Central Banking Financial System Stability and Growth Presented

Central Banking, Financial System Stability and Growth Presented by Piero Ugolini May 6, 2009

Errare Humanum Est!!! • Seneca the Younger Year 4 BC !!! • And he added: “ Sed Perseverare est Diabolicum”

Are we learning from past mistakes? • Debt crisis 1986– Brazil and others • University books : MBA – a country never defaults !!! Was it true?

What did we learn from the 80’s debt crisis? • • • International Cooperation Exchange of information Transparence Creation of Paris and London Clubs Better management and corporate governance Risk management Stress test Off-balance sheet items – Contingent liabilities Supervision

Asian crisis- What Happened? • Until 1997 Asia attracted almost half of the total capital inflow from developing countries • Paul Krugman “ Asian economic Miracle” • Thailand, Indonesia, and S. Korea exports dropped, capital outflows, devaluations, etc…

What did we learn? • Among other things --- it became clear that the world needed international standards: • BCP • IAIS • IOSCO • CPSS • Transparency • AML Overall better supervision and reduction of Government interference with the financial sector

Crisis of 2007 -8 • Excess liquidity and low interest rates in the US • Financial innovation and products disseminated w/o duly supervision • Housing bubble in the US and expectations of increasing values in the housing market • Poor supervision in the mortgage markets • Unsatisfactory market risk assessment

Crisis of 2007 -8 -cont. • Unregulated market for derivatives • Lack of transparency in key segments of financial markets –minimal information on pricing, trading volume, and others • Credit rating agencies did not do their job • Weaknesses in resolution procedures • Accounting practices: amplify business cycles- credit expansion/contraction

Crisis of 2007 -8 cont. • Poor corporate governance • Weaknesses in Disclosure- risk associated • Supervisory and regulatory policies not adequate to capture the problems • Multilateral surveillance? US had no FSAP!

Are we ready for the future? • Let’s look at 3 actions on the crisis: • G-20 April 3, 2009 • US Government • De Larosiere report for the EU-February 25, 2009

G 20 – London, April 2, 2009 The main objectives of the G-20 was summarized in their Communiqué’: • Restore confidence, growth, and jobs • Repair the financial system to restore lending • Strengthen financial regulations to rebuild trust

G 20 – London, April 2, 2009 cont. • Fund and reform international institutions • Promote global trade and investment and reject protectionism • Build an inclusive, green, and sustainable recovery

Strengthening financial supervision and regulations • Establishment of a new Financial Stability Board (FSB) as a successor to FSF • FSB to work closely with IMF • Reshape regulatory system to take account of macro-prudential risks

Strengthening financial supervision and regulations cont. • Extend regulation and oversight to include hedge funds • Address tax havens • Improve accounting standards • Extend oversight to CRA and address conflict of interest

US Government To cope with the crisis : four phases • First : intervention to contain the contagion and restore confidence in the financial system • Second: restore economic growth • Third: introduce changes to minimize risk and prevent future crises • Fourth: deal with the political, social effects of the financial crisis

US Government cont. Contain contagion ----Macro-level : • Lowering interest rates • Expanding money supply • Monetary easing • Restore confidence in the financial sector

US Government cont. ---Micro-level: • Financial rescue packages for firms in difficulty • Guaranteeing deposit at banks • Injections of capital • Disposing of toxic assets • Restructuring mortgages • Dealing with foreclosures • Addressing unemployment benefits

US Government cont. Restore economic growth • The impact of the US crisis had a world impact on country economies, enterprises, financial institutions and investors, and households—response: monetary and fiscal stimulus packages

US Government cont. • Introduce changes to prevent future crises • G-20 leaders’ Summit on Financial Markets and the World Economy- Washington DC November 15, 2008 • G 20 leaders’ Summit -London- April 2, 2009 • G 20 leaders’ Summit – November 2009

US Government cont. Dealing with Political, Social and security effects The role of the US on the world stage and its impact on : • Political leadership • Ideologies and state capitalism • International leadership • Supranational political and economic organizations • Poverty and flow of resources

U. S. Banking Regulators • • • Office of the Comptroller of the Currency Federal reserve System Federal Deposit Insurance Corporation State banking Authority Office of Thrift Supervision State Thrift Supervision

The U. S. System

U. S. Banking Regulators • • - OCC issues licenses & supervises national banks - 50 states have agencies to issue state licenses and supervise their banks, as well as branches from banks domiciled in other states - OTS issues licenses for federal thrifts and their holding companies & supervises both - FDIC insures deposits of all national banks, some state banks and all federal thrifts, some state thrifts - 50 states have agencies to issue state licenses for thrifts and supervise them - National Credit Union Administration issues federal credit union licenses, supervises & insures them and insures some state credit unions - 48 states have agencies to issue credit union licenses and supervise, some states may still have insurance funds for state credit unions -50 states have agencies to issue insurance licenses & supervise insurance companies, agents, brokers, etc.

…In addition to for the Financial Sector • Securities Exchange Commission • Commodity futures Trading Commission • Federal Housing Finance Agency ( Fannie Mae/Freddie Mac)

The High Level Group on Financial Supervision in EU The Group proposes 31 recommendations • A new regulatory agenda • Stronger coordinated supervision • Effective crisis management procedures

The High Level Group on Financial Supervision in EU cont. Disclaimer • “ The views expressed in this report are those of the High-level Group on supervision. • The members of the Group support all the recommendations. • However, they do not necessarily agree on all the detailed points made in the report”.

The High Level Group on Financial Supervision in EU cont. • Some of the main points in the report • Revision of Basel II: minimum capital, reduce pro-cycliclity, off-balance sheet items, banks’internal control-fit and proper • Regulation of Credit rating Agencies • Accounting: mark-to-market • Corporate governance: bonuses

The High Level Group on Financial Supervision in EU cont. • Risk management: internal systems • Crisis management : appropriate and equivalent crisis prevention policy • Harmonization of Deposit guarantee scheme • Supervision: creation of a European System of Financial Supervisors ( ESFS) • Creation of an European Systemic Risk Council ( ESRC) to be chaired by ECB President

The High Level Group on Financial Supervision in EU cont. • Early warning financial stability : IMF, FSF, BIS, and ESRC • Macro-prudential oversight : ESRC linked to the ECB /ESCB to bridge between macro- and micro- oversight • Greater role for the IMF in multilateral financial sector surveillance • FSAPs should be compulsory

What Kind of Reforms are needed for the Global Financial System? By summarizing the previous slides : • Macroeconomic Surveillance: need for some authorities to alert about housing bubbles and too low interest rates that may fuel investments in high risk assets • Multilateral financial sector surveillance : to set up an early warning system ? • Early remedial-crisis management resolution

What Kind of Reforms are needed for the Global Financial System? • Bilateral surveillance : FSAPs mandatory • Improved supervision: Basel II needs to be revisited and corrected: gradual increase in capital requirements, elimination of procyclicality, stricter rules for off-balance sheet items, and tighter rules on liquidity management • Supervision extended to all institutions of systemic importance- information on hedge funds, off-balance sheet items, investment funds, all institutions operating as a “parallel banking system”– see US experience-

What Kind of Reforms are needed for the Global Financial System? • Accounting : Improvements in the principles- mark to market- IASB to be strengthened • Credit Rating Agencies : need to separate rating and advisory functions and to be supervised

A Single Regulator? Advantages: • To respond to the changing structure of the financial services sector • To realize economies of scale • To deliver economies of scope

A Single Regulator? • Economies of scope • As a result of deregulation, innovation, competition, and proliferation of financial products : risks and products traditionally typical of one sector are now spread across sectors • Conglomerates make difficult for sectorbased regulators to supervise and assess their risk management and operations

A Single Regulator? A world Bank survey of 15 countries ( 2002) Found that the main reasons for adopting a single regulator were to supervise better a financial system moving towards universal banking, solve communication problems among multiple regulators, and to maximize economies of scale

A Single Regulator? • The 2008 edition of “ How Countries Supervise their Banks, Insurers and Securities Market” lists 40 countries that had single regulator in 2007 compared with 10 in 1990. • How about the internal structure?

Sector Silos or Integrated Structure? • The benefits of an integrated structure : • Economies of scale : common approaches and procedures for regulatory functions • Facilitate response to changes in financial market structures and products • Exploit economies of scope : common framework for risk-based supervision and consistent policy across sectors

Sector Silos or Integrated Structure? • Facilitate cooperation, coordination, and information sharing arrangements • Reinforce different cultures and approaches within the regulator • Facilitate the creation of an effective and efficient “ one-stop shop” to stakeholders, applicants for licensing, regulated firms, and overseas regulators

Integrated Silos • • Licensing Supervision Policy decision Legal/Enforcement Markets/Listing Company registry Support operations Others • • Banking Insurances Securities Company compliances • Pensions • Trust Funds • Others

Countries with Single Regulator and Integrated Internal Structure • • Australia Canada Denmark Estonia Finland Hungary Ireland Isle of Man • • Japan Latvia Mexico Norway Qatar Singapore Sweden UK

TWO QUESTIONS? • Are Governments going back as influential shareholders in the banking business? • “ Too big to fail” but “Not too big to save”?

As the World Turns • In Florence, in the fourteenth century, two banks “ Bardi and Peruzzi”, were the giants of the industry! (The Medici Bank took over from them) • Both banks collapsed because they failed to collect loans from two special clients: ---“ Edward III, King of England --Robert the Angevin, King of Naples. • In 2008 we have a financial collapse because we could not collect loans from poor people!!!!!

Many Thanks!!! For the invitation to this Celebration All my best wishes to the Central Bank of Nigeria!