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Chapter 3. International Capital Markets

Author(s):
International Monetary Fund
Published Date:
October 1997
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In July 1996 the Board conducted its annual review of developments in the international capital markets.3 In welcoming the opportunity for the review, Directors discussed how to broaden the application of sound supervisory and regulatory banking standards to a larger number of countries and the role of the Fund in that area. They also commented on how to reduce further the potential for disruptions in global foreign exchange markets.

Capital Flows to Emerging Markets

Directors remarked upon the speed with which net capital flows to emerging markets had recovered from the disturbances associated with the Mexican financial crisis in early 1995. There was general agreement that investors had become more aware of the risks associated with investing in emerging markets. Notably, there had been a greater reliance on a wider range of macroeconomic, financial, and banking soundness indicators in assessing both economic conditions and investment opportunities in developing markets. In particular, Directors pointed to evidence of keener investor discrimination with regard to both the nature of investments and their destination, as shown in the decline in the importance of more volatile portfolio flows, the increase in foreign direct investment and cross-border lending in most regions, and the changes in the proportion of flows to different regions as well as between countries within regions.

Risk Management

Directors welcomed the positive impact of these developments on market stability, but they cautioned against complacency. They felt that considerable progress still had to be made before the quality and availability of economic and financial data on emerging markets—and thus the supporting analysis—could compare favorably with what was available on industrial country markets.

Some Directors expressed concern, in particular, about the shift toward bonds denominated in yen and deutsche mark. To the extent that the exchange risks were not adequately hedged, borrowers might he incurring more exchange rate risk than they could manage. Lenders could also be incurring more credit risk than they fully appreciated. Directors suggested that this aspect of liability management required monitoring in several emerging market countries.

In discussing the rapidly growing size and complexity of the foreign exchange markets. Directors noted the central position of these markets in the international monetary system. The recent initiatives of the Group of Ten industrial countries in encouraging the improvement of private risk management in reducing settlement risks were praised. It was emphasized that reduction in settlement risk was primarily a task for the private sector.

Surveillance of Global Financial Markets

In reviewing trends and developments in major industrial country markets, it was observed that the evolution of international financial markets since the early 1990s provided evidence that international capital markets had become more resilient. Despite this. Directors thought it was premature to conclude that financial institutions were able to respond easily and effectively to most kinds of disturbances, including unanticipated and sharp changes in interest and exchange rates. Here again, caution would be well advised.

Directors noted that banking systems in major industrial countries had made significant progress in improving their financial condition, performance, and risk management. But some countries still had problems, and the possibility of financial stress owing to increased global competition—and the growth of new and unfamiliar financial transactions—could not be ruled out. In developing countries, the importance of improving regulatory and market infrastructure was emphasized; national authorities would have to strengthen the supervision and surveillance of their respective financial sectors.

Directors discussed existing arrangements that sale-guard the stability and efficiency of international markets. They observed that the initiatives by the Group of Ten countries to coordinate and harmonize their supervisory and regulatory activities—principally through the Basle Committee on Banking Supervision—shed light on a range of important issues. In particular, Directors noted the recent guidelines on minimum capital requirements for market risk incurred by international banks; the principles on which the division of supervisory responsibility between home and host countries would be based; and the understandings regarding the sharing of supervisory information. There was broad agreement that current supervisory and regulatory arrangements had been generally successful in coping with changes in the international financial system.

Despite these successes, Directors observed that important challenges remained. The approach taken by the Group of Ten to the formulation and implementation of supervisory and regulatory policy needed to be adapted and applied to a larger group of countries. This would not only be important in safeguarding the stability of the international financial system, but also in contributing to the effectiveness of domestic banking institutions in developing countries.

Role of the Fund

Directors welcomed the efforts of the Basle Committee and the Bank for International Settlements (BIS) in reaching out to regional associations of supervisors—besides individual countries that were not members of the Group of Ten—in formulating and implementing more effective supervision and regulation. In this context, they felt that there was no need for any new institutional structure. Members of the Board, however, emphasized that the Fund, with its universal membership, could play a critical role in promoting banking soundness and adherence to internationally agreed standards in emerging markets, transition economies, and other developing countries.

Internationally agreed supervisory and regulatory minimum standards would need to be developed. Directors said. These standards should cover key aspects of prudential rules, the architecture of the regulatory environment, and the international division of supervisory responsibility and exchange of supervisory information. As part of its responsibility, the Fund could contribute to the dissemination of such standards; the Fund could also help to monitor progress in adapting and adhering to those standards.

In subsequent discussions (see Chapter 4, the section on Banking Soundness), Directors emphasized that the Fund should draw, inter alia, on the set of core principles for effective bank supervision being developed by the Basle Committee and should collaborate closely with other international organizations and groups, including the Basle Committee and the World Bank.

The background paper prepared by the staff was subsequently published as International Capital Markets: Developments, Prospects, and Key Policy Issues (September 1996), in the Fund’s series of World Economic and Financial Surveys.

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