De Rato tells IMF-World Bank Annual Meetings: "We have lived through an earthquake in the credit markets." (IMF photo)
ANNUAL MEETINGS ADDRESS
In his final speech to the gathering October 22 before leaving office at the end of the month, de Rato said downside risks are much higher than they were six months ago, due to the turbulence in credit markets. The international community needed to ensure that the regulatory infrastructure "is strong enough and simple enough to handle crises in a globalized world, he said."
De Rato was speaking on the final day of the 2007 Annual Meetings in Washington, which addressed issues that included the global response to the credit crisis, prospects for world economic growth, and progress with reform of the IMF. Former French finance minister Dominique Strauss-Kahn, who was selected last month to succeed de Rato, will take over November 1.
"Over the past few months, we have lived through an earthquake in the credit markets. Like most earthquakes, it has been distant for most people," de Rato said. But he warned there is still a risk of aftershocks, and the full effects of the disruption would only be felt over time. "We need to consider what actions we can take to limit the damage, and also what lessons we can learn from the crisis."
Lessons from credit crisis
De Rato's address followed the October 20 meeting of the IMF's policy guidance panel, the International Monetary and Financial Committee, which called for the Fund and other international institutions to distill lessons from the credit crisis and consider actions to prevent further turbulence and strengthen the foundations for sustained global growth.
De Rato identified five weaknesses exposed by the credit crisis:
• The crisis in the credit markets arose in part because investors did not exercise sufficient due diligence. But they were also impeded in exercising due diligence by a lack of transparency and disclosure about the risk profile of new structured credit instruments. "So we should look for low-cost ways of improving transparency in credit markets," de Rato said.
• Financial innovation seemed to have increased banks' abilities to move risks off their balance sheets, but not their ability to avoid taking them back on again. This suggested that assessments of banking soundness and capital by supervisors and ratings agencies should pay more attention to off-balance sheet exposures.
• Banks' growing reliance on securities markets for financing had increased their vulnerability to liquidity risk. Regulators needed to reflect this new reality in their assessments of liquidity requirements.
• In some areas, and especially in mortgage markets, the crisis had revealed a need for better consumer education and protection, and simpler disclosures. The main victims of the crisis so far had been those who were persuaded to buy houses they could not afford, and who were now losing their homes.
• The crisis had also demonstrated the importance of coordination between supervisors, regulators, central bankers, and finance ministries, and had also demonstrated, in some countries, a need to simplify the regulatory infrastructure.
In addition, he said, the credit crisis had revealed the range and the risks of financial globalization. Those at risk were not just loan originators in the United States, but banks in Germany and the United Kingdom, borrowers in eastern Europe, and ultimately exporters in Asia and Africa. This pointed to the vital importance of multilateral cooperation on financial market issues.
Multilateral discussions
"This is why it is important that the Fund, together with other multilateral agencies with relevant expertise, does its part," de Rato declared. He noted that the IMF had a global membership, which both provided a forum for multilateral discussions and gave authority to the outcomes of those discussions.
The IMF also had the instruments—from Article IV consultations with each member country to Financial Sector Assessment Programs—to provide the necessary perspective on economic and financial issues. And it had an independent staff accumulating a growing knowledge base, as was demonstrated when the IMF warned about the recent financial market risks before problems emerged.
De Rato said that the higher downside risks to the global economic outlook made action on already agreed policies more urgent. Major economies needed to recognize that global imbalances cannot be corrected by currency movements alone, he told the delegates. These countries needed to take supporting policy actions along the lines of a roadmap arising from the IMF's first multilateral consultation earlier this year that dealt with global imbalances.
IMF governance reform
Observing that reform of the IMF's governance is "a marathon, not a sprint," de Rato acknowledged that the IMF reform milestones passed during the past year were not as dramatic as those embodied in the Governors' Resolution at the 2006 Annual Meetings in Singapore, but they are, nevertheless, very important. "Of course, the reform process now needs to be completed, and we should not underestimate the challenge involved or the commitment required. But I believe that members will rise to the challenge."
The IMF hopes to reach broad agreement on improvements in representation for dynamic emerging market countries and low-income countries by next April, with the plan expected to be finalized by the Annual Meetings next year, according to the new chairman of the International Monetary and Finance Committee, Italian Economy and Finance Minister Tommaso Padoa-Schioppa.
Highlighting the first major revision in the IMF's surveillance framework in some 30 years, enacted in June, de Rato said the move reaffirmed that surveillance should be focused on the IMF's core mandate—promoting countries' external stability. It also reaffirmed the centrality of exchange rate analysis, an area where the IMF had been steadily stepping up its work. "I realize that reporting the outcome of our analysis of vulnerability and exchange rates sometimes involves telling an inconvenient truth," he said, "but we need to do it, while giving due respect to both the complexity and the sensitivity of the issues involved."
De Rato said the ability of the IMF to evolve was shown in the ways in which the Fund is changing in response to the changed world of financial globalization. "I see the reforms that we have begun under the Medium-Term Strategy as part of an evolutionary process, one that began before I came here and will continue after I leave." He added, "I have been privileged to serve as Managing Director for the last three and a half years, and I consider it to be one of the highest honors of my life."
