February 25, 1999
|Contact:||Barry Eichengreen||(510) 642-0822|
Washington, DCA new Institute study, Toward a New International Financial Architecture: A Practical Post-Asia Agenda by Barry Eichengreen, proposes a four-part program to help prevent and manage future monetary crises:
Dr. Eichengreen, Professor of Economics and Political Science at the University of California, Berkeley, argues that immediate steps should be taken to change the way the international policy community anticipates and responds to financial crises in emerging markets. Recent crises in Russia and Brazil have pointed up inadequacies in how national governments, the International Monetary Fund, and private financial institutions react to currency and banking problems there.
The new study analyzes all the existing reform proposals and tables a pragmatic reform agenda. It argues that any practical program must reject schemes for which there is no possibility of political support. Proposals for a global financial regulator, a global bankruptcy court, a global money and a global central bank founder on the reality that national governments are not prepared to create a supranational International Monetary Fund.
But the remaining pragmatic agenda is extremely important. The first element is the need for international financial standards. High capital mobility makes it impossible to fix the international financial system without first fixing the domestic financial systems of countries that are active in international markets. But neither the IMF nor any other multilateral agency has the resources to micro-manage this process in 182 countries or to design regulatory institutions that are sensitive to their different economic, cultural, and legal traditions. The only practical approach is to develop and adopt international standards of acceptable practice, not just for bank regulation but also for auditing and accounting, corporate governance, and bankruptcy law. National practices can differ in their particulars but all must satisfy a common set of international standards.
Responsibility for designing standards must be taken by the private sector: by the International Accounting Standards Committee, the International Federation of Accountants, the International Organization of Supreme Audit Institutions, Committee J of the International Bar Association, and the International Corporate Governance Network. At the same time, the multilateral institutions should participate in these deliberations. In particular, it is important for the Fund to be involved to ensure that it assumes "ownership" of the standards it helps to set.
Making the markets pay heed to compliance with the new standards will require the IMF to issue blunt assessments of national practice. But the IMF will also have to reinforce market discipline by offering the carrot of concessionary interest rates on its loans to countries that comply, and by conditioning its programs on steps to bring national practices into conformance.
Another key area for reform is banks and capital flows. The policy community unanimously acknowledges the need to strengthen banks' risk management and supervisors' oversight and regulation. But the sad truth in many countries is that banks have a limited capacity to manage risk and that regulators have limited capacity to supervise their actions. In such countries, moreover, capital requirements in theory and capital requirements in practice are two different things, given the inadequacy of auditing and accounting practices. And the political realities in many emerging markets are such that bank capital is rarely written down. Even the proposed new standards are unlikely to prove very effective for some time.
In this environment, free access to foreign (especially short-term) finance may be incompatible with financial stability. Foreign funding gives banks an additional way to lever up their bets. Government guarantees for banks regarded as too big to fail encourage foreign investors to provide those funds. When confidence is disturbed, the short maturity of their loans provides these investors the opportunity to flee. Their rush for the exits can bring down not just the banking system but the currency and the economy as well.
This creates an argument for limiting short-term bank borrowing abroad in countries where banks' risk-management practices and regulatory supervision do not suffice. Where banks can circumvent these measures by having corporations do the borrowing and pass on the proceeds to them, broader measures may be required as well. Financial stability may have to be buttressed by a Chilean-style tax to limit short-term foreign borrowing by all domestic entities. The new study argues that the international policy community should become an unambiguous advocate of such measures.
A third area ripe for reform concerns the provisions of loan contracts. Avoiding both routine rescues and devastating defaults will require creating a more orderly way of restructuring problem debts. Majority voting and sharing clauses should therefore be added to loan contracts to prevent isolated creditors from resorting to lawsuits and other means of obstructing settlements, along with collective representation clauses specifying who will speak for the creditors in negotiations. This is the only practical way of creating an environment more conducive to orderly restructuring negotiations.
But this is a process in which no borrower wants to be first, for fear of sending an adverse signal to the markets. The IMF should therefore make clear that it will lend at more attractive interest rates to countries that issue debt securities with these provisions. US and UK regulators should require inclusion of the relevant provisions in international bonds admitted to trading on their markets.
Finally, the study emphasizes that it is important to draw the right lessons from the Brazilian debacle. One indisputable lesson is the need for the vast majority of emerging markets to move to more flexible exchange rates. It is also important to acknowledge that a new "contingent facility" for the IMF, as suggested by the Clinton administration and the G7, is not a feasible response. Brazil is a blunt reminder of how few countries have the kind of unquestionably strong policies that might permit the IMF to extend unconditional credits in advance and of how small the Fund's resources remain relative to those of the market.
Professor Eichengreen concludes that the task now facing the world is to move from abstract schemes to concrete action to reform the "international financial architecture." This means discarding unrealistic proposals and building a consensus around those that remain. It is urgent to do so if new crises are to be avoided and better managed when they do occur.