June 2, 2004
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Good afternoon ladies and gentlemen. I am delighted to have the opportunity to address this distinguished gathering, and I wish to thank the staffs of the World Bank, the Board of Governors of the Federal Reserve, and the IMF for organizing this seminar.
Developments over the past decade have underscored the importance of a robust international financial system. But the strength of the global system lies in its individual components, the national financial systems. Today I would like to focus on one critical group of countries, the emerging market and developing economies—or, more briefly, "emerging countries." I would like to share my thoughts on these countries' participation in the setting of international codes and standards in general, and Basel II in particular.
First, how does emerging country participation benefit standard setting in general?
I think we all realize that the benefits of guidelines and standards are greater the more broadly they are adopted. From an individual country perspective, standards provide benchmarks for assessing the institutional and regulatory frameworks, helping authorities to guide their reform agendas and to identify specific areas that require improvement. At the same time, common frameworks for measurement and disclosure facilitate international comparisons and the assessment of financial soundness in different countries. Broader implementation of these frameworks means better decisions by market participants. And better decisions will contribute to a more stable international financial system.
Yet standard setting does not come for free. The standard setting process is based on the premise that there are universal principles that apply in all countries. But embracing this premise of universality also implies a certain degree of rigidity. A key challenge for any standard setter is striking the right balance between the clarity and consistency of the standard, on the one hand, and flexibility and room for national discretion, on the other. Therefore, as the standard setting process matures, it becomes increasingly important to consider the circumstances and views of all countries involved.
This leads to my second question. Given the potential benefits—and the potential costs—is the current standard setting structure sufficiently conducive to input from emerging countries? And, on the flip side, are these countries making the most of the available opportunities to influence the agenda of the international standard setters?
In the case of Basel II, emerging countries have made many important proposals, which significantly altered the shape of the standards from their earlier draft. These changes include:
• formal recognition of the need for flexibility in scheduling implementation of Basel II in non-Basel member countries;
• introduction of "the simplified standard approach," which does not require the use of rating agencies or bank internal ratings.
• significant reduction of the risk weights for well-provisioned defaulted assets; and
• elimination of the sovereign risk "floor," and introduction of concessionary weights for local currency interbank markets.
Regarding the issue of flexibility, while the common implementation date for Basel II is intended to apply only to internationally active banks from G-10 countries, emerging countries have been encouraged to work toward the new set of standards at their own pace and based on their own priorities. As both the Fund and the Basel Committee have repeatedly emphasized, the premature adoption of Basel II in emerging countries could risk distracting their attention from important—sometimes even basic—supervisory deficiencies that are still widespread.
In fact, analysis of compliance with the Basel Core Principles, conducted as part of the Bank-Fund Financial Sector Assessment Program (or FSAP) exercises, shows how much remains to be done. Some 45 percent of the emerging market economies that have been assessed were found to be materially non-compliant with the principle of supervisory operational independence. Around 70 percent are not complying fully with the principle of consolidated supervision. And the loan evaluation practices of a large proportion are insufficient. Moving from this platform to the more risk-focused Basel II will be very challenging indeed. In order to ensure a fluent transition, standard setters need to better understand what underpins the observed patchy levels of compliance with the basic principles. Thus, even more input from emerging countries will be required.
Turning now to my final question: What more can we do to ensure that the emerging country voice is heard clearly?
Emerging countries should be encouraged to assert their views through bilateral communication with standard setters, as well as through multilateral channels.
It is this latter point—consultation among countries—that offers untapped potential for emerging countries, and to this end they may wish to consider greater use of regional groupings. Such groups offer valuable channels for providing structured feedback to the standard setters on the applicability of standards in particular regions or types of economies, or on practical difficulties in implementation. Perhaps even more important, they can be effective fora for sharing experience with implementation and helping countries with fewer resources to save time and avoid mistakes.
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Ladies and Gentlemen,
In concluding, let me underline that the IMF strongly welcomes the contribution of international standard setters to the cause of international financial stability, and we will continue to support their work. But we will also work to help support the more active participation of emerging and developing countries in the process of international harmonization and standard setting. Their participation is critical for ensuring rules that are more relevant, more broadly accepted, and better implemented. Equally important, such participation provides the channels for building cooperative relationships between countries and between regulators, ultimately leading to a stronger global financial system.
Thank you very much.
