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SPECIAL REPORT | FEBRUARY 2, 1998 VOL. 151 NO. 5 |
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The Need for a New IMF The time has come to create a global financial regulator with teeth By HENRY KAUFMAN
Even when the IMF is well aware of imbalances that threaten the stability of a country, it lacks either the leverage to induce timely adjustments in policy or the will to apply that leverage. It is effectively stymied by the realities of the modern financial world. In addition, the IMF is handicapped by the inadequacies of national and international structures for regulating and supervising financial institutions. Many emerging markets lack independent central banks and bank-supervisory authorities with the mandate and the power to confront institutions which take too much risk. On the contrary, important government institutions often prevent financial regulators from detecting abuses such as excessive lending to insiders, to affiliates or to politically-connected companies. The dilemma is that when the flow of foreign capital stops, any policy option available to central banks will hurt well-connected investors. If the central banks try to tighten monetary policy to stabilize the currency, the ensuing slowdown in domestic economic activity will cause insolvencies and increase the pressures on an already weakened banking system. The alternative taken by nearly every Asian country in the past six months has been to let the currency depreciate sharply. The result is that local companies that had borrowed heavily in foreign currencies in the mistaken belief that the exchange rate would hold have suffered huge losses. Ultimately, failure of such enterprises weakens the domestic banking systems. Until the IMF and its members recognize the instabilities that result from large-scale capital movements in a world of globalized, securitized financial markets, there is bound to be a recurrence of such crises. What should be done to discourage the extremes in market behavior? The answer lies with a thorough modernization of the system of regulating and supervising financial institutions and markets. It requires setting forth a code of conduct for market participants to encourage reasonable financial behavior. That should be backed up with improved supervision of risky activities covering not only those financial institutions that have always been regulated and supervised, but also new participants in the marketplace. Some sort of institution is needed to deal with these and the many other issues that inevitably flow from the greater internationalization and complexity of finance. I have for many years advocated a new official international institution to serve as the focal point for regulatory and supervisory harmonization--a Board of Overseers of Major International Institutions and Markets. This international board, which would be established alongside a restructured IMF and World Bank, should consist of members from both private and public sectors supported by a strong professional staff. It should be empowered by the member states to set minimum capital requirements for all major institutions, to establish uniform trading, reporting and disclosure standards, and to monitor the performance of institutions and markets under its jurisdiction. Initially, the various national supervisory and regulatory agencies would be responsible to the board for implementing these standards within their borders. But the board would be responsible for supervising any major financial institution whose failure would disrupt global markets. Eventually, this new international regulatory body would rate the credit quality of each institution under its jurisdiction. Failure to live up to minimum standards would be subject to disciplinary action. And lending to banks in countries that choose to remain outside its purview would be subject to exceptional capital requirements and to limitations on maturities. Also, non-member countries would be subject to restrictions on their ability to sell new securities in the credit markets of member states. Engineering a reform in the structure of financial regulation and supervision is not on anybody's list of priorities right now, when all the attention is focused on the fallout from Asia's difficulties. No framework is in place today to prevent major financial mishaps in the future. If we do not act now, the next financial contagion may well cause even greater economic and financial problems than any which we have seen in the post-World War II period. Henry Kaufman is president of Henry Kaufman & Company, Inc., an economic and financial consulting firm.
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n the wake of the Mexican crisis of 1995, the heads of
governments of the major industrial countries, spurred by the
Clinton Administration, sought to install an early warning
system at the International Monetary Fund and World Bank. This
effort failed, and the official international financial
institutions were unprepared at the beginning of the current
Asian financial crisis to isolate the problem and to keep the
pressures from spreading. It is clear that the IMF as presently
constituted and managed is ill-equipped to meet the heavy
burdens placed on it by its board of directors, the governments
of the major industrial countries.