Promoting Safe and Sound Banking Systems: An IMF Perspective -- Address by Michel Camdessus

IMF News, September 28, 1996

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Published: September 28, 1996

Overview

Remarks by Michel Camdessus, Managing Director of the International Monetary Fund, at the Conference on "Safe and Sound Financial Systems: What Works for Latin America", Inter-American Development Bank, Washington, D.C., September 28, 1996.
The speech emphasizes the centrality of banking-system soundness for domestic prosperity and global stability and outlines the IMF's perspective on causes, ongoing initiatives, and an agenda for strengthening banking systems.

Causes of banking sector problems

Common themes observed through Fund surveillance of 181 member countries:
- Lax management within individual banks; weak incentives for owners and managers to act prudently.
- Lack of legal and judicial infrastructure leading to breakdowns in credit discipline.
- Lack of transparency about banks' operations and financial condition, including insufficiently rigorous loan valuation and provisioning standards.
- Weak domestic banking supervision due to inadequate laws/regulations, political interference, or insufficient human and financial resources.
- Government involvement that distorts incentives (channeling support to ailing industries, public bail-out expectations, weak exit policies, over-generous lending of last resort).
- Greater volatility in economic and financial climates in developing countries (real exchange and interest rates, private capital flows, terms of trade) exposing banks to larger risks without commensurate capital cushions.
- Financial liberalization/privatization undertaken without simultaneous strengthening of bank and supervisor expertise and resources.
- Rapid expansion of credit fueled by capital inflows leading to poor credit decisions and loan portfolio problems; these situations require timely monetary and fiscal policy action to prevent deterioration.

Current initiatives and IMF activities

National-level reforms:
- Banking laws updated and supervision upgraded in many countries in Latin America.
- Examples cited: Chile strengthened banking supervision after its early 1980s crisis; extensive restructurings, mergers, and privatizations in Argentina and, to some extent, Brazil.
Regional efforts:
- Adoption of Basle Committee standards and regional supervisory bodies developing additional regional standards (e.g., Association of Bank Supervisory Agencies in Latin America and the Caribbean; Caribbean Supervisors Group).
IMF role through surveillance, lending, and technical assistance:
- Surveillance: improving macroeconomic environment and structural framework, more continuous and probing discussions since the Mexican crisis, greater attention to banking sector issues and sustainability of capital flows.
- Lending and technical assistance: focus on banking legislation, regulation, and supervision; monitoring progress in implementation.
Acknowledgement that major gaps remain:
- Persistent national weaknesses: poor internal governance, lack of transparency, inadequate supervision, excessive official complacency.
- Frequent reactive reforms (post-crisis) rather than preventive measures.
- International standards not comprehensive enough in areas such as accounting, loan valuation, provisioning rules, and exit policies; lack of consensus among G-10 and EU on some issues.
- Basle standards may not be well adapted to developing-country circumstances; some Latin American countries have set more demanding capital ratios and risk weights than the Basle Capital Accord suggests.

Agenda for the future and IMF contributions

Principal emphasis:
- Strengthen internal bank governance.
- Reinforce market discipline in banking practices.
- Improve external oversight and support until internal governance and market discipline become effective.
Strategy of disseminating "best practices":
- Identify standards and practices that have served particular groups of countries well and adapt them to others.
- Use voluntary international guidelines to incentivize reform via positive market reactions.
Critical issues to address:
- Early corrective action against problem banks.
- Mechanisms to close down insolvent banks.
- Designing payments systems to limit contagion.
- Ensuring lender of last resort facilities do not prolong unsound banks' lives or create moral hazard.
How the Fund stands ready to help:
- Contribute universal experience to develop internationally agreed standards tailored to developing countries.
- Help disseminate standards and monitor progress in implementation.
- Assist in restructuring banking and financial systems.
- Work in close collaboration with other international, regional, and national organizations.

Regional cooperation and practical examples

Cooperative actions with IDB and World Bank cited as sources of encouragement:
- Venezuela: coordinated technical assistance by IDB, World Bank, and Fund contributed to strengthening banking supervision after the financial sector crisis.
- Costa Rica and Nicaragua: IDB and Fund cooperation on programs to modernize and restructure state-owned banks.
- Argentina: cooperation in privatizing a number of provincial banks.
- Ecuador and Guyana: IMF and IDB assistance with drafting modern banking legislation.
- Nicaragua: ESAF-supported structural reform and macroeconomic stabilization, reinforced by an IDB technical assistance project to modernize the central bank and develop core financial and economic statistics (Fund serves as executing agent).
Emphasis on pooling surveillance, financing, and technical assistance resources and drawing on expertise from Basle and the central banking community.

Key statistics and quantitative findings (preserved as stated)

Fund surveillance covers 181 member countries.
More than two-thirds of all Fund members have experienced banking sector problems.
The crisis in Chile exceeded 30 percent of GDP.
The recent crisis in Venezuela amounted to 20 percent (context: economic cost).
Document identifiers and dates preserved: 96/17; September 28, 1996; CORRECTED VERSION.

Remarks by Michel Camdessus, Managing Director of the International Monetary Fund, at the Conference on "Safe and Sound Financial Systems: What Works for Latin America", Inter-American Development Bank, Washington, D.C., September 28, 1996.