Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey: Policymakers Need to Address Systemic Risk, says IMF

May 15, 2009

  • Framework for financial cooperation needed, says Strauss-Kahn
  • World economy to see recovery next year
  • Further tests for global economy ahead

Global cooperation in financial sector supervision needs to improve to address systemic risks, IMF Managing Director Dominique Strauss-Kahn said in a speech to bankers in Vienna.

Policymakers Need to Address Systemic Risk, says IMF

Warsaw Stock Exchange: Poland  received a Flexible Credit Line from the IMF to help bolster the country against the crisis (photo: Reuters/Kacper Pempel Poland).

Global Economic Crisis

He anticipated a recovery in the world economy next year, with the “beginning of the turning point in October, November, or December" this year.

Countries coordinated fiscal and monetary policy effectively during the crisis, said Strauss-Kahn, however weaknesses in cross border financial sector supervision and regulation, notably in the cases of the failure of investment bank Lehman Brothers and the collapse of the Icelandic banking system, showed there was still room to improve cooperation between national authorities.

Global set of rules

In a speech at the Austrian central bank on May 15, Strauss-Kahn said a first step would be to delineate a global set of rules-of-the-road to mitigate systemic risks.

“We need an agreed framework of cooperation for dealing with cross-border firms that would address conflicts of interest—this would include harmonizing national legislation where necessary,” said Strauss-Kahn.

He spelled out four areas for improved coordination in the financial sector:

• Regulation. Regulatory arbitrage must be avoided and key parts of prudential regulations must be applied consistently across countries and financial activities.

• Resolution tools. Common criteria need to be established for triggering early action when a firm is in trouble.

• Depositor and investor protection. Consistent protection for depositors and investors should be part of the framework.

• Information Sharing. Financial supervisors in home and host countries must be granted legal obligations and powers to share information among themselves and with local counterparts. The possibility of joint inspections should also be considered.

The IMF, through its surveillance work, would make sure the framework was translated into day-to-day practices and to check whether it was followed in a crisis.

Looking ahead, Strauss-Kahn said the IMF would focus surveillance on systemic risks “from all quarters,” and better monitoring the effects of policy decisions in monetary and fiscal policy on financial sectors, markets, and institutions.

Strauss-Kahn said the IMF is developing a vulnerability exercise covering both advanced and emerging market countries along with the Financial Stability Board. He said the early warnings must be “tough, and not shy away from naming and shaming”, when warranted.

Monetary and fiscal policy coordination

Looking back to the early days of the crisis, Strauss-Kahn said countries did not always respond effectively in a coordinated manner to unfolding events in the financial sector. The crisis exposed some clear fault lines and inconsistencies in regulatory systems across countries and clear conflicts of interests.

He said mistakes were made, but policymakers learned from their mistakes and are still learning.

In contrast, Strauss-Kahn, a former French finance minister, said countries’ central banks were quick to act and willing to jump in at the same time, which provided a needed boost to confidence.

When monetary policy alone proved insufficient to address the crisis, fiscal measures were deployed to avoid any erosion of the gains from the actions taken by central banks.

“Countries acted in a coordinated manner and moving together, they delivered a global fiscal stimulus of 2 percent of GDP in 2009, exactly what we had asked for a year ago,” said Strauss-Kahn.

Working in tandem, policymakers did the “same thing at the same time for the same reason,” an unprecedented achievement, he said.

Fiscal exit strategy

Noting the crisis is not over yet and further tests remain, Strauss-Kahn said countries need exit strategies from the policies put into play during the crisis, which will also require even greater coordination given the difficult choices involved.

“With fiscal policy, there is a time to sow and a time to reap, and loose policies today must go hand-in-hand with tight policies tomorrow. Complacency on this front will only lay the groundwork for serious fiscal solvency problems down the road,” he stated. “These exit strategies will also entail coordination—perhaps even greater coordination because the choices become more politically difficult. The big challenges lie ahead. Let’s not lose the momentum.”

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