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In the wake of recent international financial crises, attention has focused on the adoption and implementation of internationally-recognized standards and codes of good practice in economic and financial affairs as a tool to reduce the risk of future crises. These standards and codes can help countries to conduct their economic and financial affairs in prudent and transparent ways, so that the international financial system will be more stable and less prone to crises. Much of the work has been done at the International Monetary Fund and the World Bank. This has included a joint program of Reports on the Observance of Standards and Codes (ROSC) in individual countries, which cover a set of eleven standards in the areas of responsibility of the two institutions. ROSCs point to ways in which countries can strengthen their existing systems, which the Fund and the World Bank can help them do. Also, when ROSCs are published, they can help potential investors to better evaluate the investment climate. In both these ways, the standards and codes initiative can contribute to crisis prevention.
In the wake of the international financial crises of the 1990s, work has been underway at the IMF and elsewhere to find ways of reducing the risk of future crises. One of the principal tools to accomplish this has been the development of international standards and codes of economic and financial good practice. This work has been going on for some time, going back at least to the 1988 issuance of the Basel Core Principles for Effective Bank Supervision. Indeed, many countries—especially those with developed financial markets—have long had national standards and codes. But since 1997, considerable progress has been made in articulating new standards that are internationally recognized and more widely applicable. At the same time, greater rigor, context, and focus have been added to the implementation and assessment of the standards being developed.
Standards and codes set out what are widely accepted as good principles, practices, or guidelines in a given field. Standards relevant for sound economic and financial systems are of particular interest to the International Monetary Fund (IMF) given its mandate to oversee the international financial system. These standards cover a wide variety of often overlapping and interdependent subjects, specifying good ways of compiling and publicly disseminating economic policies and data (so that people know what is happening in an economy); of regulating financial markets (how to control the risks that banks take with depositors' funds, for example); and of structuring many of the institutions underlying modern markets (like accounting systems).
The work on standards and codes has been given increased impetus over the past three years because they have been seen as a way to reduce risk, and therefore as a way to avoid new international financial crises. However, adherence to standards and codes can also contribute to a national economy's stability and growth. This comes as a result of the increased confidence that potential investors can derive from knowing a country's economic affairs are conducted in the transparent and predictable way called for in the standards.
In 1921, the British novelist E.M. Forster expressed one view of international investing in his novel Howard's End: "She learned to her horror that Margaret...was taking her money out of the old safe investments and putting it into Foreign Things, which always smash." Today, emerging market bonds offer consistently higher returns than high-yield securities in industrial nations. This presumably reflects the fact that investors must be compensated for the greater risks that they perceive in developing economies. After eighty years, although communications are better and markets have become more sophisticated, the perception of investments in emerging market economies are riskier than those in "old, safe" economies remains—even if it is not expressed in such graphic terms.
The perceived riskiness of emerging markets is related in large part to the weakness of legal and institutional frameworks in developing countries; uncertainties about how these frameworks can be expected to function; and concerns that these systems can be manipulated to the detriment of foreign investors. For developing countries to be more fully integrated into the global financial and economic system, ways must be found to reduce the risk and uncertainty, and to assure investors that their investments in these countries are as they seem. This is also needed for investment among industrial countries, where legal and institutional frameworks do differ from one country to another. Having adequate common standards across countries is a way to provide potential investors with needed assurances.
Indeed, the need for greater clarity in the frameworks for business decisions is often just as great for domestic investors as for foreign ones. Clear information about the economic policy framework, the regulatory environment, and economic developments is essential for sound business decisions. And a well-functioning financial system is a key ingredient in countries' economic growth as well as being important to potential depositors and borrowers. International standards and codes can help to strengthen all of these vital elements of a country's economy.
The enthusiasm for standards and codes has led to the development of many new standards in recent years: up to 80 different standards have been issued by various bodies. These new standards are useful, but the proliferation of them has raised some questions about how appropriate many of the standards are and whether developing country governments and enterprises have the ability to comply with so many. In some cases, developing countries have felt that they have not had enough opportunity to contribute to the formulation of the standards. These concerns could mean that, even when the standards are of high quality, developing country governments might be less willing to try to implement them. Such apprehension, while understandable, seems misplaced given the approach to standards taken by the IMF, the World Bank, and other standard-setting bodies.i
The Bretton Woods institutions—the IMF and the World Bank—have taken a focused approach to Standards and Codes by concentrating on a core group of standards relating directly to their own responsibilities. As the institution charged with promoting international monetary and financial stability, the IMF is keenly concerned with those standards that can help to reduce the risk of financial crisis. The World Bank, which, with its responsibilities in the area of longer-term economic development and its finance, works closely with the private financial sector in developing and emerging market economies. It focuses on standards related to the financial soundness of banks and corporations. Together the Bretton Woods institutions have identified, and helped to formulate, relevant standards in eleven areas (Table 1).
By virtue of their mandates and worldwide membership, the Bretton Woods Institutions are uniquely placed to contribute to the global efforts on standards and codes. The work they do passes through the Executive Boards of the two institutions, ensuring that developing countries have a voice in the direction of the standards initiatives.iiAt the same time, they have—or have ready access to—the international expertise to develop and help implement the standards.
Indeed, the evolution of the standards work at the IMF and World Bank shows the clear influence of developing countries. In the aftermath of the Asian Crisis, when standards were first coming to public attention, they were understood by many as a way of rating countries. In this perception, those countries not fully adhering to standards would be exposed to sanctions either from the international community or, through public disclosure of noncompliance, from the financial markets. Developing country governments, among others, pointed out that such a system would punish countries, giving them little positive incentive to adopt the new standards, and would do little to strengthen the international system's crisis-resistance. Instead, they argued, compliance with standards and codes should be seen as something to aspire to—after all, many industrial countries are not in full compliance with some of the standards—and international efforts should be focused on helping countries to strengthen their practices to gradually improve compliance with standards. This view is now generally accepted.
International standards are of limited value unless they are implemented and unless country see them as helpful in their own work to strengthen their domestic economies. Since all of the standards are voluntary, countries are being encouraged to move as directly as local circumstances permit to incorporate them in domestic legislation and regulatory practice.
The IMF and the World Bank are implementing this approach through a joint program to produce Reports on the Observance of Standards and Codes (ROSCs) for individual countries. Beginning in 1998, the IMF, together with the World Bank and other relevant agencies, led three rounds of experimental country reviews on the implementation of the core standards. At the end of 2000, the ROSC program was made a permanent feature of the institutions' work.
Each assessment of a standard results in a ROSC "module", and only those standards that a country believes are most relevant to its circumstances are assessed. Indeed, it is through the prioritization of standards—and the assessment of only relevant parts of those standards—that global standards are made useful to countries at all levels of development. By April 2001, more than 100 modules had been prepared for some 40 countries, and plans have been made to produce up to 100 modules per year in the future. ROSCs contain specific recommendations for improvement and can be used by the countries themselves as a basis for upgrading their systems. When countries agree to publish their ROSCs (about 80 percent of the modules that have been prepared are available on the IMF website), and where countries are shown following international standards in their financial practices, investors can be more confident about investing in the countries concerned.
The standards that are covered by the ROSCs fall into three broad groups, covering (with some overlap) the government, the financial sector, and the enterprise sector:
Standards and codes relating to government policymaking and operations are aimed primarily at promoting increased transparency. Improved transparency (or disclosure) should lead to better-informed public debate about the design and results of economic policy and make governments more accountable for the implementation of policy, strengthening the credibility and public understanding of the choices particular policies represent. Transparency should also improve the efficiency of markets by making participants better informed. Standards in this area include data dissemination standards and codes of transparency in monetary and financial as well as fiscal policies. The data dissemination standards exemplify the current approach to standards, being divided into a Special Data Dissemination Standard (SDDS), which specifies in great detail how economic and financial market statistics should be compiled and released to the public; and the General Data Dissemination System (GDDS), which is a process for improving the statistical capabilities of those countries not yet in a position to meet the SDDS standards.
Standards and codes relating to the financial system are critical to crisis prevention. They mainly focus on ensuring that there is a sound and consistently applied regulatory environment for financial institutions. Financial system standards and codes are normally assessed in the context of another joint IMF-World Bank program, the Financial Sector Assessment Program (FSAP). The FSAP conducts analyses of individual countries, during which it seeks to identify the strengths and vulnerabilities of a country's financial system; to determine how key sources of risk are being managed; to ascertain the sector's developmental and technical assistance needs; and to help prioritize policy responses. As part of this process, ROSCs are prepared on banking supervision, securities and insurance regulation, and payments systems, as well as on transparency in monetary and financial policies.
Standards and codes relating to enterprises are also important for the financial system to operate well and to protect the integrity of markets. ROSCs in this area are prepared by World Bank staff, covering principles of corporate governance, accounting and auditing, and insolvency and creditors' rights.
The experience to date with the implementation of these standards and codes has been positive. Although the number of countries that have been formally assessed under the ROSC program remains limited, there are positive results to show from the broader initiative. Examples include the following: iii
One of the main lessons from the assessment of standards has been the importance of assisting countries to implement standards now that a good base of standards is in place. Technical assistance, from the IMF, World Bank, and others, is gaining increased emphasis, and will play an important role in the ultimate success of the standards and codes initiative.iv
International standards and codes are playing an increasing role in helping to strengthen economic and financial practices in IMF member countries. Countries making good progress in implementing the standards should benefit both from lower interest rates, reflecting reduced risk, from increased flows of investment, and from a reduced risk of financial crisis. The final result should be steadier and even faster economic growth and increased prosperity, both for the citizens of the country and its foreign investors. After all, E.M. Forster also tells us that Margaret's "Foreign Things did admirably."
iThese include the Basel Committee on Banking Supervision, the Committee on the Global Financial System, the Committee on Payment and Settlement Systems, the Institute for International Finance, the International Association of Insurance Supervisors, the International Accounting Standards Committee, the International Bar Association, the International Federation of Accountants, the International Federation of Insolvency Practitioners, the International Organization of Securities Commissioners, and the Organization for Economic Cooperation and Development, the United Nations Commission on International Trade Law. Information on these bodies can be found at http://www.imf.org/external/standards/agency.htm.
ii The view of the IMF's Executive Board on progress with standards and codes is summarized in Public Information Notice 01/17 (March 5, 2001)at http://www.imf.org/external/np/sec/pn/2001/pn0117.htm.
iv The experience of the IMF and World Bank with standards and codes is discussed at greater length in "Assessing the Implementation of Standards: A Review of Experience and Next Steps", a report by the Staffs of the IMF and World Bank. It can be found at http://www.imf.org/external/np/pdr/sac/2001/eng/review.htm.
IMF EXTERNAL RELATIONS DEPARTMENT