IMF Survey: Global Rules Make Financial System Safer to Sustain Growth

IMF News, October 14, 2010

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Canonical URL: IMF Survey: Global Rules Make Financial System Safer to Sustain Growth

Publication: IMF Survey online
Date: October 14, 2010
Context: Seminars held on the sidelines of the IMF and World Bank Annual Meetings; discussion hosted by the IMF as part of its Program of Seminars in Washington, D.C. on October 9.
Core message: New global rules designed to strengthen the financial system are a way to boost economic growth in a fragile recovery, but debate remains over the appropriate scope and intensity of regulation.

Primary objective: “a financial system that will finance strong and sustained growth” (José Viñals).
Tension identified:
- Concern about under-regulation: José Viñals warned of the danger of under regulation.
- Concern about over-regulation: Raj Singh noted concerns that implementation measures can become “more onerous and complex,” and that market participants are “pushing back and telling regulators maybe you’ve gone too far.”
Specific regulatory instrument referenced: Basel III will apply to traditional banks and not other types of financial institutions.
IMF framing: Financial sector reform is the top priority for the advanced economies, according to Olivier Blanchard.

Since late 2009 the IMF has focused on whether a firm is too important or complex to fail.
Channels of systemic risk: size and connections to other firms worldwide transmit risks “at lightning speed around the world.”
Historical example: The collapse of Lehman Brothers in September 2008 exposed the potential for one firm’s failure to cause devastating effects to global financial stability and the world economy.
Policy implication: To tackle too-important-to-fail challenges, policymakers must:
- Strengthen financial infrastructure.
- Figure out how to resolve failures of cross-border banks and other globally active financial institutions.
Direct quotation: “If we don’t have cross-border resolution, we will never solve too-important-to-fail,” said José Viñals.

Problem identified: Over-the-counter (OTC) derivatives can create domino-like effects in crises when uncertainty forces banks and investors to call in positions.
Policy direction: Move standardized derivatives to Central Counter Parties (CCPs).
New risk noted: CCPs themselves “may become too-complex-to-fail.”
Proposed mitigation: There is merit in central counter parties having access to central bank liquidity (José Viñals).

Supervision emphasis: Strong supervision is needed to complement regulations; Tan Sri Dato Zeti Akhtar Aziz favors a macro-prudential approach and strong supervision.
Incentives to avoid regulation: Randall Kroszner noted strong incentives within the financial system to try and get around regulations.
Analogy on difficulty of fixing financial systems: “Fixing problems in financial systems is harder than in engineering systems, and a better analogy is probably warfare,” said Richard Bookstaber. He contrasted engineering fixes with financial systems where “markets try to find loopholes in regulation to exploit much as an enemy might probe for weaknesses in your defenses.”

Political will required: Strong supervision and new regulations require political will.
Perception of lost resolve: Greece’s Finance Minister George Papaconstantinou said he thought “we’ve lost our nerve on this.”
Fiscal constraint note: Vitor Constȃncio reminded the panel of limits to taxpayers’ patience: “Our democracies cannot really sustain the same sort of demand from public money to be put at risk as a response to a financial crisis.”

Continue implementing global rules (e.g., Basel III) while assessing scope to cover non-bank financial institutions.
Develop cross-border resolution mechanisms for banks and financial institutions with global reach.
Transfer standardized OTC derivatives to CCPs while addressing CCP systemic risk (including considering CCP access to central bank liquidity).
Strengthen macro-prudential supervision and enforcement to close regulatory loopholes.
Balance regulation to avoid under-regulation that threatens stability and over-regulation that could impede sustained growth.
Build and sustain political will to ensure taxpayers are not repeatedly exposed to bailout costs.

IMF Survey: Global Rules Make Financial System Safer to Sustain Growth — IMF Survey online, October 14, 2010.