Opening Remarks at the High-Level Regional Symposium on “Monitoring and Managing Financial Stability: Lessons From and For the FSAP” Min Zhu, Deputy Managing Director, IMF
IMF News, December 9, 2011
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- Published: December 9, 2011
Global macro-financial environment and crisis dynamics
- Crisis evolution and current state:
- Began as a financial sector crisis, morphed into a sovereign debt crisis, and has become a crisis of confidence.
- Markets worry about an adverse feedback loop between sovereign risk and financial sector weaknesses.
- Big and bold political decisions are needed to reduce sovereign risk; increased efforts are needed to bolster financial systems in advanced and emerging economies.
- Key indicators and market moves:
- Euro Stoxx 50 index has dropped by more than 15 percent since the beginning of this year.
- MSCI world equity index is down nearly 7 percent for the year.
- VIX Index: Pre-crisis, 7/1/08: 23.65; Peak, 11/20/08: 80.86; [Today, 12/8/11]: 30.6.
- Sovereign and banking stress in Europe:
- Long-term yields on Spanish and Italian debt have risen to 6 percent.
- Market pressure on core European countries; German bund asset swap spreads reached levels not seen since the aftermath of the Lehman Brothers collapse.
- Some analysts estimate over €600 billion of maturing debt for next year. Market estimates suggest that of the €600 billion falling due, Germany accounts for €157 billion; Italy €206 billion; France €99 billion; and Spain €50 billion, with Netherlands, Belgium, Austria, Finland, Portugal and Ireland making up the rest.
- ECB funding to banks has increased by about €125 billion since June and by about €50 billion since September.
- European Banking Authority’s new 9 percent core tier 1 capital targets will be difficult for many banks to meet.
- European financial stocks have dropped by nearly a fifth since the beginning of this year; financial sector equity declines YTD (Dec 1): World (-21%); Europe (-19%); USA (-28%); Japan (-21%); Hong Kong (-25%); SKorea (-22%).
- Risk of deleveraging: banks may cut lending or sell assets, intensifying adverse feedback loops between the financial sector, the real economy, and fiscal positions.
- United States and other advanced economies:
- Revised estimate of third-quarter U.S. GDP growth: 2 percent.
- Political disagreement over fiscal policy increases uncertainty; failure of the U.S. super-committee raises the prospect of across-the-board spending cuts of $1.2 trillion.
- Japan: Japanese industrial production fell sharply in September; October PMI suggests moderate expansion in Q4 but growth prospects are not strong.
- United Kingdom: Forecast for economic growth in 2012 revised down to less than 1 percent; risk of recession if the euro area contracts.
- Spillovers to emerging economies, with emphasis on Asia:
- Emerging economies show stronger fundamentals but are not immune; vulnerabilities are increasing and potential spillovers from advanced economies are weakening their outlook.
- PMI manufacturing reports from China and India point to moderating activity relative to earlier in the year; weak trade numbers in smaller economies confirm slowing external demand.
- IMF spillover reports show Asia is highly vulnerable to shocks through the trade channel; Europe is a major export market for China, India, and the Philippines.
- Trade disruption with Europe and America would likely disrupt intra-regional trade because part of intra-regional trade is on the same supply chain as trade with Europe and America.
- Financial channel exposures: foreign investors play a significant role in Asian equity and bond markets; many Asian countries have sizeable exposures to European banks through trade credit lines, loan syndication, and other wholesale funding.
- Euro zone bank claims are greater than or just under 10 percent of GDP in 3 countries: Australia, New Zealand and Vietnam. For the NIEs, ASEAN countries, Japan and India the ratio is close to 5 percent. Euro zone bank claims on China are relatively small. Euro zone banks also supply almost 50% of Asia’s trade credit.
- Evidence of disengagement by some major European banks active in emerging markets could substantially affect credit supply; banks in emerging Asia continue deleveraging to build liquidity buffers.
Role, purpose, and recent evolution of the FSAP
- Purpose and history:
- Launched in 1999 in response to the Asian financial crisis; aimed at helping national authorities identify financial sector vulnerabilities and design longer-term policies and reforms.
- For advanced economies, FSAPs offer an opportunity to strengthen and reshape financial sectors; in emerging economies, FSAPs help prevent future crises.
- The FSAP is conducted jointly with the World Bank for emerging market and developing economies, with two components: a financial stability assessment by the Fund, and a financial development assessment by the Bank. For advanced economies, assessments are conducted by the Fund and focus on financial stability.
- Three core areas typically assessed by the FSAP:
- Assessment of the effectiveness of financial supervision against broadly accepted international standards, including preparedness to implement new standards such as Basel III.
- Assessment of the source, probability, and potential impact of key risks to macro-financial stability, including quantitative stress testing of banks and the broader financial system, qualitative assessment of authorities’ ability to monitor systemic risks, and the development of macroprudential policies.
- Assessment of authorities’ ability to manage and resolve financial crises, including contingency planning, financial safety nets, cross-border issues, and action plans for insolvent institutions.
- Recent changes and improvements:
- Participation had been voluntary until the previous year; G20 leaders decided to make FSAP mandatory for jurisdictions deemed “systemically important”.
- Mandatory FSAPs take place every five years to allow closer monitoring of members that may have the most impact on systemic stability.
- FSAP modernization bridges Article IV consultation and the FSAP, formally bringing financial sector issues to the core of the Fund’s bilateral surveillance.
- Improvements to the FSAP:
- More flexible, taking into account country-specific circumstances.
- Improved analytical toolkit covering a broader array of risks, macro-financial feedbacks, and cross-border spillovers.
- Strengthened “off-site” work to enhance continuity and effectiveness of “on-site” reviews.
FSAP uptake, effectiveness, and lessons learned
- Participation and demand:
- Since creation, 138 countries have volunteered to participate in the program (many more than once).
- About 35 FSAPs are currently under way or in the pipeline.
- Demand for FSAPs has risen sharply since the beginning of the 2007-08 financial crisis.
- In a recent survey, three-quarters of respondents indicated that they were satisfied, or very satisfied, with the overall usefulness of the FSAP.
- Findings on effectiveness:
- Internal analysis shows FSAP played a useful role as an independent review.
- Before the recent global financial crisis, FSAP assessments were able to pinpoint main sources of risk.
- FSAP teams adapted during the crisis to focus on crisis management, liquidity support arrangements, and cross-border contagion.
- FSAP recommendations have been helpful in mitigating some crisis consequences.
- Lessons and further needs:
- Assessments need to pay more attention to liquidity risks and cross-border/cross-market linkages.
- Warnings in FSAPs could be made more loud and clear when risks are identified.
- FSAP uptake in Asia:
- Only half of Asian IMF members have completed an FSAP so far—compared with all European member countries, 68 percent of countries in the Western Hemisphere, 81 percent of countries in the Middle East and Central Asia, and 59 percent of countries in Sub-Saharan Africa.
- Since the onset of the financial crisis, most Asian members with large financial sectors have completed the FSAP or have it in the pipeline.
- Recent FSAPs of China and Indonesia:
- Praised remarkable progress over the last decade in reforming financial systems, helping them weather the 2008 crisis.
- Gaps noted: China should broaden and deepen financial markets and services to create a more diversified and innovative financial sector based on commercial principles; Indonesia should enforce the rule of law and address weaknesses in transparency and governance.
Open questions, discussion topics, and next steps
- Policy and programmatic questions posed for discussion:
- Should the IMF encourage its members to conduct more FSAPs and FSAP updates?
- What about the resource constraints facing the IMF and the authorities?
- What is the best way to improve the FSAP (bottom-up versus top-down approach)?
- How can we tailor FSAPs to the needs of fast-growing emerging economies?
- Are we prepared for the major regulatory changes, including Basel III?
- Expected outcomes:
- The improved FSAP is expected to be an essential underpinning of global financial stability and a “win-win” that strengthens IMF surveillance and national authorities’ capacity to monitor and manage financial stability.
- Future FSAPs in the region are likely to become sources of best practices for others to follow.
- Delegates at the symposium will discuss these issues and are expected to derive valuable lessons to further develop the FSAP into an effective surveillance and crisis prevention tool.
Opening Remarks at the High-Level Regional Symposium on “Monitoring and Managing Financial Stability: Lessons From and For the FSAP”, Min Zhu, Deputy Managing Director, IMF, December 9, 2011.