Mr. Aditya Narain, Ms. Inci Ötker, and Ceyla Pazarbasioglu
The IMF, with the Bank for International Settlements and the Financial Stability Board, has been at the forefront of discussions on reform of the global financial system to reduce the possibility of future crises, as well as to limit the consequences if they do occur. The policy choices are both urgent and challenging, and are complicated by the relationship between sovereign debt and risks to the banking sector. Building a More Resilient Financial Sector describes the key elements of the reform agenda, including tighter regulation and more effective supervision; greater transparency to strengthen market discipline and limit incentives for risk taking; coherent mechanisms for resolution of failed institutions; and effective safety nets to limit the impact on the financial system of institutions viewed as "too big to fail." Finally, the book takes a look ahead at how the financial system is likely to be shaped by the efforts of policymakers and the private sector response.
“Space: the final frontier. These are the voyages of the starship Enterprise. Its five-year mission: to explore strange new worlds, to seek out new life and new civilizations, to boldly go where no man has gone before.”
This chapter assesses proposals to redefine the scope of activities of systemically important financial institutions (SIFIs). Alongside reform of prudential regulation and oversight, these have been offered as solutions to the too-important-to-fail (TITF) problem. It is argued that although the more radical of the proposals, such as narrow utility banking, do not adequately address the key policy objectives that emerged from the global financial crisis, two concrete policy proposals—the Volcker Rule in the United States and retail ring-fencing in the United Kingdom—are more promising, although they still entail significant implementation challenges. A risk factor common to all the measures is the potential for activities identified as too risky for retail banks to migrate to the unregulated parts of the financial system. Since such a migration could lead to the accumulation of systemic risk if left unchecked, it appears unlikely that any structural engineering will lessen the policing burden on prudential authorities and on the banks.
Jonathan Fiechter, İnci Ötker-Robe, Ms. Anna Ilyina, Michael Hsu, André Santos, and Jay Surti
The activities of cross-border banking groups can generate trade-offs between efficiency and financial stability. These groups can lower intermediation costs and improve access to credit by households and firms, facilitate a more efficient allocation of global savings, assist in the development of local capital markets, and make possible the transfer of risk management, payments, and information technology. At the same time, these groups are highly interconnected internationally and may expose individual countries to the risk that shocks in other countries will spill over into their domestic financial systems.
The crisis has elicited wide-ranging discussion and deep introspection about what the future contours of the financial system should look like, particularly about how regulation and supervision should be reformed to encourage a financial system that better mitigates systemic risks. This chapter discusses the weaknesses prevalent in the run-up to the crisis, the probable changes in the regulatory environment, and how the financial system is likely to be shaped by them as opposed to what the future contours of the financial system should look like. The chapter also explores the role that the IMF can play in moving toward a more robust and stable global financial system.
José Viñals, Jonathan Fiechter, Ceyla Pazarbasioglu, Ms. Laura E. Kodres, Mr. Aditya Narain, and Ms. Marina Moretti
The global financial crisis has provided the impetus for a major overhaul of the financial regulatory system. No other financial crisis since the Great Depression has led to such widespread dislocation in financial markets, with such abrupt consequences for growth and unemployment, and such a rapid and sizable internationally coordinated public sector response. Behind this response was the acknowledgment that these costs have been imposed partly as a result of systemic weaknesses in the regulatory architecture and the failure of supervisors to rein in excessive private sector risk taking.
Alberto Buffa Di Perrero, Silvia Iorgova, Turgut KiŞinbay, Vanessa Le LeslÉ, Fabiana Melo, Jiri Podpiera, Noel Sacasa, and AndrÉ Santos
The recent crisis revealed the significant risks posed by large, complex, and interconnected institutions and the fault lines in the regulatory and oversight systems. During the past two decades preceding the crisis, banks in advanced countries significantly expanded in size and increased their outreach globally. In many cases, they moved away from the traditional banking model to become globally or regionally active large and complex financial institutions (LCFIs).2 The vast majority of cross-border finance was (and still is) intermediated by a handful of these institutions with growing interconnections within and across borders. Common trends before the recent crisis included a sharp rise in leverage, significant reliance on short-term wholesale funding, significant off-balance-sheet activities, maturity mismatches, and an increased share of revenues from complex products and trading activities. In some systemically important countries, regulatory ratios were not sensitive to the buildup of various risks and capital was inadequate or of insufficient quality to provide a buffer.
Ana Carvajal, Randall Dodd, Michael Moore, Erlend Nier, Ian Tower, and Ms. Luisa Zanforlin
In a November 15, 2008, communiqué, the G-20 called for a review of the scope of financial regulation with “a special emphasis on institutions, instruments and markets that are currently unregulated, along with ensuring that all systemically important institutions are appropriately regulated.”
José Viñals, Jonathan Fiechter, Mr. Aditya Narain, Ms. Jennifer A. Elliott, Ian Tower, Pierluigi Bologna, and Michael Hsu
Why were some countries with similar financial systems, operating under the same set of global rules, less affected than others in the recent global financial crisis? Although there may be more than one reason, one that has been offered is simply “better supervision.” In some of the crisis-affected countries supervision has not proved to be as effective as it should have been—hence, looking ahead what is needed is not just better regulation, but also better supervision. Supervision is not only about the tasks of implementation, monitoring, and enforcement of the regulations. No less crucially, it is about the tasks of figuring out whether an institution’s risk management controls are adequate and whether the institution’s culture and appetite for risk significantly increase the likelihood of solvency and liquidity problems.
The recent financial crisis has given renewed urgency to the need for resolution systems for financial institutions that both safeguard financial stability and limit moral hazard. However, experience demonstrates that these systems will not be effective unless progress is also made in developing a framework that applies on a cross-border basis. Since many systemically important financial groups operate globally, an uncoordinated application of resolution systems by national authorities will make it much more difficult to both secure the continuity of essential functions (thereby limiting contagion) and ensure that shareholders and creditors bear the financial burden of the resolution process.