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The IMF gets radical

Inadequate, slow and badly-designed reforms

To some people’s surprise, the IMF under Christine Lagarde is pushing governments and stamping its authority on financial sector issues in ways that it has seldom done before.  Following my prediction of another financial crisis (RP’s Diary, 23 September), the IMF today argues that banking reforms do not go nearly far enough.

The reforms have not yet created a safer financial system.

“Although the intentions of policymakers are clear and positive, the reforms have yet to effect a safer set of financial structures, in part because, in some economies and regions, the intervention measures needed to deal with the prolonged crisis are delaying a ‘reboot’ of the system onto a safer path,” it said the IMF in Global Financial Stability Report.

The analysis, titled “An Interim Report on Progress Toward a Safer Financial System,” argues that reforms need to be “further refined” (ha!), are not being implemented quickly enough and that the system remains vulnerable. It is overly complex and activities are too concentrated in large institutions.

This problem is getting worse.

Reliance on non-deposit funding is “very” high, linkages across domestic financial institutions are “very” strong and complex financial products are “taking on new forms”.

The IMF does not hold back from urging radical reforms. It calls for 

  • a global-level discussion on the need for direct restrictions on business activities for banks, rather than just requiring them to hold more capital for these activities;
  • more data and understanding of nonbank financial institutions – do they act as banks
  • If they pose systemic risks, prudential regulation will be needed;
  • the use of simpler products
  • simpler organizational structures;
  • a solution to the “too-important to fail” issue
  • agreed cross-border resolution proceedures.

Like the BIS in its annual report, the IMF also underlined the high risks being run by central banks in their ultra-loose, low interest rate policies – risks for themselves and for society, notably for pension funds.

At the press conference to launch the report, Jan Brockmeijer, deputy director of the monetary and capital markets department, Laura Kodres, assistant director,  Jennifer Elliott and Srobona Mitra, co-lead authors of the chapter on the reform agenda, called attention to the need for a global solution to the global crisis.

True, despite ongoing fragmentation of financial markets in the eurozone, there had not yet been a general retreat from globalisation.

Countries were implementing reforms too slowly and in an uneven way. This creates uneven playing fields, giving new opportunities for regulatory arbitrage.

Moreover the too-big-to-fail problem might be getting even more intractable:

“Big banking groups with advantages of scale may be better able to absorb the costs of the regulations; as a result, they may become even more prominent in certain markets, making these markets more concentrated.”

The next stage is surely for the IMF to question the entire Basel III process, as many regulators are doing, and then to spell out what kind of structural reforms will be needed to make the system safer. Once they think that problem through, I believe there will be no option but to redesign the entire financial systems of developed countries along the lines outlined in The Money Trap: a move to equity, ownership and property claims at every link in the chain of intermediation (see my chapters 10, 14 and 15).

Otherwise, as I have warned, a worse crisis will be unavoidable.

More capital buffers are only useful if they consist of equity. This conclusion is supported by  Tao Sun, lead author of the chapter of the IMF report on changing global financial structures.

Congratulations to the authors and 

Bravo, Madame Lagarde!