Focus on fixing financial system, avoiding next crisis

• World central bankers meet in Asia to debate nextsteps to build stronger system
• China hosts IMF-sponsored conference onmacro-prudential policy
• Need for broader financial sector reform underlined

Central bankers and other senior financial officials from around the world discussed in Shanghai recently ways of reinforcing the stability of a global banking and financial system still vulnerable to the shocks that triggered the recent international financial and economic crisis.

Calling for continued global cooperation, Dominique Strauss-Kahn, Managing Director of the International Monetary Fund (IMF) said Asia was leading the world recovery after the recession, but fixing the fragilities of the international financial system remained a top priority.

How to prevent another systemic breakdown — when financial sector problems can spread rapidly and infect the real economy and jobs — was the topic of a high-level conference in Shanghai on 18 October. Senior central bank officials from Asia, Europe, North and South America, and Africa came together in Shanghai to debate the issue.

The conference on “Macro-Prudential Policies: Asian Perspectives” was sponsored by the IMF and hosted by the People’s Bank of China (PBC). Lead speakers included the Governor of the People’s Bank of China, Zhou Xiaochuan, IMF Managing Director Strauss-Kahn, IMF First Deputy Managing Director John Lipsky, and PBC Deputy Governor Yi Gang.

Participants from about 25 countries attended the closed-door meeting, and included central bank governors and deputy governors, along with other senior policymakers and regulators.

Importance of policy coordination

The Shanghai conference served to underscore the importance of dialogue and policy coordination linking the advanced economies, emerging market economies, and developing economies. “The great challenges of today all require a cooperative solution — especially if we are to achieve strong, sustainable, and balanced global growth in the years ahead,” said Strauss-Kahn in his keynote address.

Speaking at a closing press conference, PBC Deputy Governor Yi Gang said the conference had reached an “important consensus” on international cooperation in ensuring strong macro-prudential policies, because systemic risks “are very likely to spread over borders.” He also pointed to consensus on the need to have clear lines of responsibility in addressing macro-prudential issues — especially in the area of information gathering — and the need to foster close cooperation between central banks and other national regulators.

One key purpose of the Shanghai conference was to integrate the lessons learned from the financial turmoil of the global crisis. “This is directly related to today’s conference, which has reflected months of hard work by PBC and IMF staff,” IMF officials said. “Future growth must be safer growth, less prone to financial excess and the build-up of macroeconomic imbalances. So financial sector and macro-prudential policies are like the glue that holds the system in place.”

Range of risks

During the crisis, troubles in one institution quickly spread — leaping across national borders — to threaten the whole complex web of financial relationships. The global crisis showed that simply looking at the safety and soundness of individual financial institutions in isolation is not sufficient; supervisors need to be aware of and respond to a range of systemic risks — and to understand clearly where responsibility lies for addressing those risks.

Another lesson was that policymakers need to avoid complacency in the face of asset price and credit booms. “Clearly, conventional macroeconomic policies and macro-prudential tools are intrinsically linked, just as price stability and financial stability are intrinsically linked,” Strauss-Kahn said. “We need a holistic approach, which means a changing role for central banks in the years ahead.”

The Shanghai conference addressed a range of issues related to macro-prudential policies — meaning policies that focus on the financial system as a whole and attempt to limit system-wide distress through regulation and better supervision.

The conference sought to define the institutional contours of a new macro-prudential policy framework, and the range of tools that could be applied to mitigate systemic risk and limit procyclicality, including regulatory norms and taxes.

Officials discussed country experiences — including from within the Asian region — with a particular emphasis on the interaction of macro-prudential policies and capital flows.

They also discussed the implications of a macro-prudential approach for central bank policies.

Asia rising

At the same time, the conference was intended to highlight the growing importance of Asia in the global policy discussion, especially as the region’s policymakers are taking important steps in the post-crisis period to implement macro-prudential measures to strengthen the system.

The Shanghai conference followed a major gathering in July 2010 in Daejeon, South Korea, that marked a new stage in the Fund’s relationship with the region. The Daejeon conference brought a consensus for a stronger IMF role in Asia, with the Fund making its analysis more useful to Asian policymakers, strengthening the global financial safety net, and enhancing Asia’s voice in the global economy.