Report Of APEC Finance And Central Bank
REPORT OF APEC FINANCE AND CENTRAL BANK DEPUTIES ON STRENGTHENING INTERNATIONAL FINANCIAL ARCHITECTURE
Introduction
A well-functioning
international financial system is essential to allow an
efficient allocation of global savings and investment, and
provide the conditions needed to improve world-wide growth
and living standards in all economies. Recent events in the
world economy have demonstrated that a strengthening of the
system is needed to maximise the benefits of, and reduce the
risks posed by, global economic and financial
integration.
In this increasingly integrated global
economy, in which policy responsibility still lies mainly
with sovereign states, the challenge is to promote global
financial stability through national action as well as
through enhanced international cooperation. All economies,
together with the international financial institutions and
private sector financial institutions, face this challenge
together.
A major international effort is underway to
strengthen the International Financial Architecture in order
to make future crises less likely and to deal better with
those that do occur. This effort entails identifying
policies to help markets work properly and to provide the
public goods necessary to achieve this objective. It
requires public authorities to provide for enhanced
transparency and disclosure (including by private
institutions), improved regulation and supervision of
financial institutions and markets, and policies to protect
the most vulnerable. It also requires that private creditors
and investors bear responsibility for the risks that they
take, and are involved appropriately in crisis prevention
and crisis management. In these respects, the establishment
of internationally-agreed codes and standards for
policy-makers serves both as an incentive for better
governance and as a yardstick against which to measure
performance and risk.
APEC Leaders had in their
declaration in November 1998 tasked the Finance Ministers
and their Deputies to prepare this report on the reform of
the international financial architecture.
This report has
been divided into seven sections, reflecting the issues
identified by the leaders:
I. Prudential regulation of
financial institutions in industrialized economies,
including regulation concerning highly leveraged
institutions and Offshore Financial Centres.
II.
Transparency and disclosure standards for private sector
financial institutions
III. Capital Flows
IV.
Enhancing Supervision and Deepening Financial Markets
V.
Improving Crisis Management
VI. Outreach
VII.
Strengthening Social Safety nets
Progress in many of
these areas has been facilitated by the creation of the
Financial Stability Forum to enhance international
cooperation and coordination in the area of financial market
supervision and surveillance.
I. Prudential Regulation of
Financial Institutions in Industrialized Economies
The
Leaders attached special urgency to examining the scope of
strengthened prudential regulation of financial institutions
in industrialized countries and to encouraging sound
analysis and better risk assessment in their declaration in
November 1998. The Leaders also called for the examination
of the implications of the operations of highly leveraged
and off-shore institutions.
The recent difficulties in
some member economies have served as a reminder that
investors and other creditors often tend to underestimate
risks as they reach for higher yields. Excessive risk
taking, combined with high degrees of leverage, can magnify
the negative effects of any event or series of events.
Measures to induce creditors and investors to act with
greater discipline (i.e. to analyze and weigh risks
appropriately in their lending and investment decisions)
should aim at avoiding excessive leverage and encouraging
more prudent assessment of risks.
Measures to improve
risk assessment and risk management
Measures to induce
creditors and investors to act with greater discipline, such
as increased supervisory oversight of firms’ risk management
practices and strengthened capital adequacy, can dampen
investors’ tendency to underestimate risks in good times and
exaggerate them in bad times.
The Basle Committee
recently agreed on proposed revisions to the Capital Accord
to make it more sensitive to risk - including credit risk
involved in lending to emerging markets and in short-term
lending - and reflecting compliance with international
standards such as the IMF’s SDDS (Special Data Dissemination
Standards) and Basle Core Principles. The Basle Committee
also intends to consider broader revisions to the existing
systems of risk-based capital regulation, taking into
account changing market practices. The Basle Committee,
International Organization of Securities Commissions (IOSCO)
and International Association of Insurance Supervisors
(IAIS) have established Core Principles for supervision in
their respective areas of responsibility. IOSCO is working
to strengthen risk management practices for securities firms
in relation to highly leveraged institutions and is
considering other measures for reducing counterparty risk in
dealing with highly leveraged institutions.
Highly
Leveraged Institutions
Concerns have been expressed about
the impact of highly leveraged institutions, especially
hedge funds, on market dynamics generally and on vulnerable
economies in particular. This highly complex issue is being
analyzed by the Financial Stability Forum’s working group on
highly leveraged institutions, which responds to the
Leaders’ November 1998 declaration and which has
representatives from a number of APEC economies. The working
group has been asked to investigate the challenges posed by
highly leveraged institutions to financial stability in both
developed and developing economies. The working group has
also been mandated to take stock of work that has been
completed or is underway; to establish what is being done to
implement recommendations already made and consider the need
for further impetus to enhance implementation; to make
recommendations, where necessary, on improving coordination
between existing organizations working in this area; to
identify issues that have not been covered in existing work
and propose suitable procedures for dealing with them; and
to foster a consensus on substantive supervisory or
regulatory actions which may be needed to minimize the
destabilizing potential of highly leveraged institutions and
to facilitate the implementation of the recommendations. It
plans to issue its report early next year.
Offshore
Financial Centres
Offshore financial centres can pose
risks to international financial stability, and have the
potential to undermine the effectiveness of strengthened
regulation in onshore markets. Therefore, it is important to
ensure that they comply with international standards.
The
Financial Stability Forum has established a working group on
offshore financial centres, which will evaluate the impact
on global financial stability of the activities of market
participants operating in OFCs. The working group has been
mandated to review progress made by offshore centres in
enforcing international prudential and disclosure standards.
It will also assess the progress made in complying with
international agreements on the exchange of supervisory
information or information relevant to combating financial
fraud and money laundering. The above information will
enable the Working Group to evaluate the threats to
financial stability or to the credibility of regulatory
efforts that arise from continued non-compliance,
non-enforcement and non-cooperation by offshore centres. The
Working Group can then evaluate the scope for improving
compliance and cooperation through technical assistance to,
and/or intensified regulatory or supervisory contacts with,
offshore centre authorities, and take other appropriate
action, including supervisory reactions in the case of
non-compliance and non-cooperation. The Working Group will
issue its report early next year.
II. Transparency of the
Private Sector
The Leaders expressed the importance of
examining questions of appropriate transparency and
disclosure standards for private sector financial
institutions involved in international capital flows.
Private sector transparency is of particular importance to
the orderly and efficient functioning of financial markets.
The principles established by the Basle Committee, IOSCO and
IAIS include principles related to transparency. Valuable
actions in this area also include IOSCO’s issuance of
Disclosure Standards to Facilitate Cross-Border Offerings
and Initial Listings by Multinational Issuers. IOSCO is
reviewing the advisability and feasibility of imposing
transparency and disclosure requirements on highly leveraged
institutions. The International Accounting Standards
Committee has completed its core set of international
accounting standards, which are now under review. The
Committee on the Global Financial System (CGFS) is reviewing
ways to improve market disclosure, including a model
template for public disclosure of their exposures and risk
profile by institutions engaged in trading, investment and
lending activity, both regulated and unregulated.
III.
Capital Flows
The Leaders noted the importance of
promoting safe, sustainable capital flows to those member
economies which faced severe capital flight in the recent
past. Capital flows have to some extent returned to these
economies, suggesting increasing market confidence in the
ability of the affected economies to return to growth in the
near future. Net private capital flows to Asia are projected
to recover to $29 billion in 1999 from $8 billion in 1998.
Capital Account Liberalization and Controls
A bias
towards short-term capital – particularly in foreign
currencies - left a number of economies particularly
vulnerable to shifts in investor confidence. Economies
should rely more on long-maturity, and if possible
domestic-currency denominated, debt to maintain a debt
profile that provides substantial protection against
temporary market disruption and should avoid transforming
long-term debt into short-term debt. Economies should work
to remove biases which encourage short-term private
borrowing.
It will be important to consider the
experience of countries with controls on capital. The use of
controls on capital inflows may be justified for a
transitional period as economies strengthen the
institutional and regulatory environment in their domestic
financial systems. Where financial sectors and supervisory
regimes are weak, safeguards may be appropriate to limit
foreign currency exposure of the banking system. More
comprehensive controls on inflows have been employed by some
economies as a means to shield themselves from market
pressures and their experience may provide some insights.
However, they should not be used as a substitute for reform,
and there is a need to establish whether the benefits
outweigh the costs. In addition to these considerations,
controls on capital outflows may carry even greater long
term costs, although they may be necessary in certain
exceptional circumstances. Many economies have found that
they have not been a very effective policy instrument,
though it will be important to study the impact of recent
experience. They should not be a substitute for policy
reform.
The need to continue work on Capital Flows
The
potential problems associated with volatile capital flows
have not gone away. The Financial Stability Forum working
group on short term capital flows has been mandated to
evaluate prudential policies, regulations and risk
management (including debt management practices) in
borrowing economies that may help reduce the risks to
financial systems associated with the build-up of short-term
external indebtedness; to identify any regulatory or other
factors that may have introduced an unwarranted bias in
favor of short term flows, and recommend action to reduce
such bias; to review progress in improving the adequacy and
timeliness of the data and reporting systems on which
authorities and investors rely to monitor and assess risks
associated with capital flows, and give impetus to
improvements as needed and to evaluate other potential
measures in debtor and creditor economies to reduce the
volatility of capital flows and its adverse consequences for
financial system stability. It plans to issue its report
early next year.
IV. Enhancing Supervision
In their
declaration, APEC Leaders emphasized the importance of
developing strong, resilient and well-regulated domestic
financial markets within the framework of a stable
international financial system.
APEC Finance Ministers
urged member economies to strengthen efforts to implement
the Core Principles established by the Basle Committee,
IOSCO and IAIS, including in the context of the Core
Principles Methodology Working Group and with appropriate
involvement by the IMF and the World Bank. They encouraged
member economies relatively advanced in meeting the Core
Principles to share their experience and practical knowledge
with other interested economies.
Work is underway to
compile into a common reference the various financial and
economic policy standards and best practices that have been
developed in part in response to the financial difficulties
experienced by a number of countries in recent years. A
compendium on international financial and economic policy
standards, through which economies could articulate their
intention to implement the various standards and best
practices, is being developed under the auspices of the
international regulators and the international financial
institutions.
During the Finance Ministers’ meeting in
May 1998, the APEC Finance Ministers endorsed Action Plans
that outlined assessments of the adequacy of existing
training programs for bank supervisors and securities
regulators and identified inadequacies in the management of
training processes in some of the APEC members’ financial
regulatory authorities. The Advisory Groups on training of
bank and financial supervisors have developed specific plans
for carrying forward the implementation of the measures in
the Action Plans. In their May 1999 statement, Finance
Ministers noted that the capacities of APEC supervisory and
regulatory authorities must be continually upgraded and
thanked the ADB and the SEACEN centre for their support in
implementing the Action Plans for the Training of Bank
Supervisors and Capital Market Regulators. The results of
the survey on adequacy of banking supervisory regimes of the
APEC members conducted by Malaysia have been
encouraging.
V. Improving Crisis Management
The Leaders
in their November 1998 declaration called for further work
on improving crisis management, including orderly debt
workout arrangements with the private sector.
Official
Sector Improvements
The IMF Supplemental Reserve Facility
(SRF) and Contingent Credit Line (CCL) should play an
important part in promoting financial stability. This
facility aims at protecting from contagion countries with
reasonable debt structures, sound macro-economic and
structural policies, and which are also engaged in an
appropriate process of consultation with their private
creditors. The facility should encourage the IMF towards an
increasing focus on crisis prevention, and will provide
further incentives for countries to take early measures to
avoid the risk of financial crisis. The CCL provides an
additional mechanism for encouraging countries to implement
standards and codes of good practice.
Involving the
Private Sector
Economies should take ex ante steps to
strengthen the framework for the market-based, cooperative
and orderly resolution of the debt payment difficulties that
do arise. Appropriate communication between debtors and
creditors is important in both crisis prevention and
resolution. Emerging market economies should develop
mechanisms for more systematic dialogue with their main
creditors. Market-based tools aimed at preventing crises and
facilitating adjustment to shocks, including through the use
of innovative financial arrangements, including private
market-based contingent credit lines in emerging economies
and roll-over options in debt instruments, could facilitate
access to the international markets in times of instability
for emerging economies, and, in the context of a sound debt
management framework, help mitigate liquidity crises and
give economies a breathing space to make decisive
macro-economic or structural adjustments.
Private credit
decisions need to be based on an assessment of the potential
risk and return associated with a particular investment, and
not on the expectation that creditors will be protected from
adverse outcomes by the official sector. Governments should
narrow the scope of their guarantees of private obligations
and make those explicit, so as to make sure that creditors
do not lend to private entities with the expectation that
the government will ultimately stand behind loans to the
private sector.
The G-7 Finance Ministers recently
released a broad framework of principles and tools for
involving the private sector in crisis resolution. The
framework should help to promote more orderly crisis
resolution and therefore be of mutual benefit to debtors and
creditors in finding cooperative solutions. It should also
help to promote cooperative solutions between borrowing
economies and the private sector and to shape expectations
in a way which reduces the risk that investors believe they
will be protected from adverse outcomes. Developing a
framework of this kind which facilitates debtor/creditor
cooperation should minimise the incidence and intensity of
crises and also minimise the time before financially
troubled debtor economies can expect to regain market access
after a crisis. The G-7 Finance Ministers asked the IMF
further to develop and define the legal and technical
questions involved in implementing specific approaches
identified in the framework.
VI. Outreach
The APEC
Leaders also observed that there would be considerable value
in continuing the work on the reform of international
financial architecture in a process involving both developed
and developing economies. A number of APEC member economies
were represented in seminars of 33 economies to discuss the
reform of the international financial architecture. A Bonn
seminar in March 1999 focussed on the importance of
sustainable exchange rate regimes and consistent
macroeconomic policies, the development of new ways to
respond to crisis (in particular greater private sector
involvement in crisis containment and resolution) and
assessed the proposals for strengthening the IMF and the
World Bank. A seminar held in Washington DC in April,
studied the issues of prudential oversight, strengthening
emerging market financial systems and strengthening social
policies.
The Financial Stability Forum has been expanded
to include several additional APEC economies. As noted
above, the Forum has established working groups to focus on
three issues: the implications of highly leveraged
institutions, offshore financial centres, and capital flows.
These Working Groups include some APEC and other economies
that are not members of the Forum. The reports are to be
completed early next year.
More recently, the G-7 has
called for the establishment of an informal mechanism for
dialogue among systemically significant economies within the
framework of the Bretton Woods institutional system. The G-7
also has called for improving the effectiveness of the IMF
and other international financial institutions, including
IMF surveillance and programs so that they better reflect
the changes in the world economy, in particular potentially
abrupt large-scale cross-border capital movements.
VII.
Strengthening Social Safety Nets
The APEC Leaders
identified as a matter of high priority the intensification
of efforts to address the social impacts of crises. In
particular, the Leaders attached importance to formulating
strategies of concrete actions aimed at strengthening social
safety nets.
Recent events in member economies and
elsewhere have underlined the important link between
economic and social issues. Good economies depend on stable
relationships between governments and their citizens and
strong social cohesion. Effective social policy helps
provide the foundation for sustainable development by
sharing the benefits of globalization more widely, equipping
people for change and by fostering more robust economies.
Effective social policy can ease the costs of
adjustment, especially if these costs fall most heavily on
the poorest sections of society. Policymakers must make
difficult choices during downturns between safeguarding
immediate social welfare payments and programs and making
the adjustment necessary to promote stable growth, which is
ultimately the best way of reducing poverty and improving
welfare.
Since many economies, including many member
economies, are likely to face similar pressures, there is a
case for identifying principles, policies and best
practices, and for their promulgation through international
organizations. The World Bank, in collaboration with the
United Nations, has prepared principles of good practice in
social policy. All economies must work together with the
international financial institutions to develop and promote
practices in social policies that most effectively support
economic development.
The World Bank will report at the
1999 Annual Meetings on policies and best practices to
protect the poorest groups and maintain the momentum for
development. The G-7 has urged the IMF to consider the
degree to which a country’s adjustment program provides for
adequate spending in the social sector when assisting
economies to improve macroeconomic frameworks in times of
crisis.