G-20 leaders committed to financial sector reviews after global crisis showed that problems in one country can affect global economy (photo: Toby Melville/Reuters)
FINANCIAL REFORM
The landmark decision by the IMF’s Executive Board on September 21 converts the financial stability component of the voluntary Financial Sector Assessment Program (FSAP) into a mandatory part of the IMF’s surveillance for the world’s top 25 financial sectors.
The global economic crisis laid bare the devastating economic consequences a financial crisis in one country can have on the global economy. This decision is a concrete step toward strengthening the IMF’s surveillance of those members whose financial sectors could have the biggest potential impact on global stability. It is one of the key steps taken by the Fund to modernize its surveillance mandate and modalities in light of the recent crisis, and is consistent with the commitment made by the leaders of the Group of 20 advanced and emerging economies at the Washington Summit in November 2008 to subject their financial sectors to greater scrutiny.
The IMF chose the 25 economies (see box) based on the size of their financial sectors and their connections with financial sectors in other countries. The IMF criteria do not reflect a country’s broader economic or political importance, and would be periodically reevaluated as financials sectors develop and their size and connections change over time.
25 biggest, most interconnected economies
Australia
Austria
Belgium
Brazil
Canada
China
France
Germany
Hong Kong SAR
India
Ireland
Italy
Japan
Luxembourg
Mexico
Netherlands
Russia
Singapore
South Korea
Spain
Sweden
Switzerland
Turkey
United Kingdom
United States
Casting a wider net on financial stability issues
All of the IMF’s 187 member countries are already required to undergo an annual economic health check-up, known as an Article IV consultation. In addition, the FSAP offers the opportunity to all member countries to undergo, on a voluntary basis, a comprehensive financial sector assessment. More than three-quarters of the Fund’s membership have so far volunteered for FSAPs. All FSAPs include an in-depth assessment of financial stability done by the Fund. In addition, in developing and emerging market countries, FSAPs include an evaluation of developmental and structural aspects of the financial sector conducted by the World Bank.
• Financial stability assessments examine the soundness of the banking and other financial sectors; conduct stress tests; evaluate the quality of bank, insurance, and financial market supervision against accepted international standards; and assess the ability of supervisors, policymakers, and financial safety nets to respond effectively in case of systemic stress. While these financial stability assessments do not evaluate the health of individual financial institutions and cannot predict or prevent financial crises, they identify the main vulnerabilities that could trigger one.
• Financial development assessments examine the quality of the legal framework and of financial infrastructure, such as the payments and settlements system; identify obstacles to the competitiveness and efficiency of the sector; and examine its contribution to economic growth and development. Issues related to access to banking services and the development of domestic capital markets are particularly important in low-income countries.
The recent Executive Board decision bridges the gap between the Fund’s Article IV consultation and the FSAP and expands considerably the financial component of the former in a risk-based manner, by concentrating on the most important financial sectors. Financial development issues are, of course, important in developing and emerging market countries, where they could also have repercussions on financial stability. Financial development assessments under the FSAP will therefore continue to be made available to these countries by the World Bank on a voluntary basis, as at present. The Fund and the Bank will continue to collaborate closely in these countries.
The review of a country’s financial stability would cover three core elements.
• Risk—the source, probability, and potential impact of the main risks to financial stability
• Policies—the country’s financial stability policy framework
• Crisis resolution—the authorities’ capacity to manage and resolve a financial crisis.
The reports produced by the IMF are typically made public by countries, and used to improve the functioning of their financial sector.
