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Business and Economics > Banks and Banking

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  • Type: Journal Issue x
  • IMF Staff Position Notes x
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Cover IMF Staff Position Notes
Impact of Regulatory Reforms on Large and Complex Financial Institutions
Ms. Inci Ötker
and
Ceyla Pazarbasioglu
Financial sector reforms are being considered to address the risks posed by large and complex financial institutions (LCFIs). The vast majority of global finance is intermediated by a handful of these institutions with growing interconnections within and across borders. Common trends that contributed to the recent global crisis included sharp increases in leverage, significant reliance on short-term wholesale funding, growth of off-balance-sheet activities, maturity mismatches, and increased share of revenues from complex products and trading activities. The key objective of the financial sector reforms is to promote a less leveraged, less risky (or better cushioned), and thus a more resilient financial system that supports strong and sustainable economic growth. The recent proposals of the Basel Committee on Banking Supervision (BCBS) on capital standards represent a substantial improvement in the quantity and quality of capital in comparison with the pre-crisis situation. The analysis of this paper suggests that, subject to usual caveats associated with limited data disclosures and availability, phase-in arrangements will allow most banks to move to these higher standards through earnings retention, assuming a modest economic and earnings outlook. It also suggests that should banks generate strong earnings in the coming years, and distribute lower dividends, they could rebuild common equity capital ratios faster than required under the current phase-in periods. The analysis of the paper also suggests that the new capital standards will have a significant impact on investment-banking-type activities, including through tighter requirements for trading book exposures. Investment banking activities will also be affected by a host of other regulatory initiatives, including the new accounting rules and higher standards for securitization, derivatives, and trading businesses, as well as measures to restrain certain activities. Yet, LCFIs with an investment banking focus have flexible business models and can adjust their strategies easily to mitigate the effects of the regulatory reforms, notwithstanding a multitude of regulations affecting their activities. The ultimate effect of the reforms on business models remains to be seen until the regulations take their final shape.
Keywords:
SPN; bank; capital; derivatives business; bank analyst; capping bank exposure; liquidity risk profile; conservation buffer; financial system; Basel capital regulation; Liquidity requirements; Investment banking; Commercial banks; Capital adequacy requirements; Countercyclical capital buffers; Global; North America; Europe
Cover IMF Staff Position Notes
Shaping the New Financial System
Ms. Marina Moretti
,
Mr. Aditya Narain
,
Ms. Laura E. Kodres
,
Ceyla Pazarbasioglu
,
José Vinãls
, and
Jonathan Fiechter
Three years after the onset of the global financial crisis, much has been done to reform the global financial system, but there is much left to accomplish. The regulatory reform agenda agreed by G-20 leaders in 2009 has elevated the discussions to the highest policy level and kept international attention focused on establishing a globally consistent set of rules. Comprehensive reform, once agreed and implemented in full, will have far-reaching implications for the global financial system and the performance of the world economy. In designing the reforms, it is imperative that policymakers keep their focus on the overarching objective of creating a financial system that provides a solid foundation for strong and sustainable economic growth. This paper argues that the current reforms are moving in the right direction, but many policy choices lie ahead—nationally and internationally?which are both urgent and challenging. Policies need to address not only the risks posed by individual banks but also, importantly, those posed by nonbanks and the system as a whole. The recent proposals of the Basel Committee on Banking Supervision (BCBS) represent a substantial improvement in the quality and quantity of bank capital, but these apply only to a subset of the financial system.
Keywords:
SPN; financial institution; market; capital; global financial system; repurchase market; financial system; conservation buffer; financial activity; IMF-FSB early warning exercise; commercial paper; private label securitization market; OTC derivatives market; bank capital; market discipline; market infrastructure; market dynamics; Financial sector stability; Systemic risk; Bank resolution framework; Liquidity requirements; Global
Cover IMF Staff Position Notes
Fiscal Space
Mr. Jonathan David Ostry
,
Mr. Atish R. Ghosh
,
Mr. Jun I Kim
, and
Miss Mahvash S Qureshi
In this note, the authors reexamine the issue of debt sustainability in a large group of advanced economies. Their hypothesis is that, when debt is in a moderate range, its dynamics are sustainable in the sense that increases in debt elicit sufficient increases in primary fiscal balances to stabilize the debt-to-GDP ratio. At high debt levels, however, the dynamics may turn unstable, and the debt ratio may not converge to a finite level. Such a framework allows the authors to define a “debt limit” that is consistent with a country’s historical track record of adjustment in the sense that, without an extraordinary fiscal effort, any debt increment beyond this limit would cause debt to increase without bound. This debt limit is not an absolute and immutable barrier, however, but rather defines a critical point above which a country’s normal fiscal response to rising debt becomes insufficient to maintain debt sustainability. Nor should this debt limit be interpreted as being in any sense the optimal level of public debt. Indeed, since this limit delineates the point at which fiscal solvency is called into question—and the analysis abstracts entirely from liquidity/rollover risk—prudence dictates that countries will typically want to be well below their debt limit. Given a country’s normal pattern of adjustment, “fiscal space” is then simply the difference between its debt limit and its current level of debt.
Keywords:
SPN; interest rate; debt limit; interest rate schedule; interest rate-growth rate differential; interest rate-growth differential; interest rate-output growth rate differential; interest rate-growth rate schedule; risk-free interest rate; public debt debt ratio; model-implied interest rate; Fiscal stance; Fiscal space; Debt limits; Market interest rates; Southern Europe
Cover IMF Staff Position Notes
Default in Today's Advanced Economies: Unnecessary, Undesirable, and Unlikely
Mr. Carlo Cottarelli
,
Mr. Paolo Mauro
,
Lorenzo Forni
, and
Jan Gottschalk
This note summarizes the main arguments put forward by some market commentators who argue that default is inevitable, and presents a rebuttal for each argument in turn. Their main arguments focus on the size of the adjustment and continued market concerns reflected in government bond spreads. The essence of our reasoning is that the challenge stems mainly from the advanced economies’ large primary deficits. Thus, by lowering the interest bill while triggering the need to move to primary balance or a small primary surplus, default would not significantly reduce the need for major fiscal adjustment. In contrast, the emerging economies that defaulted in recent decades did so primarily as a result of high debt servicing costs, often in the context of major external shocks. We conclude that default would be ineffective and undesirable in today’s advanced economies.
Keywords:
SPN; economy; debt; Greece; default; advanced economy; default episode; emerging economy defaulter; country default; gross financing; public debt debt ratio; restructuring debt; Fiscal consolidation; Fiscal stance; Debt restructuring; Real interest rates; Global
Cover IMF Staff Position Notes
Redesigning the Contours of the Future Financial System
Ms. Laura E. Kodres
and
Mr. Aditya Narain
This paper explores the private- and public-sector responses to the crisis and some of the probable outcomes. Aside from improved supervision of individual institutions, greater emphasis needs to be put on financial regulations that reflect the systemic nature of financial risks and the role that macroeconomic policies play. Global consistency of regulation and financial sector taxation will be essential to mitigate systemic risks, avoid unintended distortions, and help ensure a level playing field. This note suggests the key aspects of the future contours will likely be: ? Banks are expected to return to their more traditional function as stricter regulation will limit the risks and activities they can undertake. ? The nonbanking sector will likely have a greater competitive advantage—both in supplying credit and providing investors with nonbank services—and will thus grow. ? The perimeter of regulation will need to expand to take into account risks in the nonbank sector. ? Market infrastructure will be reinforced to protect investors and will need to provide simplicity and transparency to make risks clearer and the financial system safer. ? The global financial system is likely to be smaller and less levered than in the recent past, and could well be less innovative and dynamic, at least for a while.
Keywords:
SPN; functioning financial system; economic growth; IMF policy advice; credit risk; banking sector; banking system assets; market discipline; financial system assets; CDS market; accounting rule; market practice; Commercial banks; Systemic risk; Financial sector stability; Credit; Nonbank financial institutions; Global
Cover IMF Staff Position Notes
Monetary Policy and Bank Risk-Taking
Mr. Giovanni Dell'Ariccia
,
Mr. Gianni De Nicolo
,
Mr. Luc Laeven
, and
Mr. Fabian Valencia
This paper contributes to the current debate on what role financial stability considerations should play in monetary policy decision and how best to integrate macro-prudential and monetary policy frameworks. The paper broadly supports the view that monetary policy easing induces greater risk-taking by banks but also shows that the relationship between real interest rates and banking risk is more complex. Ultimately, it depends on how much skin in the game banks have. The central message of the paper is broadly complementary to those in the recent MCM board paper “Central Banking Lessons from the Crisis.”
Keywords:
SPN; bank risk; bank equity; franchise value; leverage ratio; bank Risk Taking; leveraged bank
Cover IMF Staff Position Notes
The Making of Good Supervision: Learning to Say "No"
Ms. Jennifer A. Elliott
,
Mr. Aditya Narain
,
Ian Tower
,
José Vinãls
,
Pierluigi Bologna
,
Michael Hsu
, and
Jonathan Fiechter
The quality of financial sector supervision has emerged as a key issue from the financial crisis. While most countries operated broadly under the same regulatory standards, differences emerged in supervisory approaches. The international response to this crisis has focused on the need for more and better regulations (e.g., in areas such as bank capital, liquidity and provisioning) and on developing a framework to address systemic risks, but there has been less discussion of how supervision itself could be strengthened. The IMF’s work in assessing compliance with financial sector standards over the past decade in member countries suggests that while progress is being made in putting regulation in place, work remains to be done in many countries to strengthen supervision. How can this enhanced supervision be achieved? Based on an examination of lessons from the crisis and the findings of these assessments of countries’ compliance with financial standards, the paper identifies the following key elements of good supervision—that it is intrusive, skeptical, proactive, comprehensive, adaptive, and conclusive. To achieve these elements, the “ability” to supervise, which requires appropriate resources, authority, organization and constructive working relationships with other agencies must be complemented by the “will” to act. Supervisors must be willing and empowered to take timely and effective action, to intrude on decision-making, to question common wisdom, and to take unpopular decisions. Developing this “will to act” is a more difficult task and requires that supervisors have a clear and unambiguous mandate, operational independence coupled with accountability, skilled staff, and a relationship with industry that avoids “regulatory capture.” These essential elements of good supervision need to be given as much attention as the regulatory reforms that are being contemplated at both national and international levels. Indeed, only if supervision is strengthened can we hope to effectively deliver on the challenging—but crucial—regulatory reform agenda. For this to happen, society must stand with supervisors as they play their role as naysayers in times of exuberance.
Keywords:
SPN; supervision; agency; authority; market; risk management
Cover IMF Staff Position Notes
Financing the Response to Climate Change
Ms. Catherine A Pattillo
and
Mr. Hugh Bredenkamp
This note outlines a scheme for mobilizing financing to help developing countries confront the challenges posed by climate change. The idea is to create a “Green Fund” with the capacity to raise resources on a scale commensurate with the Copenhagen Accord ($100 billion a year by 2020). By providing a unified resource mobilization framework, with up-front agreement on burdensharing and the capacity to meet the financing needs identified at Copenhagen, the Green Fund could facilitate progress toward a binding global agreement on reducing greenhouse gas emissions and allow developing countries to begin scaling up their climate change responses without delay. To achieve the necessary scale, the Green Fund would use an initial capital injection by developed countries in the form of reserve assets, which could include SDRs, to leverage resources from private and official investors by issuing low-cost “green bonds” in global capital markets. Contributors could agree to scale their equity stakes in proportion to their IMF quota shares, making these the “key” for burden sharing among the contributing countries. Since much of the financing would need to be provided ultimately as grants or highly concessional loans, the fund would also need to mobilize subsidy resources from contributors. Governments would likely require new sources of fiscal revenue for this purpose, including from carbon taxes and expanded carbon-trading schemes, which may take time to put in place. In the interim, the Green Fund could cover its subsidy needs from bond proceeds, interest income on its reserve asset capital base, and/or revenues from other innovative international tax schemes. Resources mobilized by the Green Fund could be channeled through existing climate funds, or via newly created special-purpose disbursement facilities. We are not proposing that the IMF itself would create, finance, or manage the Green Fund. The ideas set out in this note are being offered purely for consideration by the international community, and as a contribution to the broader public debate.
Keywords:
SPN; fund; bond; resource; financing; proceeds
Cover IMF Staff Position Notes
Rethinking Macroeconomic Policy
Mr. Olivier J Blanchard
,
Mr. Giovanni Dell'Ariccia
, and
Mr. Paolo Mauro
The great moderation lulled macroeconomists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. The crisis clearly forces us to question that assessment. In this paper, we review the main elements of the pre-crisis consensus, we identify where we were wrong and what tenets of the pre-crisis framework still hold, and take a tentative first pass at the contours of a new macroeconomic policy framework.
Keywords:
SPN; monetary policy; central bank; interest rate; inflation expectation; core inflation; interest rate rule; monetary policy action; inflation neutral; inflation shock; inflation stability; economic system; inflation rate; Inflation; Asset prices; Central bank policy rate; Inflation targeting; Eastern Europe
Cover IMF Staff Position Notes
The Debate on the International Monetary System
Mrs. Isabelle Mateos y Lago
,
Rupa Duttagupta
, and
Rishi Goyal
This paper considers options to address concerns related to functioning of the International Monetary System. Despite its relative stability, the current “non-system” has the inherent weaknesses of a setup with a dominant country-issued reserve currency, wherein the reserve issuer runs fiscal and external deficits to meet growing world demand for reserve assets and where there is no ready mechanism forcing surplus or reserve-issuing countries to adjust. The problem has amplified in recent years in line with a sharp rise in the demand for reserves, reflecting in part emerging markets’ tendency to self-insure against costly capital account crises. On the demand side, the paper explores alternative insurance arrangements that could mitigate the precautionary demand for reserves. On the supply side, it assesses a menu of alternative reserve assets that could offer sustained stability and efficiency. Many of the proposals presented would require fundamental changes in the forms and degree of international cooperation, however, may gain realism and practical relevance if more incremental efforts at strengthening the current system fail.
Keywords:
SPN; U.S. dollar; dollar asset; central bank; lender of last resort; market SDR rate; private sector; SDR component currency; SDR-denominated reserve asset; SDR market; SDR assets; Currencies; Reserve currencies; Reserve assets; International monetary system; Exchange rates; Global