April 18, 1997
|Contact:||Morris Goldstein||(202) 328-9000|
Washington, DC—Three-fourths of the world's economies have been hit by banking crises over the past 15 years. The public costs of bailing out banks in developing countries alone have totaled almost $250 billion. At least a dozen of these episodes have cost their countries 10 percent or more of total output. But existing international banking agreements do not address the main sources of these problems. Morris Goldstein, Dennis Weatherstone Senior Fellow at the Institute, concludes in The Case for an International Banking Standard that the best way to motivate serious banking reform in both developing and industrial countries is to install a voluntary international banking standard (IBS). He calls for international agreement on an IBS at least by the time of the annual meetings of the International Monetary Fund and World Bank in Hong Kong in September 1997. The IBS guidelines would focus on:
Goldstein documents that, between 1980 and 1996, over 50 developing countries experienced banking crises. In a dozen cases, the costs to the public of resolving these crises amounted to 10 percent or more of the country's GDP (by comparison, the US saving and loan crisis carried a resolution cost of 2-3 percent of GDP). There have also been notable banking problems in industrial countries during this same period, including the current huge bad loan problem facing Japanese banks and the crises experienced by three Nordic countries during the late 1980s and early 1990s.
The costs of banking crises extend well beyond their enormous fiscal impact. Goldstein notes that banking crises exacerbate economic downturns, keep saving from flowing to its most productive use, and severely constrain the authorities' willingness to raise domestic interest rates. As highlighted in the recent Mexican crisis, monetary authorities will be attempting to deal with volatile private capital flows with one hand tied behind their backs when the banking system is in trouble.
The author shows that banking crises in developing countries pose increasing risks to industrial countries because the weight of developing countries in global financial markets is growing rapidly. Developing countries now account for approximately 45 percent of global output, about a third of global foreign direct investment and portfolio flows, and roughly an eighth of global stock market capitalization and global banking assets. They also purchase 25 percent of industrial-country exports.
Net private capital flows to developing countries have already totaled over one trillion dollars in the 1990s. Most analysts expect these flows to continue to grow over the next decade. They will be driven by high expected rates of return, large untapped opportunities for risk diversification by industrial-country investors, the globalization of production, and the growing liquidity and maturity of developing-country securities markets.
Banking crises in developing countries depress their growth and foreign trade, strain their debt-servicing capacity, often wind up as liabilities of their governments, and frequently lead to a need for new loans from the IMF and the World Bank. Hence industrial countries have an important stake in promoting stronger banking systems in the developing world. Moreover, industrial countries' own spotted record of banking problems suggests that they too have ample scope for improving their systems of banking supervision.
Existing international banking agreements were designed primarily for the industrial countries and are not comprehensive enough to deter banking crises in developing countries. All too often, governments in those countries use banks to channel government assistance to ailing industries--thereby falling outside traditional measures of the fiscal stance and escaping public scrutiny until the crisis erupts. With relatively high macroeconomic instability, limited diversification of bank loans and a relatively small financial cushion in the form of capital and loan-loss provisions, banks in developing countries have been skating on thin ice. Accounting conventions are not rigorous enough to prevent banks from concealing the true size of their non-performing loans. Official safety nets do not give bank owners, managers, and creditors "enough to lose" when they bring a bank to insolvency.
Participation in an IBS would be voluntary but Goldstein argues that market knowledge of who has and has not signed on would establish market penalties for slow movers. Experience with other international standards in financial markets—including the IMF's Special Data Dissemination Standard, the Group of Thirty's guidelines on clearance and settlement and on risk management of derivatives, and the 1988 Basle Capital Adequacy Accord—suggests that international standards/guidelines can induce countries to make improvements that they would not make on their own, either because of considerations of competitiveness with other firms/countries or because unilateral reforms are less credible than those monitored by an international agency. Other approaches to motivating banking reform in developing and industrial countries, such as relying exclusively on market discipline or technical assistance, look less promising.
Dr. Goldstein's idea is already receiving widespread attention in official quarters around the world. Action proposals are being developed by the Basle Committee on Banking Supervision, by the IMF, and by a G-10/developing-country working group of finance and central bank deputies. This issue of international banking guidelines is likely to be discussed intensively in official circles over the next six months, and The Case for an International Banking Standard provides an objective benchmark against which to judge the forthcoming official proposals.