STABILIZING THE INTERNATIONAL FINANCIAL SYSTEM KEY ISSUES FOR DEVELOPING COUNTRIES IDEAs Conference

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STABILIZING THE INTERNATIONAL FINANCIAL
SYSTEMKEY ISSUES FOR DEVELOPING COUNTRIESIDEAs
Conference on Re-regulating Finance in the Light
of the Global CrisisApril 9 2009, Beijing

• Yilmaz Akyüz

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Issues/Objectives

• Preventing or reducing the likelihood of
  financial crises with global ramifications
• Minimizing negative international spillovers from
  crisis response by governments
• Improving international intervention and
  resolution of crises in emerging markets.

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Three Sources of Instability

• Policies in systemically important countries,
  including some larger emerging markets.
• Problems inherent to an international reserves
  system based on a national currency- the dollar.
• Financial and currency markets.

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And Three Areas of Reform

• Effective multilateral discipline in
  macroeconomic and exchange rate policies to
  secure stable exchange rates and payments
• Establishment of an international reserves system
  not based on a national currency
• Regulation and supervision of international
  financial markets and capital flows.

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Prevention Multilateral Policy Discipline in
Money and Finance

• Asymmetry between trade and finance Adverse
  global spillovers from macroeconomic, exchange
  rate and financial policies are more damaging
  than those from trade policies but not subject
  to multilateral disciplines.
• IMF members have same de jure obligations to
  maintain orderly exchange rates and payments.
  But Fund is unable to exert disciplines over its
  non-borrowing members. How to remove this
  asymmetry and make surveillance effective,
  even-handed and independent of IMF lending?
• In surveillance, the Fund should recognize that
  stability depends as much on combating inflation
  in asset markets (asset bubbles) as combating
  inflation in product markets. But it fails to do
  so (US and Iceland)

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PreventionA Stable International Reserves
System

• Inherent instability of a reserves system based
  on a national currency, now aggravated by
• Absence of effective multilateral discipline over
  US policies
• Liberalization vulnerability of DCs to shifts in
  cap. flows
• Pro-cyclical behaviour of financial markets
• Absence of an international lender of last resort
  (ILOLR)
• High reserve costs in DCs (some 130 billion per
  annum).
• Solutions
• Multiple reserves systems no more stable
• LOLR is neither feasible nor desirable
• An SDRs based system

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PreventionAn SDRs-Based Reserve System?

• Holding SDRs entails no cost cost incurred only
  when used. There are proposals for regular
  allocation to all or only to poor members.
• Going further and funding IMF by SDRs, not by
  quotas, GAB or NAB. IMF could distribute SDRs to
  itself at regular intervals, linked to growth in
  world income or trade guaranteed by its
  shareholders (like WB).
• Allow banks to hold SDRs. Make it possible to
  use SDRs for currency interventions.
• Greater automaticity in access widen reserve
  tranche on the basis of need (not quota
  subscriptions) should be designed for
  countercyclical CA financing.

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Prevention Regulation of Financial Markets and
Capital Flows

• Why regulations should be international
• Since financial instability has adverse global
  spillovers, national regulatory practices should
  be subject to multilateral disciplines
• This would also reduce the influence of
  politicians on regulators
• And prevent regulatory arbitrage whereby business
  could run away from tightly to lightly regulated
  jurisdictions
• Options
• A fully fledged multilateral system built on the
  same principle as the WTO
• A selective approach regulate certain areas
  through multilateral bodies
• An eclectic approach extended current system
  based on voluntary cooperation
• Selective-eclectic mix G20 approach?

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Prevention Regulation of Financial Markets and
Capital Flows

• A fully fledged system (WFA) based on
• Binding multilateral agreements on regulations
• Commitment by governments to implement through
  national regulators
• A multilateral institution to oversee
  implementation and impose sanctions for
  non-compliance.
• Hurdles likely to be faced
• Difficulties in agreeing how best to regulate
  financial institutions and markets
• Major ICs unwilling to give up autonomy,
  particularly if such an institution is to have a
  real clout- even EU cannot do it.
• Risks for developing countries
• Governance problems
• Problem of one-size-fits-all. SD Treatment does
  not work
• Concession on free capital movements and market
  access in financial services

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Prevention Regulation of Financial Markets and
Capital Flows

• A selective approach
• Establish international supervisory bodies for
  large transnational banks and credit rating
  agencies on the basis of agreed standard and
  rules.
• Favoured by France
• Such a step would involve complex issues of
  sovereignty and power of international bodies
  vis-à-vis national regulators.
• An eclectic approach
• Extend the mandate and improve the governance of
  existing bodies such as FSF, BIS, Basle Committee
  on Banking Supervision.
• Need to keep the IMF out of it.
• Favoured by the US. Likely to be combined with
  global regulation and supervision of rating
  agencies and some big banks

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Prevention Regulation of Financial Markets and
Capital Flows

• DCs are not ready to negotiate need common
  reflection and an agenda to maintain autonomy but
  reduce vulnerability. Key areas
• 1. Reduce pro-cyclical behaviour of international
  lenders to DCs
• 2. Regulate investors in DCs (institutional
  investors, hedge funds)
• Improve transparency through reporting and
  disclosure requirements
• Restrict their investment strategies to reduce
  destabilizing effects on EMs
• 3. Rating agencies regulate them
• To eliminate procyclical rating and bias against
  DCs borrowers/issuers
• To improve ratings of securities held by CBs and
  private investors in DCs
• Recognition of rights to impose control over both
  inflows and outflows
• 5. A statutory framework for temporary debt
  standstills.
• 6. Arbitration for sovereign debt of DCs to
  private and official creditors.

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Crisis Response National

• Prevent adverse global spillovers from crisis
  response by governments- e.g. import restrictions
  and subsidies in US (WTO)
• Prevent beggar-my-neighbour exchange rate
  policies (IMF).
• Prevent free riding and promote coordination of
  macro-economic policy response to crises (IMF)

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Crisis Intervention and Resolution International

• IMF interventions bailing-out creditors and
  investors, keeping debtors current on debt
  payments, maintaining open capital account
  promoting pro-cyclical policies.
• Problematic because of moral hazard,
  burden-sharing and impact on poverty. But
  initiatives for reform came to nothing, including
  new mechanisms to bail-in the private lenders and
  investors, and terms and conditions of IMF
  lending.
• Now IMF is back to business and it looks business
  as usual.
• Modalities of IMF interventions the first issue
  to be taken up. This should be part of a general
  reform of IMF including its funding, operating
  procedures and governance (see YA paper for the
  G-24).
• Now urgent need for a large, highly concessional
  global countercyclical facility (like two oil
  facilities in the 1970s) to be funded by a
  reversible SDRs allocation, larger than agreed by
  G20.