Financial Reform: What Must Be Done
IMF Blog, July 5, 2010
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Bibliographic details
- Authors: JosVials
- Published: July 5, 2010
Overview and context
- Author: José Viñals
- Date: July 5, 2010
- Key moment: The Group of Twenty (G-20) reaffirmed its commitment at a summit in Toronto on June 26-27 to a comprehensive reform agenda.
- Imperative: Seize the moment to press forward with comprehensive financial reform before political and fiscal pressures dilute efforts.
Five principal challenges
- First: Address both micro-prudential and macro-prudential dimensions of financial reform.
- Micro-prudential objective: Make individual financial institutions healthier.
- Current action: The Basel Committee is working on strengthening the bank capital and liquidity framework.
- Timing: Visible progress needs to be made by the time of the November G-20 summit in Seoul.
- Linkage: Successful macro-prudential implementation depends on correcting flaws in the micro-prudential framework.
- Second: Look beyond banks to nonbank financial institutions.
- Risk: The reform agenda has so far focused on banks; nonbanks and the shadow banking system risk being addressed too slowly.
- Requirement: Regulators, policy makers, and standard setters must speed up work on markets and products, and nonbank financial actors.
- Third: Strike the right balance among safety, efficiency, and regulatory certainty.
- Necessary action: Move ahead and finalize the core rules governing capital and liquidity to make the system safer and provide market certainty.
- Caution: Calibrate required levels of capital and liquidity cautiously and assess impacts—both individually and collectively—on the financial system and the overall economy before finalization.
- Objective: Avoid a system that is either inherently unstable or that imposes an excessive burden on the financial sector and the economy.
- Fourth: Ensure regulations are nationally appropriate and internationally consistent.
- Danger: Uneven adoption of the regulatory framework could lead to migration of risky activities to jurisdictions with easier requirements.
- Consequence: Migration would put those financial systems at risk and endanger the global financial system.
- Fifth: Reform supervision in addition to regulation.
- Principle: A rule is only of value if implemented correctly; quality of implementation depends on strong supervision.
- Shortcomings identified: Supervisors did not always take effective and timely action during the crisis.
- Necessary supervisor attributes: Powers, mandate, appropriate skills, resources, and the will to act.
- Cultural failings before the crisis: Many supervisors lacked an understanding of risks and/or the will to challenge institutions; they were too deferential to industry and not sufficiently objective and skeptical.
- Public and political support: Supervisors require support from policymakers, government, and the public, including political backing and public expectation that supervisors will take decisions independently.
- Role illustration: The supervisor’s job is “to take away the proverbial punch bowl just as the party is getting started,” and to require more conservative underwriting when a sector is becoming “frothy.”
- If consensus does not exist: Supervisors may lack necessary moral, political or legal support to be rigorous, thorough, skeptical, and to follow through with unpopular judgments and actions.
Implementation and institutional roles
- IMF focus: The IMF has intensified its focus on the quality of supervision in its regular financial sector surveillance.
- Collaboration: The IMF will work with the Financial Stability Board (FSB) and others to develop specific recommendations to strengthen oversight and supervision.
- G-20 stance: The G-20 has declared enhanced supervision to be the second pillar of financial reform; their support will emphasize this work.
- Leadership and agenda: Under the leadership of the FSB, the IMF, the World Bank, and the standard setters, FSB member countries have embarked on an ambitious agenda to reduce the likelihood and costs of future financial crises.
Policy recommendations (summary)
- Preserve the integrity and strengthening of the Basel Committee’s bank capital and liquidity reforms; resist dilution by political pressures.
- Create and intensify a macro-prudential regulatory framework linked to robust micro-prudential reforms.
- Accelerate reform work on nonbank financial institutions, markets, and products to cover the entire financial system.
- Finalize core capital and liquidity rules to enhance safety and regulatory certainty while cautiously calibrating levels after assessing systemic and economic impacts.
- Promote international consistency while allowing national appropriateness to prevent migration of risky activities across borders.
- Reform supervision: equip supervisors with powers, mandate, skills, resources, and political/public support; cultivate supervisory independence and willingness to act.
- Strengthen multilateral cooperation (IMF, FSB, World Bank, standard setters) to implement and sustain the reform agenda.
Source: Financial Reform: What Must Be Done — José Viñals, July 5, 2010.