Global Financial Surveillance and the Quest for Financial Stability: Back to Basics?

1. Global Financial Surveillance and the Quest for Financial Stability:Back to Basics? Christopher Towe Deputy Director Monetary and Capital Markets Department Disclaimer: The views expressed in this presentation are those of the author and should not be attributed to the IMF or its Board.

2. Outline • Will try to complement other speaker and panelists' remarks • Will focus principally on how multilateral agencies—especially the IMF—are responding to the crisis • And will try to flag some issues that we—the international community—still need to work hard on

3. What are we doing? • The IMF, in particular, is going “back to basics” including by: • redesigning our core mandate for multilateral and bilateral surveillance • Redesigning our instruments for providing emergency liquidity

4. In our surveillance… • Going “back to basics” means “ruthless truth telling” • The crisis drove home: • Warnings were unclear • Policy messages not prioritized • Misunderstanding of transmission channels • Policy impact was limited

5. So how are we responding? • Policy messages are becoming more forthright • And coordination between agencies being enhanced • Takes advantage of gains from trade (IMF, FSB, BIS) • Tools are being strengthened • IMF/FSB Early Warning Exercise • IMF/WB Financial Sector Assessment Program becoming more risk and analytically focused • Surveillance of systemically important institutions (not just countries) • Methodologies for both identifying systemically important institutions • Designing and promoting prudential norms to internalize externalities

6. Our lending facilities are also going “back to basics”… • IMF lending facilities have been significantly expanded • Trying to keep pace with global capital markets • Re-establishes IMF mandate as international lender of last resort • Adapted our conditionality framework • New Flexible Credit Line relies on “ex ante” conditionality and helps reduces moral hazard • Other facilities have also been streamlined • “Structural” performance criteria have been eliminated

7. What will be the challenges? • Candor v. effectiveness • Maintaining interest in tail events • Blurred accountability • Cross-border cooperation • Information gaps • Deciding on the acceptable level of systemic risk

8. What will be the challenges? • Trade-off between public candor and effectiveness • Long worried that outspokenness undermines authorities’ willingness to engage and seek advice • But this concern is (more often than not) is outweighed by: • The greater impact that candid and public messages can bring • And the critical need to demonstrate that the Fund and others are impartial

9. What will be the challenges? 2. Maintaining policymakers' interest in low probability tail events • By definition, these events are unlikely to materialize • Undermines the credibility of the risk manager • Requires that stridency is consistent with likelihood/potential severity of impact of risk • But, just as in a bank, the culture of policymaking has to value risk management • True both nationally and internationally

10. What will be the challenges? 3. The danger of blurred accountability • The IMF’s original mandate was as the pre-eminent global systemic risk regulator • But the number of actors has grown • E.g., BIS, FSB, OECD, standard-setters, G7, G20, etc. • Large number of actors risks: • Lack of clarity about institutional responsibility • Conflicting messages • Loss of attention by policy makers • Steps taken to clarify IMF/FSB roles recently and close cooperation will be vital

11. What will be the challenges? 4. Encouraging/enforcing cross-border cooperation • Lehman Brothers/Icelandic banks illustrates the need • Absent action on this front, risk of retreat to financial autarky and barriers to international transactions and markets • Goals should include: • Internationally harmonized bank resolution and bankruptcy regimes • Clarity with regard to burden sharing (deposit insurance and beyond) • Supervisory cooperation that extends beyond MOUs (and even colleges) • But at the global level, progress is likely to be slow • Focus instead on ensuring consistent standards • E.g., FSB principles for cross border crisis management • And (perhaps) supporting coalitions of the willing • I.e., encouraging regional approaches to cooperation

12. What will be the key challenges? 5. Filling information gaps • Crisis illustrated massive gaps at the national and multi-national levels • On- and off-balance sheet exposures of banks • Level of risk associated with CDOs and CDS • Connectivity • Given magnitude of cross-border flows and spillover risks… • Agencies such as BIS and IMF need to take a leadership role in requiring internationally consistent data • E.g., strengthen BIS international bank flow data and IMF “Financial Sector Indicators” • But will require major effort and cooperation of national authorities

13. What will be the challenges? 6. Deciding on the acceptable level of systemic risk • Too much stability is boring! • Regulation is costs and could weigh excessively on innovation and investment • So decisions on higher capital, liquidity, etc. charges need to be well calibrated • And… • Better to build formula based norms that are counter-cyclical, in order to keep average cost low • But • Do not rely too much on “rules” • Regulators must be held accountable for exercising “discretion” to tighten when vulnerabilities appear • E.g., Pillar II

14. THE FINANCIAL SECTOR ASSESSMENT PROGRAM Christopher Towe Deputy Director, Monetary and Capital Markets Department

15. Global Financial Surveillance and the Quest for Financial Stability:Back to Basics? Christopher Towe Deputy Director, Monetary and Capital Markets Department Disclaimer: The views expressed in this presentation are those of the author and should not be attributed to the IMF or its Board.