STRENGTHENING THE ARCHITECTURE OF THE GLOBAL FINANCIAL SYSTEM
May 15, 1998
Previous summits have focussed on ways to strengthen the global financial system. Over the past four years considerable progress has been made in the face of rapid globalisation and technical change in developing and implementing specific recommendations. However, the process of globalisation and recent events in Asia have revealed a number of weaknesses and vulnerabilities in national and international financial systems, as well as in the borrowing and lending practices of banks and investors. We therefore need to act to strengthen the global financial system, both to reduce the likelihood of such crises occurring in future and to improve our techniques for handling crises when they do occur.
2. This report presents proposals where there is now an emerging consensus for modifications to the architecture of the international financial system. It does not, however, complete the process. There are important aspects of the issues discussed that require further work. Discussion within our countries, with emerging market countries and other interested countries, with the International Financial Institutions and with the private sector will continue over the coming months.
3. We have identified the need for action in five key areas:
This report outlines how work is being taken forward in each of these areas and signals a number of areas for further work.
4. Broad based prosperity and growth require financial institutions, commercial enterprises and entrepreneurial individuals that are prepared to take risks. Risk inevitably involves the possibility of failure. We could not and should not seek to eliminate failure entirely, rather large financial systems need to be robust enough to accommodate the occasional failure and to contain risks which might threaten the whole financial system. And borrowers and lenders, be they governments, companies or individuals should be responsible for their decisions and actions. The principles and measures set out below are designed to help meet these objectives.
5. This report focuses on a range of areas where specific changes could help prevent and handle future crises. This focus should not undermine the important message that, as far as individual countries are concerned, the pursuit of sound economic policies that promote sustainable broad based non-inflationary growth is the most important single contribution to avoiding a crisis. And when countries implement an IMF supported reform programme, their commitment to and ownership of the programme is crucial to its success. Sound policies need to tackle structural economic issues so that sufficient provision is made for the poorest sections of society and other vulnerable groups, development is sustainable and living and working standards for all are improved. This is also key to securing the support needed for successful economic reform. In this respect we also encourage the IMF and MDBs to work with the ILO to promote core labour standards and with the competent international institutions to promote sound environmental standards.
Disclosure of data and information
6. Accurate and timely economic data are essential for prudent economic management, improved risk assessment by investors, enhanced market stability, and effective surveillance. The Asian crisis has revealed the need, for example, for better and more timely information on countries' official international reserve assets and reserve-related liabilities and on the short term external assets and liabilities of the financial sector.
7. Work is underway to improve the timeliness and accuracy of data.
8. In addition, it would be useful if countries were to provide more qualitative descriptive information on their financial systems, markets, institutions, laws, and other aspects of the financial sector including detail on banking supervision, bankruptcy procedures and the credit culture, skills and structure of banking sectors, including the relationship between banks and the government and industrial sector. We need to consider further, in conjunction with the International Financial Institutions, who should collect this information and how it should be published.
Openness in policy making
9. More openness in national policy making could have helped anticipate the crisis, and more generally helps to inform the market as well as promote public understanding and support for sound policies.
Openness at the International Financial Institutions
10. The Fund and World Bank have traditionally communicated their concerns and recommendations for policy action in confidence. This avoids the risk of provoking an undue market reaction and gives countries the opportunity to take action on their own account. However, we think there is a case for greater openness at the Fund and the World Bank, as well as for encouraging members to comply with the standards they and others set and advice they provide.
11. It is important for the IMF and World Bank to publish information on member countries on a regular basis to help investors take better informed decisions. The World Bank and the MDBs have made substantial progress on this front over a period of years. The IMF has also taken steps to provide more information in recent years. In particular the introduction of Press Information Notices (PINS) last year was an important step forward in enhancing transparency. These enable members to release the conclusions of IMF Article IV consultations, if they choose to do so.
Helping countries prepare for Global Capital Flows
12. International capital flows enable a better global allocation of capital and foster economic development. However, events in Asia have shown that weaknesses can suddenly be exposed by global capital markets, making countries with weak fundamentals, including weak financial systems, more vulnerable to external shocks. It has also highlighted the dangers of poorly sequenced and unbalanced liberalisation.
13. Capital account liberalisation should not be confused with open access to domestic markets for foreign firms.
Strengthening National Financial Systems and Corporate Governance
14. Weaknesses in the financial sectors in some Asian countries increased their vulnerability to external shocks. These weaknesses included over-extended lending to the property sector, the build up of large off-balance sheet positions, excessive exposure to highly leveraged borrowers, policy directed loans and excessive reliance on short-term borrowing in foreign currency. Had information about these developments been more widely available earlier, the international markets and International Financial Institutions might have been better placed to assess the risks in Asia and elsewhere. The crisis also highlighted weaknesses in risk assessment in our own financial sectors. Some institutions paid inadequate attention to risks. There is therefore a need for strengthened mechanisms to ensure appropriate risk analysis. This points to the need for enhanced international surveillance and improved prudential standards, and to the need to encourage internationally active financial institutions to act prudently on available information.
15. A primary need is to encourage countries to strengthen their own financial systems, to ensure that banks and other financial intermediaries have the information, skills and corporate incentives to take well founded credit and risk decisions, and are properly supervised and regulated; that corporate and financial sectors follow good accounting, disclosure and auditing practices; and to promote deeper, more transparent and more open local bond and equity markets that will provide alternative sources of finance to short-term foreign currency bank borrowing.
16. Strong efforts are needed to ensure that sound and transparent standards are implemented. While this is primarily a matter for the national authorities concerned, incentives need to be put in place that will help deliver this. The primary incentive is the need for emerging markets to maintain confidence in order to access capital market. In addition:
17. There is a gap in the current international system with respect to surveillance of countries' financial supervisory and regulatory systems. Enhanced surveillance in this area would help encourage national authorities to meet international standards and help reduce financial risk. Such assessments of supervision and regulation can lay the groundwork for policy discussions and appropriate assistance, where needed, from the IMF and MDBs for programmes to strengthen financial systems. We need to address how best to organise international work in this and related areas. A number of international institutions are involved in various aspects of policy advice in the regulation of national financial systems. Their functions include assistance at times of financial crisis, long-term systems building and regular surveillance. There is a case for considering how to co-ordinate this work more effectively.
Burden sharing by the Private Sector and Moral Hazard
18. The global economy needs private sector financial institutions that take risks on the basis of careful assessment. If such institutions believe that the entities to which they lend will be bailed out, they have no incentive to make a proper risk assessment. It is therefore important to ensure that the private sector takes responsibility for its own lending decisions. We also need approaches to ensure that the private sector is involved in crisis resolution, and bears the costs as well as the rewards of its lending decisions.
19. There will always be pressure in the event of a crisis to act quickly to stabilise the situation. We need to find ways in which this can be done without implicitly insuring debts to the private sector. It would be highly desirable to create in advance a framework for handling debt arrears to make it clear that all exposed institutions in the private sector will bear some costs.
20. There needs to be a framework for ensuring continuing private sector involvement when a country, or its financial or corporate sector, is facing difficulties in meeting its foreign currency liabilities as they fall due.
IFI Resources and Financing
21. The response of the IMF and World Bank to the Asian crisis has confirmed their role at the centre of the international financial system. The Asian Development Bank has also played a crucial part in responding to the crisis. However, this has involved an unprecedented level of new commitments for the IMF and other International Financial Institutions. We need to address the increased demand on resources:
22. The Asian crisis also demonstrated that in special circumstances bilateral financing can provide a source of additional financing for balance of payments:
23. We have suggested a number of ways to enhance the role of the IMF and World Bank.
Strengthening Global Dialogue
24. These issues and our response to them have demonstrated the need for a more intensive global dialogue on developments in the global financial system between industrial and emerging market countries and countries in transition. We have had useful discussions over the last few months, in the lead up to the Birmingham Summit. We would like this report to be seen as a contribution to the debate on the lessons of the Asian crisis, and we will continue to consult widely as we develop our thinking.
Source: Released at the Birmingham G8 Summit
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