WASHINGTON, DC: The world is in the midst of an unprecedented financial crisis affecting all countries. Coordinated measures have been taken, unique in size and scope, to restore confidence and limit the damage caused to the world economy. President George W. Bush has invited world leaders to a summit in Washington on November 15 to design a new financial architecture that could prevent crises like this one from recurring.
The International Monetary Fund, the only global institution with a mandate to protect financial stability, can play a central role.
Reform of the international financial architecture should focus on improved financial supervision, more transparency in financial markets, an effective early-warning system for financial crises, and better international policy coordination.
The crisis has made it clear that national supervision of banks that operate globally is insufficient. Regulatory gaps have caused spillover effects to other countries. Crisis resolution mechanisms for banks that operate globally were absent. International coordination of regulation is clearly required.
More transparency also implies international agreement on incentive structures in the financial sector that discourage excessive risk-taking. For too long, all financial innovations were thought to promote economic development and help spread risk. However, as financial products became more complex, nobody knew who assumed the risks.
Of course, there have been warnings that risk-taking had become excessive, but for too long it was hoped that market forces would solve all problems.
We need early-warning mechanisms with concrete follow-up. This does not necessarily imply that the right answer is more regulation; the important thing is that measures are consistent.
Improved supervision is important, but countries should be prepared to coordinate their economic and exchange rate policies. Owing to massive dollar purchases, emerging economies have for too long supported the credit culture in the United States that ultimately led to this crisis.
A stronger role for the IMF is especially important because all these issues are interlinked. Indeed, the IMF, with its global membership and its accumulated international expertise, is best positioned to take the leading role in a multilateral approach to financial stability.
This role should go beyond the Fund’s traditional tasks of adviser and lender of last resort. Its advisory role renders the IMF vulnerable to criticism by developing countries that the industrial world does not heed its advice.
As IMF teams now work across the globe to assist governments in devising programs that can restore confidence, it is clear that the role of lender of last resort is not obsolete. But this has a bitter undertone: the IMF must now clean up the mess in emerging countries caused by a financial crisis whose origin lay elsewhere.
On a global level, the IMF can assist in designing an overarching regulatory system for financial markets by providing a platform for key players. The Fund can lend analytical support, identify regulatory gaps, and indicate where regulation needs to be enhanced. It should monitor progress, but refrain from acting as a regulator itself. That mandate remains with current supervisors and international groupings, such as the Financial Stability Forum. But the IMF would become the “supervisors’ supervisor .
On a national level, the IMF can assess regulatory systems and give recommendations. Many IMF members have sought this on a voluntary basis. Until now, however, the US has refrained from allowing the IMF to get involved. Reviews under the IMF’s Financial Sector Assessment Program should become mandatory, and their follow-up should be integrated into the Fund’s regular surveillance activities.
Better policy coordination can profit from improved analytical work on the linkages between financial developments and the real economy. Based on its independent analysis, the IMF should be authorized to bring policymakers of key member states to the table. Multilateral consultations can help prevent countries from taking economic measures that negatively affect the financial and economic stability of other countries. Global imbalances must be addressed more forcefully.
Finally, the IMF should be better equipped to deal with financial-sector problems. Traditional IMF programs that focus on budgetary or monetary policy do not suffice in this financial crisis. The Fund should establish credit lines for countries that conduct sound macro-economic policies. In those cases, traditional IMF conditionality is not needed. This week the IMF established a new liquidity fund of up to $100 billion. This is a step in the right direction.
At its recent Annual Meeting, the IMF was asked to take the lead, draw lessons from the crisis, and come up with proposals for a better financial architecture. So far, the IMF has had to rely on the quality of its advice, but stand by idly if its advice was ignored. This will have to change.
The IMF’s advisory role should be given teeth. The Fund must dispense more powerful policy messages and, if necessary, should be able to enforce action. The coming weeks will make clear if the government leaders that are now calling for a Bretton Woods II are willing to give such an enhanced mandate to multilateral institutions such as the IMF.
Age Bakker of the Netherlands is Executive Director of the IMF, representing 13 countries. This commentary is published by DAILY NEWS EGYPT in collaboration with Project Syndicate (www.project-syndicate.org).
