IMF warns finance is vulnerable

Insufficient progress in addressing the problems resulting from the crisis has left the global financial system vulnerable to funding shocks and a loss of market confidence, the International Monetary Fund (IMF) says.

In its latest Global Financial Stability Report (GFSR), published last week, the IMF warned that although better regulation is “critical” for sustaining a healthy recovery, regulators have not done enough yet. While the IMF and other regulators argue that improved regulation and supervision will make the global financial sector more stable, banks and financial firms argue it could do the opposite.

The Institute of International Finance (IIF), the body which represents financial institutions, for example, has repeatedly voiced concerns over the complexity and uncertainty of the regulatory landscape. (article continues below)

The organisation argues that regulators must first deepen their understanding of the effects their regulatory practices and requirements might have globally. Otherwise, it says, regulators’ desire to relieve uncertainty might ­create even more of it.

To tackle such criticisms the IMF is pressing for policies that address sovereign risks and strengthen confidence in the financial system on a national and supra-national level. This includes, where necessary, recapitalisation and stronger sovereign balance sheets.

“Apparently isolated difficulties in a few spots can have large spillover effects via complex financial linkages and deterioration of fragile confidence,” the IMF report says. “More progress with financial sector repair and reform should thus be a top priority for advanced economies.”

Over the past two years, policy­makers have been working on related regulations, including the Basel III requirements by the Basel Committee on Banking Supervision.

Although Basel III requirements are a substantial improvement, the IMF says further progress in addressing weak banks is needed. During the first six months of this year, global financial stability has suffered a setback. Market volatility has increased and risk appe­tite has declined when heavy selling of the sovereign debt of vulnerable eurozone economies rattled the banking system and triggered a systemic crisis.

Especially in Europe, banks are struggling with fragile funding and profitability as well as sovereign debt exposure and real estate lending. Efforts of individual countries have been relatively unco-ordinated. In Britain, Ireland and Spain, for example, govern-ments have taken decisive actions. In other countries, such as Germany, long-standing problems have not been addressed yet.

In America, banks, for example, have recognised losses and started to rebuild capital. However, systemic risks remain.

The IMF says policymakers should consider a range of measures, including forcing weak banks to raise additional capital if necessary, secure stable funding and further clean up their balance sheets.

Yet the IIF remains wary of those, sometimes vague proposals. Instead, it has created the Cross-Border Resolution group and the Cumulative Effects Working Group, which lobby for improving the focus on the origination and development of policies.

Their goals are not to increase or tighten regulation but to make regulations more effective by identifying and rectifying “unduly burdensome or counterproductive practices”.

This discussion suggests that it will be difficult to find a balance of what regulators want and what those that will be regulated are willing to accept. Many, including George Barrow, an investment analyst at HIM Capital, expect more initiatives over the coming months. “The Basel III regulations and the bank stress tests were important but people do question the results,” he says.

The IMF says that beyond addressing the unresolved problems from the crisis, policymakers are facing the challenge of putting in place prudential frameworks that deliver a safer and stronger global financial system.

So far, much of the regulatory reform introduced after the financial crisis has focused on improving the conditions for individual institutions. Now, the IMF says, a more global view is needed.

Tom Elliott, a global strategist at JP Morgan Asset Management, is also wary about the the regulatory framework.

“It is difficult to know what will come,” Elliott says. “Basel II, for example, was widely perceived as suitable for banks [when it was first introduced in 2005] but it did not work as it did not stop banks from lending too aggressively.”