Article

Policy: Prescriptions for Financial Stability

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 2006
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Everyone recognizes a financial crisis. But financial stability, according to the IMF’s Garry Schinasi, is more difficult—but not impossible—to define, measure, and monitor. In a new IMF publication, Safeguarding Financial Stability: Theory and Practice, he addresses these issues and develops a framework for assessing national and international financial stability.

A 10-year veteran of international capital market surveillance, Schinasi saw a need for such a framework. His book offers a comprehensive approach—analysis of macro-economic and financial conditions and of institutions, markets, and infrastructures—for evaluating the sources of risk and vulnerability in financial systems. The framework is not a blueprint but a more generic tool that can be adapted to countries’ needs. It relies on coordinating sources of information and formalizing the information into an assessment. “It’s a conceptual and analytical approach to evaluating what problems might arise, thinking about the policies required to deal with the problems, and putting changes in place to prevent them from recurring,” he says.

Schinasi sees the assessment process as continuous and organic, and he uses a medical analogy to explain it. Financial stability is akin to human health, he says. A person who is healthy and wants to maintain good health needs to be in preventive mode. Similarly, a country that is showing no signs of becoming unstable in the near future should also be in preventive mode, maintaining and updating its policies to prevent future imbalances.

A patient with symptoms may not be ill but may nonetheless require remedial action. If a market is showing symptoms, the authorities responsible for market surveillance would assess the problem. What is causing spikes in asset prices? Why is everyone selling? Is it a market dislocation requiring remedial action, or will it work itself out?

Then there is the resolution mode. The patient gets sick and requires surgery. The treatment may cause the patient to get worse before he gets better. Like a doctor, a country’s financial authorities will intensify their policies as the financial system moves toward, or crosses, the boundary of stability.

The book also takes up the benefits and challenges of modern finance; it draws on a rich vein of real-world experiences—the growing reliance on over-the-counter derivatives, the growth of credit derivatives, and the capital market activities of insurers and reinsurers. Schinasi says, “We’ve learned how the advanced markets have evolved, how they’ve innovated, and what risks come with innovation.” Much of the rest of the world will go through its own cycles of innovation and should benefit from the lessons that have emerged so far.

The book has three audiences: policymakers at central banks, supervisory authorities, and finance ministries; IMF staff engaged in financial surveillance; and graduate students studying economics, finance, and public policy. Unable to find a book to prepare people to work on financial stability issues, Schinasi drew on his experience to write one. Still, he doesn’t consider his framework the definitive approach. Rather, he sees it as the start of a debate. People should read the book and think about the issues. “If a better way to safeguard financial stability is developed as a result,” he says, “that would be great.”

Elisa Diehl

IMF External Relations Department

Copies of Safeguarding Financial Stability: Theory and Practice, by Garry J. Schinasi, are available from IMF Publication Services for $28.00 each. See this page for ordering information.

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