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Mr. Carl-Johan Lindgren and Mr. D. F. I. Folkerts-Landau

Abstract

This study outlines the broad principles and characteristics of stable and sound financial systems, to facilitate IMF sruveillance over banking sector issues of macroeconomic significance and to contribute the general international effort to reduce the likelihood and diminish the intensity of future financial sector crises.

Mr. Carl-Johan Lindgren and Mr. D. F. I. Folkerts-Landau

Abstract

It is now well recognized that vulnerable and unstable banking systems can severely disrupt macro-economic performance in industrial, developing, and transition economies alike.1 The widespread incidence and the high cost of banking problems have prompted calls for concerted international action to promote the soundness and stability of banking systems. At the Lyon Summit in June 1996, the Group of Seven (G-7) industrial countries called for “the adoption of strong prudential standards in emerging market economies,” and encouraged the international financial institutions to “increase their efforts to promote effective supervisory structures in these economies.”2 These intentions were reinforced by the IMF Interim Committee’s “Partnership for Sustainable Global Growth” in September 1996 (see IMF, 1996). In Denver, in June 1997, the G-7 Ministers of Finance meeting considered a report by a Group of Ten (G-10) working party on financial stability in emerging market economies (G-10, 1997) and requested “the IMF and the World Bank to report to Finance Ministers next April on their efforts to strengthen the roles they play in encouraging emerging market economies to adopt the principles and guidelines identified by the supervisory community” (G-7, 1997). The G-7 Heads of Government then called “on the international financial institutions and the international regulatory bodies to fulfill their roles in assisting emerging market economies in strengthening their financial systems and prudential standards.” The Heads of Government also welcomed “the IMF’s progress in strengthening surveillance and promoting improved transparency. Increased attention to financial sector problems that could have significant macroeconomic implications, and to promoting good governance and transparency, will help prevent financial crises” (G-7, 1997).

Mr. Carl-Johan Lindgren and Mr. D. F. I. Folkerts-Landau

Abstract

The thrust of policy efforts to strengthen financial sector performance has to originate with national authorities. But the Fund and the international community at large have an important stake in the success of these efforts, because banking crises have macroeconomic consequences and may generate significant regional and international spillovers. As more countries remove remaining restrictions on their capital account transactions, and as banking and finance assumes a more regional and international dimension, the cross-border impact of banking system problems can be expected to increase as well. These considerations have motivated broad international interest in contributing to the effort to achieve greater stability in banking and financial systems around the world, culminating in the statement by G-7 Heads of Government in Denver. The Fund’s efforts to support the initiatives of many of its members to strengthen their financial system policies through its surveillance, lending, and technical assistance activities should be seen as part of this larger international effort now under way, and the Fund’s work will have to be in concert with the endeavors of this broader international initiative.

Mr. Carl-Johan Lindgren and Mr. D. F. I. Folkerts-Landau

Abstract

While not the subject of this paper, it must always be remembered that an unstable macroeconomic environment is a principal source of vulnerability in the financial system. Significant swings in the performance of the real economy, and volatile interest rates, exchange rates, asset prices, and inflation rates make it difficult for banks to assess accurately the credit and market risks they incur. Moreover, banks in many developing and transition economies have limited scope to diversify these risks as much as is possible in industrial economies. Large and volatile international capital flows often add to the challenges faced by banks in these countries. While Fund surveillance will seek to improve the macroeconomic framework, a structural framework for sound banking should also attempt to ensure that the macroeconomic risks are adequately reflected in prudential restraints and structural policies.

Mr. Carl-Johan Lindgren and Mr. D. F. I. Folkerts-Landau

Abstract

This chapter first discusses issues relating to the quality of financial data and difficulties in valuing bank assets. It then examines the types of information required by the various users of data describing the financial condition of banks. The adoption of internationally accepted accounting standards,30 including the principles of accrual and consolidation, would facilitate the production of high-quality data. In addition, detailed rules governing the valuation of bank assets and the treatment of income and expenditure are often desirable. A by-product of good-quality banking data is a more reliable input to the determination of macroeconomic policy, but that subject is beyond the ambit of this paper. However, to the extent possible, coordination with compilers of monetary statistics will help reduce the burden on reporting entities. The focus here will be on the information needs of two types of recipients with an interest in bank soundness, supervisors, and the public.

Mr. Carl-Johan Lindgren and Mr. D. F. I. Folkerts-Landau

Abstract

In almost all countries, financial safety nets are considered an integral part of the financial infrastructure and are seen as necessary for promoting the stability of financial systems by enhancing confidence in the banking system. Most financial safety nets have two key elements, namely, a lender of last resort, usually the central bank, and a deposit insurance scheme.66

Mr. Carl-Johan Lindgren and Mr. D. F. I. Folkerts-Landau

Abstract

Banking laws and prudential regulations need to define a framework that induces banks to operate in a safe and prudent manner, and the regulatory and supervisory framework needs to counteract the distortions introduced by public sector guarantees. This requires a consistent set of requirements governing accounting, asset valuation, supervisory reporting and public disclosure, risk-taking and risk management, and entry and exit. This chapter is divided into three parts, covering entry policy, governance and risk management, and quantitative tools of prudential supervision.83

Mr. Carl-Johan Lindgren and Mr. D. F. I. Folkerts-Landau

Abstract

This chapter examines the attributes of an effective banking supervisory system. It is based on practice established in major supervisory authorities, and to a large extent reflected (sometimes only implicitly) in the published recommendations of the Basle Committee.103 The first issue addressed is the degree of supervisory autonomy, which is necessary to permit the supervisory authority to perform its responsibilities without undue political interference and to allow the authority to acquire and allocate its financial and staff resources. The second issue relates to the tools that should be provided to the supervisory authority to carry out its mandate. The third section of this chapter addresses the powers of the supervisory authority to request information from and cooperate with other financial sector supervisors and law enforcement agencies. The fourth issue pertains to the choice of location for the banking supervisory function within the public sector. The fifth section discusses the characteristics of off-site analysis and on-site supervision. Finally, this chapter discusses the appropriate range of remedial and punitive measures available to the supervisory authority.

Mr. Carl-Johan Lindgren and Mr. D. F. I. Folkerts-Landau

Abstract

This chapter discusses international aspects of maintaining banking soundness. It identifies some of the key problem issues in supervising banks and banking groups with cross-border operations, that is, the location of the home supervisor, licensing of internationally active banks and their establishments and affiliates abroad, cross-border compliance with prudential standards, information flows, inspections, cross-border remedial action, shell banks and parallel-owned banks, international financial conglomerates, and international bank liquidation.