core sector communique

Remarks by Naoyuki Shinohara, IMF's Deputy Managing Director, at Panel Discussion on Global Financial and Economic Governance

World Capital Markets Symposium
Kuala Lumpur, September 27, 2010

As prepared for delivery

Distinguished guests,

It is a great pleasure for me to be here today to participate in this discussion and share with you the Fund’s view on global financial governance.

The crisis of the recent past has provided an impetus for a complete overhaul of the international financial regulatory system. The reform agenda that has emerged, under the leadership of the advanced and emerging country members of the G-20, aims to address the shortcomings in the financial system exposed by the crisis while ensuring globally-consistent rules and a level playing field across countries and sectors. Once implemented, the program of reforms will have far-reaching implications for global finance and the world economy.

No other financial crisis since the Great Depression has led to such widespread dislocations in financial markets and such adverse consequences on growth. It is thus imperative that, after the initial rapid and sizable internationally coordinated public sector response, the international community keep the reform’s momentum and focus on the overarching objective of building a safer financial system with sufficient dynamism and innovation to finance solid and stable growth.

The IMF, in collaboration with the BIS, the Financial Stability Board (FSB) and standard-setting bodies on financial sector regulatory issues, is playing an active role in helping to reshape the post-crisis financial regulatory landscape. In the Fund’s view, financial regulatory policies should aim to ensure:

• Financial intermediation that is geared more toward serving the needs of the real economy;

• A competitive financial system with better governed institutions and more transparent corporate structures, instruments and markets;

• Less leveraged and complex institutions with higher and better quality capital and liquidity that leave a smaller systemic risk footprint;

• A globally coordinated framework that can resolve institutions—even systemically important ones—in an effective and timely way with little cost to the taxpayer;

How do we view the progress so far?

The Basel Committee on Banking Supervision revised proposals for the new capital, liquidity and leverage requirements in July 2010, which are at the core of the reform program endorsed by the G-20. The revised proposals constitute a substantial improvement in the quality and quantity of bank capital in comparison with the pre-crisis situation, and will raise the resilience of global banking systems. However, there is still much to accomplish in the period ahead. In particular, as the global financial system stabilizes and economic recovery takes hold, shorter phase-in periods of the higher capital standards and the phasing out of all intangible assets from capital should be considered. Comparable rules should also extend to nonbank financial instituions that pose systemic risk. In the meantime, supervisors will need to remain diligent to guard against excessive risk taking by institutions with weak capital.

This said, the revised proposals represent an important achievement that keeps the reform agenda moving forward. Obtaining international consensus on reform takes time, both because of the diversity of financial systems and because of the need to assess the impact of the proposed measures. This underscores the importance of reconciling the need to demonstrate quick action and the need to ensure that the regulatory solutions achieve the intended objectives without unintended effects on financial stability. It is also important to ensure that the totality of the impact of the reforms does not run counter to the desired effect of individual measures.

It is imperative that the international community maintain the momentum of reform and resist further pushback and compromises. We are now at a critical juncture where difficult policy choices have to be made to keep the reform agenda on the right path. Going forward, we need to keep the focus of the reform agenda in the following areas:

• First, it is important to ensure a level playing field in regulation. Global coordination is needed to reap the benefits of global finance while minimizing the scope for regulatory arbitrage, which could be damaging to global financial stability

• Second, there needs to be a macroprudential framework to supplement the existing microprudential framework. This new regulatory framework will employ many of the traditional prudential measures but will address systemic risks stemming from both the inter-connectedness of institutions, instruments and markets and the procyclicality of lending behavior.

• Third, reform must address weaknesses in the entire financial system including the nonbank sector, not just those of banks. Without an extended regulatory perimeter that includes insurance companies, securities firms and other nonbank financial institutions, riskier activities and products will, again, migrate to less regulated or unregulated segments of the financial system.

• Fourth, reform must focus on improving the effectiveness of supervision. The Fund’s work on assessing financial sector standards has found that many countries have good rules on books, but often lag behind in adopting best practices in supervising key risks, taking prompt corrective action and sanctioning noncompliance.

• Fifth, an internationally compatible cross-border resolution framework is essential. A cross-border framework capable of ensuring a smooth and orderly resolution of insolvent financial institutions would put financial institutions on notice that none are too important to fail while enhancing confidence in the financial system. Because of the complexity of the issues involved, moving this work forward will require political commitment at the highest levels.

• Last but not least, the private sector must take greater ownership of the reform agenda. Aligning business models and practices with the new financial structure laid out by public policy would be key to the successful implementation of the new rules. Boards of financial institutions should be equipped with powers to ensure that excessive risk taking is avoided and be held accountable for it.

What’s the IMF’s role in all this?

The Fund brings to the table a universal membership, a track record in economic and financial surveillance, a strong capability of assessing the implementation of financial standards and disseminating good practices, and substantial experience in assisting countries in dealing with financial and economic crises. With its universal membership, the IMF is uniquely positioned to promote proposals that are both nationally relevant and internationally consistent. In a globalized world, consistency in implementing international financial regulation is crucial to ensure a level playing field that minimizes regulatory arbitrage and a sound framework for cross-border resolution.

In a forthcoming Staff Position Note, we will outline our views about how much progress we have made so far and what we need to do going forward. We believe that the comprehensive reforms, once agreed and implemented, will have far-reaching implications for the global financial system and the performance of the world economy.

Furthermore, as part of our Financial Sector Assessment Program, or FSAP, we provide advice to countries on a host of financial areas, including regulation. The FSAP is a comprehensive and in-depth analysis of a country’s financial sector. Since it was introduced in 1999, more than 130 countries have participated in the program (many more than once), including 14 in Asia, and another 35 or so are currently underway or in the pipeline. This includes almost all the G-20 countries. The focus of financial assessments is twofold: to measure the stability of the financial sector and to assess its potential contribution to growth and development. You may be aware that we completed our first ever FSAP of the United States during the last year.

Ladies and gentlemen, let me close my remarks by noting once again that the Fund is committed to the international reform agenda and preserving global financial stability. In doing so, we encourage all policymakers to keep their focus on the overarching objective of creating a financial system that provides a solid foundation for stable and sustainable economic growth.