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---

### Purpose and motivation
- Written to fill a gap in policy, academic, and commercial literatures on financial stability.
- Motivated in early 2003 after nearly 10 years of international capital market surveillance experience at the IMF.
- Aimed to produce a policy-oriented, analytical framework to:
  - Explain why financial stability matters and what it means.
  - Identify sources of risks and vulnerabilities in international monetary and financial systems.
  - Communicate the importance of financial stability to practitioners and policymakers.
  - Encourage development of operational frameworks for maintaining national and international financial stability.
- Work undertaken during a one-year sabbatical from the IMF.

### Scope and structure
- Preface, Acknowledgements, Abbreviations, and a Glossary.
- Part I: Foundations
  - Chapter 2: Money, Finance, and the Economic System
  - Chapter 3: Public Policy Aspects of Finance
  - Chapter 4: Efficiency and Stability
- Part II: Toward a Framework for Financial Stability
  - Chapter 5: Defining Financial Stability
  - Chapter 6: A Framework for Financial Stability
  - Chapter 7: The Role of Central Banks in Ensuring Financial Stability
- Part III: The Benefits and Challenges of Modern Finance
  - Chapter 8: Challenges Posed by the Globalization of Finance and Risk
  - Chapter 9: Systemic Challenges Posed by Greater Reliance on Over-the-Counter Derivatives Markets
  - Chapter 10: The Market for Credit Risk Transfer Vehicles: How Well Is It Functioning and What Are the Future Challenges?
  - Chapter 11: Systemic Implications of the Financial Market Activities of Insurance and Reinsurance Companies
  - Chapter 12: Ongoing National and Global Challenges
- Supporting material: List of Tables, List of Figures, List of Boxes, Bibliography, Index, About the Author.

### Key analytical aims and themes
- Develop a comprehensive analytical approach and policy paradigm for financial stability distinct from, but related to, monetary policy and supervision.
- Understand how calm market conditions can lead to turbulence and why market sentiment shifts often occur with little warning.
- Search continuously for new ways to identify "pot-holes"—sources of risks and vulnerabilities—in capital markets, especially in mature markets.
- Encourage adaptation and learning by private and official sectors to prevent and cope with financial difficulties and crises.
- Chapters 2, 3, 5, and 6 draw on material from IMF Working Papers WP/04/101, WP/04/120, and WP/04/187.
- Part III chapters built in part from earlier IMF publications: International Capital Markets (1995–2001) and Global Financial Stability Report (2002–2003).
- Collaborative material used with permission; specific coauthorships include Chapters 9–11 (Charlie Kramer, Burkhard Drees, Todd Smith, Peter Breuer) and Chapter 6 (Aerdt Houben and Jan Kakes).

### Nature of financial-stability analysis (observations and challenges)
- Financial-stability analysis remains more an art than a rigorous discipline; few widely accepted models exist for monitoring and assessing financial-system stability.
- Financial systems are seldom expressed rigorously; when included in macroeconomic models they often amount to one or two equations.
- Strong doubts exist that a single measurable target variable for financial stability can be identified analogous to an inflation target in monetary policy.
- The study proposes a practical, evolutionary framework rather than a final blueprint, acknowledging scope for more scientific and rigorous efforts.

### Key trends altering financial systems (selected findings and statistics)
- Financial deepening and scale:
  - United Kingdom: total financial assets grew from 110 percent of GDP in 1980 to 377 percent in 2000.
  - Germany: total financial assets grew from 182 percent of GDP in 1980 to 353 percent in 2000.
  - United States: total financial assets grew from 111 percent of GDP in 1980 to 257 percent in 2000.
  - Figure 1.1 (average of eight economies): total assets of financial institutions almost tripled relative to GDP between 1970 and 2000.
- Composition shifts and leverage:
  - Declining share of monetary assets and increasing share of nonmonetary assets; greater leverage of the monetary base.
  - Currency relative to GDP broadly stable or decreased in all countries except Japan.
  - In the United States, sizes of both M1 and M2 have fallen as financial innovation progressed.
  - Japan: increasing importance of narrow money in the 1990s may be attributable to incentives to hold money because of the financial sector’s fragile state and enduring deflationary pressures.
  - Figure 1.2: monetary aggregates decreased in relative importance while nonmonetary components increased rapidly (index, 1970 = 100, for 1970–2004).
- Integration across industries and borders:
  - Rise in financial conglomerates offering banking, underwriting, brokering, asset-management, and insurance products.
  - 1990s surge in mergers and acquisitions within the financial sector; in Europe roughly half the deals in this period were cross-border, cross-industry, or both.
  - Increasing size of cross-border transactions in bonds and equity relative to GDP; outstanding international debt securities surged over the past decades.
- Complexity and risk mobility:
  - Worldwide development of several types of derivatives since the mid-1980s:
    - Total notional amounts outstanding increased more than 40 times.
    - Number of derivative contracts increased fivefold.
- Selected tables and figures (numeric excerpts preserved exactly):
  - Table 1.2 Distribution of Financial Sector Mergers and Acquisitions, 1991–1999 (In percent)
    - Within border/within industry 80 53 64
    - Within border/cross industry 12 19 16
    - Cross border/within industry 6 21 14
    - Cross border/cross industry 2 8 5
    - Total 100 100 100
  - Table 1.3 Cross-Border Transactions in Bonds and Equities (In percent of GDP) — selected rows
    - United States — Bonds 4.0 9.4 63.6 93.9 139.0 188.0 161.4 208.4 262.1
    - United States — Equities 1.9 3.6 9.9 14.7 45.0 90.8 87.4 85.0 82.1
    - Japan — Bonds 2.2 9.8 115.3 72.9 63.7 70.2 73.7 73.8 77.8
    - Japan — Equities 1.1 4.4 14.9 9.6 17.2 36.5 36.7 33.1 35.3
    - Germany — Bonds 5.3 9.7 37.8 86.5 208.7 350.5 378.7 351.1 394.0
    - Germany — Equities 1.9 3.4 11.7 14.9 48.6 132.6 133.6 115.6 112.2
    - France — Bonds . . . 6.8 21.9 108.6 233.5 293.9 288.1 299.3 362.0
    - France — Equities . . . 2.4 12.1 16.9 56.1 150.7 140.2 138.1 154.0
    - Canada — Bonds 1.2 3.9 29.3 104.5 216.6 149.5 135.6 157.0 175.8
    - Canada — Equities 3.3 6.5 14.8 19.2 52.3 122.8 101.9 151.5 132.1
    - Italy 1 0.9 1.4 9.4 114.7 518.8 1,126.5 821.9 1,197.0 1,705.2
  - Table 1.4 Outstanding International Debt Securities by Nationality of Issuer (In percent of GDP)
    - United States 0.1 0.7 3.1 17.8 27.9 28.6
    - Japan 0.0 1.5 10.5 6.0 6.3 6.4
    - Germany 0.1 0.4 4.5 47.9 80.5 86.4
    - France 0.1 2.1 7.8 24.0 42.2 45.9
    - Italy 0.1 0.5 4.6 19.4 35.8 40.6
    - United Kingdom 0.2 2.3 14.9 40.8 63.0 68.0
    - Canada 0.2 13.4 18.6 27.9 31.0 29.9
    - Netherlands 0.6 2.4 13.0 79.4 112.6 118.6
    - Sweden 0.3 7.5 20.1 44.5 52.4 52.4
    - Switzerland 0.5 1.7 4.5 41.2 49.0 72.9
    - Belgium 0.4 2.1 15.0 57.3 82.5 85.9
  - Table 1.5 Exchange-Traded Derivative Financial Instruments: Notional Principal Amounts Outstanding and Annual Turnover — selected figures
    - Notional principal amounts outstanding (In billions of U.S. dollars)
      - Total 614.8 2,286.4 9,282.1 14,257.7 23,764.1 23,815.7 36,739.8 46,621.5
      - North America 514.6 1,264.4 4,852.3 8,167.9 16,203.2 13,693.8 19,504.0 27,612.3
      - Europe 13.1 461.4 2,241.3 4,197.4 6,141.3 8,800.4 15,406.1 16,307.9
      - Asia and Pacific 87.0 560.5 1,990.2 1,606.2 1,308.5 1,192.4 1,613.2 2,452.4
    - Annual turnover (In millions of contracts traded)
      - Total 314.9 478.2 1,211.6 1,646.1 2,802.0 4,216.8 5,911.7 6,144.6
      - North America 288.7 312.3 455.0 461.3 675.7 912.2 1,279.7 1,633.6
      - Europe 10.3 83.0 354.7 718.5 957.8 1,074.8 1,346.4 1,412.6
      - Asia and Pacific 14.3 79.1 126.4 331.3 985.1 2,073.1 3,111.5 2,847.5

### Historic episodes of market turbulence and crises (selected)
- 1992 Exchange rate crises involving Italy and the United Kingdom
- 1994 Bond market turbulence in Group of Ten countries
- 1994–95 Mexican (tesobono) crisis
- Failure of Barings
- 1996 Bond market turbulence in United States
- 1997 U.S. equity market correction
- 1997–98 Asian crises (Thailand, Indonesia, Republic of Korea)
- 1998 Russian default
- Long-Term Capital Management crisis and market turbulence
- 1999 Argentina and Turkey crises
- 2000 Global bursting of equity price bubble
- 2001 Corporate governance problems—Enron, WorldCom, Marchoni, Global Crossing, and so forth
- September 11 terrorist attacks
- 2001–2002 Argentina crisis and default
- Parmalat

### Gaps, challenges, and rationale for a framework
- No widely understood and accepted definition of “financial stability” exists.
- The discipline lacks a generally accepted and useful framework for: thinking about systemic financial-stability issues; monitoring and assessing financial stability in real time; preventing problems from becoming systemic; resolving crises; and designing policies to optimize net social benefits of finance.
- Financial crises are difficult to foresee; financial resilience in the early 2000s may reflect luck as much as successful policy design and surveillance.
- Modern finance yields enormous private benefits that depend on private-collective, publicly sanctioned, publicly mandated, and taxpayer-financed conventions, arrangements, and institutions; these social arrangements are prerequisites for effective finance.
- Market imperfections inherent in finance include:
  - Some financial services provide positive externalities while others provide negative externalities.
  - Some financial services are public goods.
  - There are information failures in the provision of financial services.
  - Financial contracts and markets are incomplete.
  - Competition is not always perfectly balanced.
- These imperfections can lead to underconsumption/underproduction of socially desirable financial activities and overconsumption/overproduction of socially undesirable ones; they can create and accumulate economic and financial imbalances that may threaten financial stability.

### Policy considerations and recommended reform directions
- Policy design principles:
  - Implement policies addressing market imperfections depending on significance of associated efficiency losses.
  - Provide incentives to supply and consume activities with positive externalities and public benefits, unless natural monopolies are present.
  - Minimize production and consumption arising from market imperfections that encourage undesirable activities.
  - Strive for policy cohesiveness to avoid offsetting benefits across interventions.
  - Implement only policies that provide clear and measurable net benefits—recognizing spatial and intertemporal tradeoffs and risks such as moral hazard and regulatory arbitrage.
- Specific reforms highlighted:
  - Realign private market incentives within firms to improve internal governance at the board level, management and risk controls, and incentive alignment across board, management, and staff.
  - Reevaluate regulatory incentives and their consistency with private market incentives—to reduce moral hazard.
  - Enhance disclosure by a wide range of financial and nonfinancial entities—to improve market discipline and monitoring.
  - Improve market transparency—to reduce asymmetries and adverse selection.
  - Enhance legal certainty where ambiguous, for example with close-out procedures for swaps, credit derivatives, and other complex structured financial instruments.
  - Develop and implement comprehensive, targeted frameworks for monitoring, assessing, and safeguarding financial stability.
  - Increase international cooperation and coordination in financial-system regulation, surveillance, and supervision—to reduce opportunities for regulatory arbitrage.

### Framework, organization, and intended readership
- The study proposes a basic framework for financial-stability analysis that develops:
  - a working definition of financial stability;
  - a broad practical framework for monitoring, assessing, and maintaining financial stability (extendable from national to international scope).
- Organization:
  - Part I: foundations for thinking about financial-stability issues.
  - Part II: working definition of financial stability and a broad monitoring/assessment framework.
  - Part III: ongoing challenges posed by structural financial changes (globalization, OTC derivatives, credit derivatives, insurance market activities).
- Intended readership: practitioners who safeguard financial stability—central bankers, supervisors, policymakers, and market participants—and aims to be accessible while stimulating academic debate and further research.

*Source: _sfs - Introduction and Summary*

### 1. Finance. 2. Banks and banking, Central. 3. Risk.  I. International

### Safeguarding Financial Stability: Theory and Practice — Garry J. Schinasi

### Purpose and motivation (Preface)
- Written to fill a gap in policy, academic, and commercial literatures on financial stability.
- Motivated in early 2003 after nearly 10 years of international capital market surveillance experience at the IMF.
- Aimed to produce a policy-oriented, analytical framework to:
  - Explain why financial stability matters and what it means.
  - Identify sources of risks and vulnerabilities in international monetary and financial systems.
  - Communicate the importance of financial stability to practitioners and policymakers.
  - Encourage development of operational frameworks for maintaining national and international financial stability.
- Work undertaken during a one-year sabbatical from the IMF.

### Scope and structure (Contents overview)
- Preface, Acknowledgements, Abbreviations, and a Glossary.
- Part I: Foundations
  - Chapter 2: Money, Finance, and the Economic System
  - Chapter 3: Public Policy Aspects of Finance
  - Chapter 4: Efficiency and Stability
- Part II: Toward a Framework for Financial Stability
  - Chapter 5: Defining Financial Stability
  - Chapter 6: A Framework for Financial Stability
  - Chapter 7: The Role of Central Banks in Ensuring Financial Stability
- Part III: The Benefits and Challenges of Modern Finance
  - Chapter 8: Challenges Posed by the Globalization of Finance and Risk
  - Chapter 9: Systemic Challenges Posed by Greater Reliance on Over-the-Counter Derivatives Markets
  - Chapter 10: The Market for Credit Risk Transfer Vehicles: How Well Is It Functioning and What Are the Future Challenges?
  - Chapter 11: Systemic Implications of the Financial Market Activities of Insurance and Reinsurance Companies
  - Chapter 12: Ongoing National and Global Challenges
- Supporting material: List of Tables, List of Figures, List of Boxes, Bibliography, Index, About the Author.

### Key analytical aims and themes
- Develop a comprehensive analytical approach and policy paradigm for financial stability distinct from, but related to, monetary policy and supervision.
- Understand how calm market conditions can lead to turbulence and why market sentiment shifts often occur with little warning.
- Search continuously for new ways to identify "pot-holes"—sources of risks and vulnerabilities—in capital markets, especially in mature markets.
- Encourage adaptation and learning by private and official sectors to prevent and cope with financial difficulties and crises.

### Methodology and sources
- Chapters 2, 3, 5, and 6 draw on material from IMF Working Papers WP/04/101, WP/04/120, and WP/04/187.
- Part III chapters built in part from earlier IMF publications: International Capital Markets (1995–2001) and Global Financial Stability Report (2002–2003).
- Collaborative material used with permission from coauthors and institutions; specific chapter contributions acknowledged (e.g., Chapters 9–11 coauthored with Charlie Kramer, Burkhard Drees, Todd Smith, Peter Breuer; Chapter 6 with Aerdt Houben and Jan Kakes).

### Practical orientation and intended readership
- Targeted at practitioners who safeguard financial stability: central bankers, supervisors, policymakers, and market participants.
- Designed to be accessible to practitioners and policymakers while stimulating academic debate and further research.
- Seeks to provide foundations for operationalizing assessment of financial stability.

### Notable embedded resources (as presented)
- Extensive tabular and graphical material, including:
  - Tables such as "Changes in Key Financial Aggregates", "Distribution of Financial Sector Mergers and Acquisitions, 1991–1999", "Exchange-Traded Derivative Financial Instruments: Notional Principal Amounts Outstanding and Annual Turnover".
  - Figures such as "Composition of Key Financial Aggregates in 1970 and 2000", "Growth of Key Financial Assets, 1970–2004", and "Framework for Maintaining Financial System Stability".
  - Boxes covering practical episodes and concepts (e.g., "Prisoner’s Dilemma", "Remedial Action: Dutch Housing Market Boom in the 1990s", "Crisis Resolution: Terrorist Attacks on September 11, 2001", "Long-Term Capital Management and Turbulence in Global Financial Markets").

### Abbreviations highlighted (selected)
- ART, CDO, CDS, CFTC, CLS, ERISA, FA, FSAP, GDP, GIC, GKO, HKMA, IAIS, ISDA, LIBOR, LTCM, NDF, OCC, OFZ, OTC, SAR, SEC, SPV, TARGET

*Source: Safeguarding Financial Stability: Theory and Practice, Garry J. Schinasi — excerpted material from the provided PDF content unit.*

### Introduction and Summary

### Introduction and Summary

### Objective and structure of the book
- Objective: develop and present a framework for safeguarding financial stability.
- Structure:
  - Part I: reviews logical foundations linking finance to real economic processes and argues finance provides public goods requiring private-collective and public policy action.
  - Part II: proposes and develops a comprehensive and practical framework for safeguarding financial stability encompassing both prevention and resolution of financial imbalances, problems, and crises.
  - Part III: examines ongoing real-world challenges to financial stability posed by structural financial changes such as globalization of finance, growing reliance on over-the-counter derivative instruments and markets, growth of credit derivatives markets, and capital market activities of insurance and reinsurance companies.

### Core questions and analytical challenges
- Key questions the book addresses:
  - Does financial stability require sound institutions, stable markets, absence of turbulence, and low volatility—or something more fundamental?
  - Can stability be achieved and maintained through individual private actions and unfettered market forces alone?
  - What is the role of the public sector versus private-collective action in fostering financial stability?
  - Is a proactive public-sector role necessary to achieve the full private and social benefits of finance?
  - Is there a consensus on how to achieve and maintain financial stability?
- Major analytical challenge: no single, widely accepted framework or definition of financial stability exists, impeding development of monitoring, assessment, and policy frameworks analogous to those for monetary or macroeconomic stability.
- Implication: safeguarding financial stability requires a practical framework that promotes continuous development and use of both analytical tools and policy analyses.

### Nature of financial-stability analysis
- Current state: financial-stability analysis is more an art than a rigorous discipline; few widely accepted models exist for monitoring and assessing financial-system stability.
- Observations:
  - Financial systems are seldom expressed rigorously; when included in macroeconomic models they often amount to one or two equations within larger models.
  - There are strong doubts that a single measurable target variable for financial stability can be identified analogous to an inflation target in monetary policy.
- The study’s approach: proposes a practical framework for safeguarding financial stability, intended as an evolutionary step rather than a final blueprint, with recognition of the scope for more scientific and rigorous efforts.

### Increasing importance of financial stability issues
- Evidence of rising prominence:
  - Since the early 1990s, safeguarding financial stability has become an increasingly dominant objective in economic policymaking.
  - More than a dozen central banks and several international financial institutions (including the IMF, the Bank for International Settlements [BIS], and the World Bank) launched periodic financial stability reports.
- Drivers of increased emphasis:
  - Expansion, liberalization, and globalization of financial systems have increased the possibility of larger adverse consequences of financial instability on economic performance.

### Key trends altering financial systems (selected findings and statistics)
- Financial deepening and scale:
  - In advanced economies total financial assets now represent a multiple of annual economic production.
  - Examples (total assets in financial institutions, percent of GDP):
    - United Kingdom: grew from 110 percent of GDP in 1980 to 377 percent in 2000.
    - Germany: grew from 182 percent in 1980 to 353 percent in 2000.
    - United States: grew from 111 percent in 1980 to 257 percent in 2000.
  - Growth of assets in equity and bond markets described as “phenomenal.”
  - Broad measures of total financial assets involve some double counting due to claims between financial institutions; mutual holdings are relevant because they represent links, interactions, and complexities.
- Composition shifts and leverage:
  - Declining share of monetary assets (aggregates) and increasing share of nonmonetary assets; greater leverage of the monetary base.
  - Currency relative to GDP broadly stable or decreased in all countries except Japan.
  - In the United States, sizes of both M1 and M2 have fallen as financial innovation progressed.
  - Japan: increasing importance of narrow money in the 1990s may be attributable to incentives to hold money due to the financial sector’s fragile state and enduring deflationary pressures.
- Growth illustrated:
  - Figure 1.1 (average of eight economies) shows total assets of financial institutions almost tripled relative to GDP between 1970 and 2000.
  - Figure 1.2 shows monetary aggregates decreased in relative importance while nonmonetary components increased rapidly (index, 1970 = 100, for 1970–2004).
- Integration across industries and borders:
  - Financial institutions now encompass a broader range of activities beyond traditional deposit-taking and lending.
  - Rise in financial conglomerates offering banking, underwriting, brokering, asset-management, and insurance products.
  - 1990s surge in mergers and acquisitions within the financial sector; in Europe roughly half the deals in this period were cross-border, cross-industry, or both.
  - Increasing size of cross-border transactions in bonds and equity relative to GDP; outstanding international debt securities surged over the past decades.
- Complexity and risk mobility:
  - Greater intricacy of financial instruments, diversity of activities, and mobility of risks due to deregulation, liberalization, and financial innovation.
  - Worldwide development of several types of derivatives since the mid-1980s:
    - Total notional amounts outstanding increased more than 40 times.
    - Number of derivative contracts increased fivefold.
  - Greater complexity and higher mobility of risks make it more difficult for market participants, supervisors, and policymakers to track risk development within the system and over time.

### Implications for policymakers and surveillance
- These trends have contributed substantially to economic efficiency but have important implications:
  - Altered nature of financial risks and vulnerabilities.
  - Increased potential impact of financial instability on real economies.
  - Heightened need for policymaker roles in promoting financial stability, including monitoring, assessment, and appropriate public-sector and private-collective responses.

*Source: _sfs - Introduction and Summary*

### INTRODUCTION ANDSUMMARY

### _sfs - INTRODUCTION ANDSUMMARY

### Background and motivation
- Global financial systems in the 1990s and early 2000s were exposed to repeated episodes of:
  - asset-price volatility and misalignments;
  - volatile if not unsustainable financial and capital flows;
  - extreme market turbulence, at times leading to concerns about potential systemic consequences;
  - a succession of costly country crises in 1994–95, 1997, 1998, 1999, and in the early 2000s.
- These stresses occurred within both advanced countries with highly sophisticated financial markets and developing countries with financial systems of varying degrees of immaturity and dysfunction.
- Policy-makers at major central banks, supervisory authorities, and the IMF intensified efforts to understand and reform national and international financial architectures; monitoring efforts were stepped up both nationally and internationally.
- The IMF strengthened surveillance of member countries’ macroeconomic policies, assessed national financial systems’ compliance with international financial standards and codes (under the Financial Sector Assessment Program implemented jointly with the World Bank), and enhanced multilateral surveillance of the global economy and financial system.
- There is a general sense that policy responses are likely to require coordination between a greater number of authorities from a greater number of countries.

### Common practitioner understandings about finance and financial stability
- Finance is fundamentally different from other economic functions such as exchange, production, and resource allocation.
- Finance contributes importantly to economic development, growth, efficiency, and social prosperity.
- Financial stability is an important social objective—a public good—even if it is not widely seen as being on par with monetary stability.
- Monetary and financial stability are closely related, if not inextricably intertwined, even though there is no consensus on why this is so.

### Market data and structural change (selected numeric excerpts from source)
- Figure 1.3: Financial Sector Mergers and Acquisitions, 1990–1999 (Number of mergers and acquisitions in Group of Ten countries) — source: Group of Ten, 2001.
- Table 1.2. Distribution of Financial Sector Mergers and Acquisitions, 1991–1999 (In percent)
  - North AmericaEuropeJapan and Australia
  - Within border/within industry805364
  - Within border/cross industry121916
  - Cross border/within industry62114
  - Cross border/cross industry285
  - Total100100100
  - Source: Group of Ten, 2001.
- Table 1.3. Cross-Border Transactions in Bonds and Equities (In percent of GDP) — selected rows
  - United States
    - Bonds 4.0 9.4 63.6 93.9 139.0 188.0 161.4 208.4 262.1
    - Equities 1.9 3.6 9.9 14.7 45.0 90.8 87.4 85.0 82.1
  - Japan
    - Bonds 2.2 9.8 115.3 72.9 63.7 70.2 73.7 73.8 77.8
    - Equities 1.1 4.4 14.9 9.6 17.2 36.5 36.7 33.1 35.3
  - Germany
    - Bonds 5.3 9.7 37.8 86.5 208.7 350.5 378.7 351.1 394.0
    - Equities 1.9 3.4 11.7 14.9 48.6 132.6 133.6 115.6 112.2
  - France
    - Bonds . . . 6.8 21.9 108.6 233.5 293.9 288.1 299.3 362.0
    - Equities . . . 2.4 12.1 16.9 56.1 150.7 140.2 138.1 154.0
  - Canada
    - Bonds 1.2 3.9 29.3 104.5 216.6 149.5 135.6 157.0 175.8
    - Equities 3.3 6.5 14.8 19.2 52.3 122.8 101.9 151.5 132.1
  - Italy 1 0.9 1.4 9.4 114.7 518.8 1,126.5 821.9 1,197.0 1,705.2
  - Sources: Bank for International Settlements; and national balance of payments data.
  - Note: Gross purchases and sales of securities between residents and nonresidents. 1 No breakdown between bonds and equities is available.
- Table 1.4. Outstanding International Debt Securities by Nationality of Issuer (In percent of GDP)
  - 1970 1980 1990 2000 2003 2004
  - United States 0.1 0.7 3.1 17.8 27.9 28.6
  - Japan 0.0 1.5 10.5 6.0 6.3 6.4
  - Germany 0.1 0.4 4.5 47.9 80.5 86.4
  - France 0.1 2.1 7.8 24.0 42.2 45.9
  - Italy 0.1 0.5 4.6 19.4 35.8 40.6
  - United Kingdom 0.2 2.3 14.9 40.8 63.0 68.0
  - Canada 0.2 13.4 18.6 27.9 31.0 29.9
  - Netherlands 0.6 2.4 13.0 79.4 112.6 118.6
  - Sweden 0.3 7.5 20.1 44.5 52.4 52.4
  - Switzerland 0.5 1.7 4.5 41.2 49.0 72.9
  - Belgium 0.4 2.1 15.0 57.3 82.5 85.9
  - Sources: Bank for International Settlements; and IMF, World Economic Outlook database.
  - Notes: 1 Figure in 1970 column is from 1971. 2 Figure in 1970 column is from 1972.
- Table 1.5. Exchange-Traded Derivative Financial Instruments: Notional Principal Amounts Outstanding and Annual Turnover — selected figures
  - Notional principal amounts outstanding (In billions of U.S. dollars)
    - Total 614.8 2,286.4 9,282.1 14,257.7 23,764.1 23,815.7 36,739.8 46,621.5
    - North America 514.6 1,264.4 4,852.3 8,167.9 16,203.2 13,693.8 19,504.0 27,612.3
    - Europe 13.1 461.4 2,241.3 4,197.4 6,141.3 8,800.4 15,406.1 16,307.9
    - Asia and Pacific 87.0 560.5 1,990.2 1,606.2 1,308.5 1,192.4 1,613.2 2,452.4
  - Annual turnover (In millions of contracts traded)
    - Total 314.9 478.2 1,211.6 1,646.1 2,802.0 4,216.8 5,911.7 6,144.6
    - North America 288.7 312.3 455.0 461.3 675.7 912.2 1,279.7 1,633.6
    - Europe 10.3 83.0 354.7 718.5 957.8 1,074.8 1,346.4 1,412.6
    - Asia and Pacific 14.3 79.1 126.4 331.3 985.1 2,073.1 3,111.5 2,847.5
  - Source: Bank for International Settlements.

### Historic episodes of market turbulence and crises (Table 1.6)
- 1992 Exchange rate crises involving Italy and the United Kingdom
- 1994 Bond market turbulence in Group of Ten countries
- 1994–95 Mexican (tesobono) crisis
- Failure of Barings
- 1996 Bond market turbulence in United States
- 1997 U.S. equity market correction
- 1997–98 Asian crises (Thailand, Indonesia, Republic of Korea)
- 1998 Russian default
- Long-Term Capital Management crisis and market turbulence
- 1999 Argentina and Turkey crises
- 2000 Global bursting of equity price bubble
- 2001 Corporate governance problems—Enron, WorldCom, Marchoni, Global Crossing, and so forth
- September 11 terrorist attacks
- 2001–2002 Argentina crisis and default
- Parmalat

### Gaps, challenges, and the need for a framework
- Despite progress in monitoring, standards, and academic literature, financial-stability analysis remains in a formative stage compared with macroeconomic and monetary analysis.
- No widely understood and accepted definition of “financial stability” exists.
- The discipline lacks a generally accepted and useful framework for: thinking about systemic financial-stability issues; monitoring and assessing financial stability in real time; preventing problems from becoming systemic; resolving crises; and designing policies to optimize net social benefits of finance.
- Financial crises are difficult to foresee; financial resilience in the early 2000s may reflect luck as much as successful policy design and surveillance.
- A possible reason for lack of consensus is absence of a widely accepted logical foundation for why private finance should be the purview of collective action and public policy.
- Modern finance yields enormous private benefits that depend on private-collective, publicly sanctioned, publicly mandated, and taxpayer-financed conventions, arrangements, and institutions; these social arrangements are prerequisites for effective finance.
- Market imperfections inherent in finance include:
  - Some financial services provide positive externalities while others provide negative externalities.
  - Some financial services are public goods.
  - There are information failures in the provision of financial services.
  - Financial contracts and markets are incomplete.
  - Competition is not always perfectly balanced.
- These market imperfections can lead to underconsumption/underproduction of socially desirable financial activities and overconsumption/overproduction of socially undesirable ones; they can create and accumulate economic and financial imbalances that may threaten financial stability.

### Policy considerations and trade-offs
- Private-collective and public actions could be designed to address each source of market imperfection, depending on the significance of associated efficiency losses.
- Policies should aim to provide incentives to supply and consume more activities that provide public benefits and positive externalities, open new markets, and increase competition, unless natural monopolies are present.
- For market imperfections encouraging undesirable activities, policies should minimize production and consumption resulting from these failures.
- Policy design should strive for cohesiveness so that a policy addressing one market imperfection does not offset benefits of another policy.
- Desirability of collective intervention is clearer when a market imperfection poses a significant threat to financial stability.
- The literature rarely distinguishes clearly between sources of market imperfections that threaten stability and those that do not.
- A practical rule suggested: implement only policies that provide clear and measurable net benefits—recognizing spatial and intertemporal tradeoffs and risks such as moral hazard and regulatory arbitrage.
- Ultimately, whether to intervene is a social and political decision requiring consideration of costs, benefits, intertemporal effects, and political feasibility.

### Specific objectives and organization of the study
- The study proposes a basic framework for financial-stability analysis, developing:
  - a working definition of financial stability;
  - a broad practical framework for monitoring, assessing, and maintaining financial stability (extendable from national to international scope).
- The study is divided into three parts:
  - Part I presents foundations for thinking about financial-stability issues.
  - Part II develops a working definition of financial stability and a broad framework for monitoring, assessing, and ensuring it.
  - Part III examines ongoing challenges to financial stability posed by relatively recent structural financial changes, drawing on parts of the framework presented.
- Chapter 2 (Part I) lays out the essence of modern finance as the temporary transfer of the liquidity and payment services of money in return for a promise to return a greater amount of money; human trust in financial relationships is the source of finance’s strengths (efficiency gains) and weaknesses (fragility).

*Source: _sfs - INTRODUCTION ANDSUMMARY (PDF).*

### INTRODUCTION ANDSUMMARY

### INTRODUCTION ANDSUMMARY

### Purpose and conceptual focus
- Examines the manner in which finance does or does not enhance the efficiency and effectiveness of other real economic processes, particularly intertemporal economic processes such as production, wealth accumulation, economic development and growth, and ultimately social prosperity.
- Notes that precise measurement of finance’s contribution to these processes is extremely difficult if not impossible.
- Develops a simple logic drawn from disparate literatures and applies concepts from the economics of the public sector to finance (see Chapter 3), identifying sources of market imperfections in finance and justifying a role for both private-collective and public policy involvement.
- Argues that both fiat money and finance have the potential to convey significant positive externalities and the characteristics of a public good.

### Efficiency versus stability
- Chapter 4 clarifies the economic meaning of efficiency and stability.
- Emphasizes that not all market imperfections in finance necessitate private-collective or public policy responses; desirability of intervention depends on the size and importance of the imperfection with regard to its impact on efficiency.
- Distinguishes between volatility, fragility, and instability, drawing on experience in the 1990s and early 2000s with market turbulence and country crises.

### Part II — Framework for financial-stability policy and practice
- Develops a broad policy-oriented framework for assessing and safeguarding financial stability and for resolving problems when they arise.
- Framework is applicable to a wide variety of existing ways of managing financial system policies in various countries.
- Chapter 5 develops a working definition of financial stability in terms of economic processes—in principle, measurable ones—and identifies several practical implications of the definition for financial-stability work.
- Chapter 6 proposes a generic framework for financial-stability monitoring, assessment, and policy that is generic in three senses:
  - It encompasses all the important aspects of financial systems (institutions, markets, and infrastructure).
  - Its implementation entails monitoring, analytical assessments, and policy adjustments when necessary.
  - It remains at a general level that allows it to be an umbrella framework for most existing frameworks.
- Chapter 6 also identifies remaining analytical and measurement challenges.
- Chapter 7 discusses the role of central banks in ensuring financial stability, which in many countries might be a natural or special role.

### Part III — Structural changes, risks, and targeted analyses
- Identifies and analyzes ongoing challenges to financial efficiency and stability posed by relatively recent structural changes in national and global finance.
- Notes that each structural change likely improves financial efficiency but may pose new risks or redistribute existing risks in poorly understood ways.
- Sequencing of chapters moves from general to specific:
  - Chapter 8: examines the stability implications of the globalization of finance and financial risk for national financial systems and the international financial system.
  - Chapter 9: examines the potential for instability in national and global financial markets related to the growing reliance on over-the-counter derivatives instruments and markets.
  - Chapter 10: examines implications for financial stability of the increased reliance on efficiency-enhancing risk transfer mechanisms, focusing in particular on credit derivatives.
  - Chapter 11: examines supervisory, regulatory, and perhaps systemic challenges raised by the now greater role of insurance companies (and implicitly of other institutional investors) in financial and capital market activities.

### Consolidation of challenges and reform direction (Chapter 12 and overarching conclusion)
- Chapter 12 collects the main challenges to financial stability discussed in the book and likely to be faced in the future.
- Concludes strongly that further and continuous reforms are desirable and should aim to strike a better balance between relying on market discipline and relying on official or private-collective action.
- Identifies heterogeneity in country needs:
  - In some countries—most of them advanced countries with mature markets—a rebalancing toward relying more on market discipline is desirable.
  - In other countries—many of them with poorly developed markets—strong efforts are needed to improve the financial infrastructure through private-collective and government expenditures and commitments and to target the role of government to enhance the effectiveness and efficiency of market mechanisms for finance.

### Specific areas where reforms are most needed
- a realignment of private market incentives, including within firms—to improve internal governance at the board level, to improve management and risk controls, and to improve the alignment of incentives at the board, management, and staff levels;
- a reevaluation of regulatory incentives and their consistency with private market incentives—to reduce moral hazard;
- enhancements to disclosure by a wide range of financial and even nonfinancial entities—to improve the potential for effective market discipline and to improve private-collective and official monitoring and supervision;
- improvements to market transparency—to reduce asymmetries in markets and the tendency toward adverse selection;
- an enhancement to legal certainty where it is still ambiguous, such as with close-out procedures for swaps, credit derivatives, and other complex structured financial instruments;
- the development and implementation of comprehensive and appropriately targeted frameworks for monitoring, assessing, and safeguarding financial stability to better ensure financial stability and restore it when this fails;
- an increase in international cooperation and coordination in financial-system regulation, surveillance, and supervision—to eliminate international gaps in information and analysis and to reduce, if not eliminate, opportunities for regulatory arbitrage.

*Source: _sfs - INTRODUCTION ANDSUMMARY*

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_Source: https://www.imf.org/-/media/websites/imf/imported-publications/external/pubs/nft/2005/sfs/eng/_sfs.pdf_