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Financial crises and recovery

What is to be done

Regulatory systems required to recover from the global financial crisis

Authors: L. Kodres; A. Narain
Publisher: Finance and Development, IMF, 2009

Full text of document

This article from the IMF’s Finance and Development publication argues that one of the key contributors to the global financial crisis was inadequate regulation. Regulatory structures are fragmented and lack enforcement. A revamp is needed to prevent another build-up of systemic risks and to provide a basis for connecting global savers and investors that is more sound. A clear and consistent method is needed to deal with financial instability when it arises.

The IMF has been examining several areas that will require attention to prevent systemic crises which the authors discuss:

  • the perimeter of regulation. A two-perimeter approach is suggested with most in an ‘outer perimeter’ and those posing systemic risks moved to an ‘inner perimeter’ and subjected to prudential regulations
  • procyclicality. Regulating capital, that institutions keep to absorb losses, by introducing incentives to encourage accumulation of capital could address this challenge
  • information gaps, particularly the inability to see what risks were distributed to various holders and who those holders were. Data are most needed on the risk exposures of systemically important banks and nonbank financial institutions
  • harmonising national regulatory policies and legal frameworks. Regulators and supervisors must decide what information is essential to collect and communicate, taking into account its relevance for systemic stability
  • providing liquidity to markets. The authors suggest central banks devote attention to determining how they can directly support intermediation during periods of balance sheet adjustment
The article reiterates the importance of restructuring regulation but warns that it is also important to keep in mind the need to strengthen the ability and willingness of supervisors to enforce these regulations in a timely and credible manner. Regulatory redesign will be ineffective unless enforcement is improved. This will require operational independence and adequacy of resources available to supervisory agencies.

It concludes that restructuring regulation will take time so should be undertaken as soon as possible. Some investors are waiting for regulations to be in place before deploying funds. When the regulatory landscape is more certain investors will be more confident - boosting the global economy.