In considering ways of strengthening the international financial system, the finance ministers and central bank governors of the Group of Seven countries asked me at their meeting on October 3, 1998, “to consult with other appropriate bodies and to consider with them the arrangements for cooperation and coordination between the various international financial regulatory and supervisory bodies and the international financial institutions interested in such matters, and to put to us expeditiously recommendations for any new structures and arrangements that may be required.” This mandate was restated and extended in the declaration by the Group of Seven finance ministers and central bank governors on October 30, 1998 [see IMF Survey, November 16, 1998, page 360].
In order to fulfill this mandate, I have held thorough consultations with representatives of all the Group of Seven countries, the international financial institutions, and various international bodies. These consultations were helpful in identifying key areas in the international financial system where improvements are essential in order to safeguard the proper functioning of the markets. A broad consensus emerged during this consultation process and is reflected in this report.
Current Arrangements for Supervision and Surveillance
Various international organizations share responsibility for the current arrangements concerning the supervision and surveillance of the international financial system. The international financial institutions contribute in various ways to strengthening the global financial system:
- The IMF has responsibility under its Articles for surveillance of all member countries and monitors developments in the global economy and financial markets.
- The World Bank under its mandate uses its expertise to assist countries in the design and implementation of reforms to strengthen financial systems, including banking, capital markets, and market infrastructure.
- The Bank for International Settlements (BIS) provides analytical, statistical, and secretariat support for various official groupings working to strengthen the global financial system.
- The Organization for Economic Cooperation and Development (OECD) participates in the process of macroeconomic and financial surveillance and formulates guidelines for evaluating and improving the framework for corporate governance.
The cooperation and coordination ofsupervisory practices are affected by various sector-specific international groupings of regulators and supervisors, in particular:
- The Basle Committee on Banking Supervision serves as an important rule-setting body in the field of banking supervision.
- The International Organization of Securities Commissions (IOSCO) provides mutual assistance in order to promote the integrity of securities and futures markets worldwide.
- The International Association of Insurance Supervisors (IAIS) cooperates with supervisors in promoting high standards in the field of insurance supervision.
Current arrangements have made a significant contribution to raising standards of soundness and risk awareness in financial systems. These are remarkable achievements, even though they are sector-specific in their approach. However, the pace of change in markets and financial intermediaries brought about by the process of global financial integration has increasingly exposed the limitations of such an approach. The establishment of the Joint Forum on Financial Conglomerates represented an initial response to the dichotomy of fragmented supervisory structures and increasingly integrated markets. The rationale behind such an approach now has to be applied in a comprehensive manner.
There are three aspects to this: first, overcoming the separate treatment of microprudential and macro-prudential issues; second, bringing together the major international institutions and key nationals in financial sector stability; and third, integrating emerging markets more closely in this process.
Systemic threats can also arise from unsupervised financial service providers, notably major highly leveraged institutions. Additionally, spillover effects could arise from difficulties at nonbank financial institutions and large insurance companies. Developing an appropriate response will require the involvement of the various regulatory groupings and the national authorities of the markets in which these equities are domiciled and operate.
Developing and Implementing Standards
Strengthening financial systems will demand a systematic approach to ensuring that gaps in international standards or codes of conduct are identified and effectively filled. This calls for intensified cooperation and coordination between the national authorities, international regulatory bodies, and the international financial institutions charged with monitoring and fostering implementation. In particular, national authorities and the regulatory groupings need to ensure that the process of developing standards benefits from the wide-ranging information obtained by the international financial institutions in their surveillance and assistance activities in individual countries. Greater involvement in these processes of the emerging market economies to which those standards would apply is needed to augment their commitment to implementing them.
A significant challenge for the international community in the years ahead will be to foster and monitor the worldwide implementation of accepted best practices and, in particular, of compliance with the core principles issued by both the Basle Committee on Banking Supervision and IOSCO and those being developed by other international groupings. The international financial institutions, using their established procedures for consultations, will need to assist countries in strengthening their financial systems. The information and expertise available to national authorities and international supervisory groupings can enhance the effectiveness of the international financial institutions in these tasks, and vice versa.
National and international regulatory authorities must also develop procedures to ensure that market participants heed the standards that have been developed in managing and pricing the risks they incur with respect to their counterparties. Strengthened procedures will be needed to coordinate and promote efficiency in this effort, as well as to avoid overlaps between the international financial institutions, and also with the rule-making capacities of the international supervisory bodies.
Improvements in Financial Supervision
The international regulatory groupings have made considerable progress in harmonizing and strengthening national financial regulation and supervision. Minimum standards have raised levels of soundness and helped to create a more level playing field, and the continuing issuance of risk-management guidance improves defenses at individual institutions. These efforts, including the work of the joint forum, should be sustained. At the same time, further efforts are required to address issues raised by the blurring of distinctions between different types of financial operations and institutions.
Advances on issues, such as consistent rules for the treatment of risk, arrangements for the pooling of information, and closer cooperation between different supervisory authorities, continue to be hampered by the fact that countries have different financial and supervisory systems.
The functional bodies also need to take account of the work being done by private sector groupings and to assess, in cooperation with national authorities, the question of the appropriate prudential and regulatory response to significant players operating outside existing regulatory arrangements, including the adjustment of prudential policies governing those within their purview.
Specific Issues to Be Addressed
From the current standpoint, action is required in the following areas:
- Improving arrangements for the surveillance of global vulnerabilities, including the pooling of information available to the international financial institutions and the international regulatory groupings, the development and assessment of macro early warning indicators, and the creation of procedures to ensure that information reaches the relevant parties.
- Creating procedures for coordinating the work of national and international regulatory groupings and for the exchange and pooling of information among them.
- Assessing the need for the regulation of nonregu-lated entities.
- Strengthening and, when appropriate, encouraging the development and implementation of international best practices and standards, including fostering improved in-house risk management at financial institutions in the wake of recent market events, and promoting appropriate transparency and disclosure rules for all market participants.
Convening a Financial Stability Forum
The previous sections set out a number of specific areas in which existing arrangements for the supervision and surveillance of the international financial system could be strengthened. Sweeping institutional changes are not needed to realize these improvements; instead, a process in line with the mandate should be set in motion to ensure that national and international authorities and groupings can coordinate efforts to promote the stability of the international financial system and to improve the functioning of the markets in order to reduce systemic risk.
The following approach would appear to be suitable: The Group of Seven should take the initiative in convening a Financial Stability Forum. Such a forum should meet regularly to assess issues and vulnerabilities affecting the global financial system and to identify and oversee the actions needed to address them.
The forum would report to the Group of Seven ministers and central bank governors. It would replace the series of ad hoc groups that have been convened by the Group of Seven over the past few years, with a view to strengthening the international financial system.
The forum should be limited to a size that permits an effective exchange of views and the achievement of action-oriented results within a reasonable time frame. In developing objectives, priorities, and programs for action, the forum would work through its members, taking into account their comparative advantages.
The members of the forum would be representatives of national and international authorities responsible for questions of international financial stability. It would initially comprise the ministries of finance, central banks, and senior supervisory authorities of the Group of Seven countries. In addition, the international financial institutions and key international regulatory groupings would participate. Representation should be at a high level. Participation could, over time, be extended to include representatives from a small number of additional (that is, non-Group of Seven) national authorities that could contribute substantially to the process, or to invite them to attend meetings as guests.
The chairperson should be appointed in a personal capacity for a period of time that is adequate to ensure continuity in the work of the forum. I would like to suggest the appointment of Andrew Crockett, General Manager of the BIS, for a term of three years.
The forum would meet as often as needed to achieve its objectives. Initially, two meetings a year could be envisaged.
The first meeting of the forum could be held in spring 1999.