The Role of Law in Preserving Financial Stability
IMF Blog, July 1, 2016
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Bibliographic details
- Authors: Sean Hagan, Ross Leckow
- Published: July 1, 2016
Overview
- Authors: Sean Hagan, Ross Leckow
- Date: July 1, 2016
- Event referenced: high-level seminar on “Law and Financial Stability” held on May 16-18 in Washington, D.C., organized by the IMF’s Legal Department to mark its 70th Anniversary, which brought together more than 120 senior lawyers and policymakers from over 80 countries.
- Core takeaway: Significant legal progress since the 2008 global financial crisis, but substantial additional implementation and development work remains to address cross-border, institutional, and emerging challenges.
Progress since the 2008 global financial crisis
- Many countries have strengthened legal frameworks governing the financial sector.
- Specific advances highlighted:
- Bank resolution through international standards:
- Many resolution authorities now have the mandate and powers needed to resolve a troubled financial institution in an orderly manner.
- National authorities from key jurisdictions have established Crisis Management Groups (CMGs) and progressed on cross-border resolution planning.
- Central Clearing Counterparties (CCPs) and resolution:
- Following the Pittsburgh summit in September 2009, G-20 leaders agreed that all standardized over-the-counter derivatives contracts should be, where appropriate, cleared through CCPs.
- Reforms to implement this mandate have advanced, though CCP resolution involves complex legal and regulatory challenges.
- Macroprudential policy:
- Recognition of the need for dedicated macro-prudential policies to achieve financial stability.
- Central banks are being given macro-prudential tasks, often alongside microprudential supervision of banks or resolution, requiring effective legal frameworks.
- Corporate debt restructuring and economic recovery:
- Countries affected by the crisis face overleveraged corporate sectors and need comprehensive strategies for non-performing loans, including robust insolvency regimes and speedy, cost effective out-of-court debt restructuring mechanisms.
- Islamic finance:
- Rapid growth in Shari’ah-compliant banking activities and progress in developing international standards for Islamic banking that complement general international norms.
- The Islamic Financial Standards Board (IFSB) and other standard setters have played a key role.
Remaining gaps and weaknesses
- Many countries still lack effective resolution regimes.
- Challenges in designing effective frameworks for cross-border cooperation to ensure resolution actions in one jurisdiction can be given effect in another jurisdiction’s laws.
- Legal frameworks still need strengthening for:
- CCP resolution,
- Macro-prudential frameworks,
- Corporate debt restructuring.
- International standards (including those enforcing bank resolution and AML/CFT) may need modification to accommodate specific features of Islamic financial institutions.
Emerging issues identified
- Reduction in correspondent banking relationships (CBRs):
- Several countries have reported a reduction in CBRs by global banks in recent years.
- Pressure on CBRs has been associated with restricted access to financial services by certain categories of customers, business lines, jurisdictions or regions.
- IMF staff support includes analyzing risks and policy responses in surveillance and the Financial Sector Assessment Program; assessing compliance with international standards including AML/CFT; building capacity to strengthen regulatory and supervisory frameworks; and facilitating international dialogue.
- Expansion of the shadow banking system:
- Estimated to account for approximately 25% of total assets of the financial sector.
- Need to strengthen interaction between banks and shadow banks and to make securitization safer.
- Further work required to decide whether institution-based or activity-based regulation is appropriate for shadow banking.
- Rising misconduct risks:
- International work continues on reducing misconduct risks through exchange of best practices on governance frameworks, development of supervisory toolkits, and examination of post-crisis compensation reforms.
- Sharing experiences on bank regulators’ enforcement powers to address market abuse.
- Recognition that regulatory measures alone may be insufficient; a shift in the ethical climate within the financial sector may be necessary.
- Financial inclusion in emerging economies:
- Broadening access to formal financial networks supports empowerment and inclusive growth.
- Growing use of financial technology, supported by robust legal and regulatory frameworks, may play an important role.
The road ahead — policy recommendations and priorities
- Continue developing international standards and best practices to guide national legislation and cross-border cooperation frameworks.
- Countries should enact national legislation and strengthen institutional capacity to implement existing international standards and best practices.
- Legal reform is necessary across multiple areas, but cultural and ethical changes in financial market participants and public authorities are also essential to address some problems.
- The IMF remains committed to advancing the legal reform agenda across all relevant areas.
Source: IMF Blog post “The Role of Law in Preserving Financial Stability” (July 1, 2016).