively to reverse a slump in global trade and industrial activity by cleaning up the banking system, restructuring the financial sector, and reviving the global economy in a coordinated manner.

He said in a speech at a meeting of South East Asian Central Banks (SEACEN) in Kuala Lumpur, Malaysia, that loss of confidence by investors, employers, and consumers was now the central problem. "Our central goal should be to restore it. At a global level, this means that governments and central banks need to act decisively so that investors once again feel confident about the solvency of financial institutions. And they should credibly commit to measures sufficient to eliminate the risk of a repeat of the Great Depression," Strauss-Kahn said.

A coordinated global response was needed to contain the crisis. "We saw in 2008 that piecemeal responses are not enough. This does not mean that all countries should do the same things, or that there is a "one size fits all" solution. But policy responses have to take into account the interconnectedness of national economies, and the fact that decisions taken in one country can have profound effects on others."

He blamed the crisis, which began in the subprime market in the United States and has since spread around the world, on "the opacity of financial markets, the greed of some bankers, [and] the complacency of regulators and policymakers."

Avoid protectionist solutions

Strauss-Kahn warned of the risks of protectionism and said it could be very damaging if countries adopted such measures. "Some countries are trying to make government support of banks conditional on their giving priority to domestic borrowers, to the detriment of financing across borders. This will hurt emerging economies, whose growth depends on access to foreign bank financing. It is protectionism in the financial markets, and its consequences could be as damaging and dangerous as the trade protectionism of the 1930s."

On January 28 the IMF released projections that show that global growth will be close to zero in 2009. It forecast recessions in most of the advanced economies. Asian growth is projected to fall to about 2½ percent. There are some prospects of a recovery in 2010, but even this will depend on strong policy action.

Strauss-Kahn said that action was needed across three fronts:

• Financial market measures, in order to get credit flowing again.

• Monetary and fiscal policy measures, to offset the abrupt fall in private demand.

• Liquidity support for some emerging market countries, to reduce the risk that growth in these countries grinds to a halt if key financing needs are not met.

Restoring stability to financial markets

Strauss-Kahn, who also attended celebrations marking the 50th anniversary of Malaysia's central bank, Bank Negara, said financial stability was essential to the recovery of the global economy.

Policymakers have already acted to address the immediate threats to systemic stability, through massive liquidity support. They have also extended deposit insurance and other guarantees.

But more must be done to address the underlying lack of confidence in the solvency of the system, which stems from a lack of confidence that past losses have been properly recognized, and now also concern about new losses—extending well beyond real estate—as the economy turns down.

He said the task for governments was to push the bank restructuring process forward—with an emphasis on cleansing balance sheets—using its authority to:

    • Re-examine bank balance sheets on a worst-case basis, determine the viability of various institutions, and restructure them if required. Authorities need to be ready to respond as needed, including full-fledged intervention.

    • Provide public support where necessary to banks that can be rehabilitated, in the form of capital, bad asset carve outs, and guarantees.

    • Sell or wind-up insolvent banks quickly, depending on whether any franchise value remains.

    • Establish new public resolution agencies to manage "bad assets" to maturity or sale.

The United States and Western Europe could learn from the previous experience of countries like Korea, Malaysia, Thailand, and also Sweden, which set up public resolution agencies, and often recovered a lot of public money.

"Even with these measures, it will take time to restore credit growth. They will also be expensive for governments. But you know very well that the costs of banking crises increase if problems are not addressed quickly. This is not the time for hesitation," Strauss-Kahn said.

Reviving demand

Strauss-Kahn repeated earlier IMF advice that while fixing the financial sector was essential, it was not enough, given the damaging feedback loop from weaker growth to financial stress. A combination of monetary and especially fiscal policies were required to restore aggregate demand.

"Of course, not every country can undertake fiscal stimulus. Some countries—both emerging and advanced economies—cannot finance higher deficits without great risk to their creditworthiness. Some will need to contract their budgets rather than expand them," he acknowledged. "But the fact that some advanced and emerging economies cannot or should not engage in fiscal stimulus, makes it all the more important that other countries do their part."

In addition to fiscal stimulus some countries, such as China, could do other things. He said China has room further fiscal stimulus, and could also rebalance demand toward private consumption by improving the social safety net, and especially social insurance and pensions, so that its citizens do not need such high precautionary savings. Allowing greater flexibility for its currency to appreciate over time would also help. In doing so, China could support both domestic demand and intra-regional trade, because more domestic demand from China would mean more exports for other Asian countries.

Support for crisis-hit countries

Strauss-Kahn said that the worst effects of the crisis on emerging economies, including Asian countries, were probably still to come, as the cuts in exports and drying up of capital flows feed through into countries' economies.

The IMF has already provided substantial support to Hungary, Ukraine, Pakistan, Iceland, Latvia and Belarus. It has also increased support to many low-income countries and was ready to do more, but would need adequate resources to do so.

The 185-member institution has said that it aims to double its lendable resources to around $500 billion.

Rebalancing IMF representation

As part of measures to restore the global economy, Strauss-Kahn said there was a need for a central body to assume leadership for responses to systemic risks in the global economy. The Group of Twenty (G-20) leading industrialized and emerging market economies were beginning to play this role, but the G-20 did not represent all countries.

"Can the IMF play this role?" he asked. "I think it can, but first we would need to address deficits in ownership and efficiency." He said the IMF member countries needed to implement recent agreements on rebalancing quota shares to give a greater say to emerging markets and low-income countries, and also to agree on a timetable for the next stage of quota reform. Quotas determine the voting power of members in the institution. Strauss-Kahn said he hoped both steps would be achieved in 2009.

In a press statement the SEACEN governors welcomed the call to double the size of the IMF's resources. They supported the idea of the Fund establishing co-financing schemes with regional groupings to address regional financing needs. Governors supported the more inclusive approach by the IMF to ensure that decision making on global issues takes into account the implications for emerging economies.

Comments on this article should be sent to imfsurvey@imf.org


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