Yilmaz Akyüz

1. STABILIZING THE INTERNATIONAL FINANCIAL SYSTEMKEY ISSUES FOR DEVELOPING COUNTRIESIDEAs Conference on Re-regulating Finance in the Light of the Global CrisisApril 9 2009, Beijing Yilmaz Akyüz

2. Issues/Objectives • Preventing or reducing the likelihood of financial crises with global ramifications; • Minimizing negative international spillovers from crisis response by governments; • Improving international intervention and resolution of crises in emerging markets.

3. Three Sources of Instability • Policies in systemically important countries, including some larger emerging markets. • Problems inherent to an international reserves system based on a national currency− the dollar. • Financial and currency markets.

4. And Three Areas of Reform • Effective multilateral discipline in macroeconomic and exchange rate policies to secure stable exchange rates and payments; • Establishment of an international reserves system not based on a national currency; • Regulation and supervision of international financial markets and capital flows.

5. Prevention: Multilateral Policy Discipline in Money and Finance • Asymmetry between trade and finance: Adverse global spillovers from macroeconomic, exchange rate and financial policies are more damaging than those from trade policies; but not subject to multilateral disciplines. • IMF members have same de jure obligations to maintain orderly exchange rates and payments. But Fund is unable to exert disciplines over its non-borrowing members. How to remove this asymmetry and make surveillance effective, even-handed and independent of IMF lending? • In surveillance, the Fund should recognize that stability depends as much on combating inflation in asset markets (asset bubbles) as combating inflation in product markets. But it fails to do so (US and Iceland)

6. Prevention:A Stable International Reserves System • Inherent instability of a reserves system based on a national currency, now aggravated by: • Absence of effective multilateral discipline over US policies • Liberalization; vulnerability of DCs to shifts in cap. flows; • Pro-cyclical behaviour of financial markets • Absence of an international lender of last resort (ILOLR) • High reserve costs in DCs (some $130 billion per annum). • Solutions • Multiple reserves systems no more stable • LOLR is neither feasible nor desirable • An SDRs based system

7. Prevention:An SDRs-Based Reserve System? • Holding SDRs entails no cost; cost incurred only when used. There are proposals for regular allocation to all or only to poor members. • Going further and funding IMF by SDRs, not by quotas, GAB or NAB. IMF could distribute SDRs to itself at regular intervals, linked to growth in world income or trade; guaranteed by its shareholders (like WB). • Allow banks to hold SDRs. Make it possible to use SDRs for currency interventions. • Greater automaticity in access: widen reserve tranche on the basis of need (not quota subscriptions); should be designed for countercyclical CA financing.

8. Prevention: Regulation of Financial Markets and Capital Flows • Why regulations should be international: • Since financial instability has adverse global spillovers, national regulatory practices should be subject to multilateral disciplines; • This would also reduce the influence of politicians on regulators • And prevent regulatory arbitrage whereby business could run away from tightly to lightly regulated jurisdictions • Options: • A fully fledged multilateral system built on the same principle as the WTO • A selective approach: regulate certain areas through multilateral bodies • An eclectic approach: extended current system based on voluntary cooperation • Selective-eclectic mix: G20 approach?

9. Prevention: Regulation of Financial Markets and Capital Flows • A fully fledged system (WFA) based on: • Binding multilateral agreements on regulations • Commitment by governments to implement through national regulators; • A multilateral institution to oversee implementation and impose sanctions for non-compliance. • Hurdles likely to be faced: • Difficulties in agreeing how best to regulate financial institutions and markets • Major ICs unwilling to give up autonomy, particularly if such an institution is to have a real clout- even EU cannot do it. • Risks for developing countries: • Governance problems • Problem of one-size-fits-all. S&D Treatment does not work; • Concession on free capital movements and market access in financial services

10. Prevention: Regulation of Financial Markets and Capital Flows • A selective approach: • Establish international supervisory bodies for large transnational banks and credit rating agencies on the basis of agreed standard and rules. • Favoured by France • Such a step would involve complex issues of sovereignty and power of international bodies vis-à-vis national regulators. • An eclectic approach: • Extend the mandate and improve the governance of existing bodies such as FSF, BIS, Basle Committee on Banking Supervision. • Need to keep the IMF out of it. • Favoured by the US. Likely to be combined with global regulation and supervision of rating agencies and some big banks

11. Prevention: Regulation of Financial Markets and Capital Flows • DCs are not ready to negotiate; need common reflection and an agenda to maintain autonomy but reduce vulnerability. Key areas: 1. Reduce pro-cyclical behaviour of international lenders to DCs 2. Regulate investors in DCs (institutional investors, hedge funds) • Improve transparency through reporting and disclosure requirements; • Restrict their investment strategies to reduce destabilizing effects on EMs; 3. Rating agencies: regulate them • To eliminate procyclical rating and bias against DCs borrowers/issuers • To improve ratings of securities held by CBs and private investors in DCs • Recognition of rights to impose control over both inflows and outflows 5. A statutory framework for temporary debt standstills. 6. Arbitration for sovereign debt of DCs to private and official creditors.

12. Crisis Response: National • Prevent adverse global spillovers from crisis response by governments− e.g. import restrictions and subsidies in US (WTO) • Prevent beggar-my-neighbour exchange rate policies (IMF). • Prevent free riding and promote coordination of macro-economic policy response to crises (IMF)

13. Crisis Intervention and Resolution: International • IMF interventions: bailing-out creditors and investors, keeping debtors current on debt payments, maintaining open capital account; promoting pro-cyclical policies. • Problematic because of moral hazard, burden-sharing and impact on poverty. But initiatives for reform came to nothing, including new mechanisms to bail-in the private lenders and investors, and terms and conditions of IMF lending. • Now IMF is back to business and it looks business as usual. • Modalities of IMF interventions the first issue to be taken up. This should be part of a general reform of IMF including its funding, operating procedures and governance (see YA paper for the G-24). • Now urgent need for a large, highly concessional global countercyclical facility (like two oil facilities in the 1970s); to be funded by a reversible SDRs allocation, larger than agreed by G20.