Leading world bankers took stock of a year of financial turmoil as they gathered in Philadelphia last week for the International Monetary Conference.
Economic crises shook Russia and Brazil, hedge fund problems wreaked havoc, and war broke out in Kosovo. "We could not anticipate such major incidents, and it is my honest feeling that I am overwhelmed by the magnitude and speed of changes that have taken place," said Yoh Kurosawa, chairman of Industrial Bank of Japan and president of the IMC.
Much discussion during the four-day gathering was devoted to ways of strengthening the architecture of international monetary markets. Refining regulation of the increasingly complex financial services industry was also a major topic.
Excerpted below are remarks from three key speakers.
Managing director, International
If we are to build a more durable, integrated international financial system, the foundation for successful crisis resolution should exist long before crisis strikes.
Quite simply, it should consist of the market structures, practices, and relationships that exist under normal conditions. We need to foster a mature market, which is based on stable relationships among players that rely on enlightened self-interest, and in which official involvement can be limited to establishing strong legal, regulatory, and supervisory frameworks. ...
Of course, occasionally crises will occur, and we need to be ready with measures to assist in their resolution. This requirement entails a delicate balance among the objectives of preserving countries' market access in normal times, ensuring equitable treatment of creditors if crisis strikes, and avoiding debtor and creditor moral hazard.
We should approach this task by seeking market-based and market-friendly solutions. To this end, let me suggest two yardsticks that will help to evaluate any proposals:
Measures to reduce vulnerability to crisis should promote the efficient operation of capital markets in normal times, including due attention to the management of risk.
Measures intended to resolve crisis should not have the perverse effect of precipitating them. In other words, if measures are introduced that are seen by creditors as locking them in once crisis has developed, then they may become hyper-sensitive to market volatility, even if that volatility is the result of contagion, and not precipitated by domestic economic weakness.
Guillermo OrtizGovernor, Bank of Mexico
The recent financial crises demonstrated that for private markets to work properly, effective financial regulation should be supplemented by strong legal systems, such as clear and enforceable bankruptcy laws and strong judicial systems.
In addition, the presence of more foreign banks is essential in containing a run on the banking system and in increasing its efficiency.
Although the roots of these crises lie partially in the fundamentals of the countries most affected, external developments significantly contributed to the buildup in the imbalances that eventually led to the crises.
Large private capital inflows to emerging markets were driven, to an important degree, by liquidity conditions in international financial markets and by an imprudent search for high yields by international investors without due regard to potential risks.
And finally, the reversal of these flows cannot always be completely explained by fundamentals, so contagion and sudden shifts in investors' sentiment have also played a role.
An important element in the reform of the international financial architecture should be to strengthen incentives in industrialized countries to encourage more disciplined investment decisions and to reduce leverage and limit systemic risk.
Capital flows originate in industrialized countries; thus the global nature of their financial institutions has linked the solvency of their systems with those of emerging markets. Therefore, measures should be implemented to improve the information and regulation of their activities in emerging markets. Among the areas where efforts should concentrate, we find:
Strengthen risk management systems.
Greater differentiation in banks' capital requirements and higher capitalization ratios.
Better disclosure standards.
Howard DaviesChairman, U.K. Financial Services Authority
Domestic regulatory consolidation is taking many different forms around the world. But two clear trends can be identified. First, countries are increasingly moving banking supervision out of their central banks, to create institutions more closely focused on the regulatory task, and perhaps also to avoid the implicit extension of safety net arrangements to nonbanks.
Second, there is a trend toward merging securities and banking regulation in one agency or, less frequently, banking and insurance supervision.
The United Kingdom has gone further, both taking banking supervision out of the Bank of England, and merging essentially all supervision of the financial sector into one Financial Services Authority.
Merged or single regulators offer, in principle, the possibility of a more systematic approach to assessing risk across financial markets. They make it possible for supervisors to assess risk, and to think about how to manage it, in the ways in which sophisticated institutions themselves do. But merged regulators must take care to avoid cross-contamination risk which could, in certain circumstances, increase rather than diminish risk.
At present, the technology of risk assessment in diversified financial institutions is not well developed. This is something on which we are beginning now to work, with some other interested institutions, in Australia, Canada, and elsewhere.