Report on the Conclusions and
Recommendations
by a High-level Expert Group on
IN GLOBALIZED FINANCIAL MARKETS Chaired by Valéry Giscard d'Estaing 19th - 20 th April 1991
Paris, France
1. On 19 and 20 April 1991, the InterAction Council convened in Paris a High-level Expert Group on "The Role of Central Banks in Globalized Financial Markets", chaired by Mr. Valery Giscard d'Estaing. The meeting was attended by four other members of the InterAction Council - Maria de Lourdes Pintasilgo (Portugal), Malcolm Fraser (Australia), Manuel Ulloa (Peru) and Olusegun Obasanjo (Nigeria) - and fourteen experts. The list of participants is annexed to this report as are the terms of reference.
2. In recent years, considerable changes have taken place in domestic and international capital markets: deregulation, disintermediation, the creation of new financial instruments, the use of futures markets, a blurring of frontiers between financial intermediaries, computer-based instant dissemination of information and arbitrage operations closely linking markets, instruments and currencies.
3. In many respects, these changes were advantageous and represent a positive trend. Under the pressure of competition, the cost of financial services to potential users was reduced. Individuals, enterprises and countries were enabled to find at any time financial instruments tailored to their own requirements. The large-scale internationalization of capital markets and banking activities has brought about benefits in terms of access, transaction costs and an efficient and market-based allocation of resources.
4. But these changes have created an environment in which emerged new problems, both domestically (such as the S and L's situation in the United States) and internationally, as exemplified by periodic defaults, failures, and rescue operations in the interbank money or currency markets and in other markets which were made more fragile by the rapid development of new financial instruments (e.g. floating rate notes, highly leveraged transactions, swaps). More fundamentally, the growing interconnection between markets may lead to the proliferation of a crisis originating in a specific market with cumulative and mutually reinforcing downward adjustments in all markets on a worldwide basis - such as in the 1987 market crash. All these conditions have increased the potential for systemic risks.
5. As a consequence, shifts by major countries may have large - and disproportionate - repercussions on emerging financial markets, banking systems and development strategies in developing countries and on the management of economic policy in small and open economies, which may see their domestic stabilization efforts impaired by developments in international capital markets and their currencies being overwhelmed by excessive capital flows.
6. Central banks and other regulators have already taken measures to enhance their capacity to deal with any such crisis in the new financial environment through better, more appropriate and coordinated regulation: the Basle concordat allocating supervisory responsibilities, the internationally agreed capital adequacy requirements (the "Cooke ratios"), the new relationship between bank regulators and market regulators domestically and between market regulators internationally, the coordinated responses to international liquidity crises (e.g. through collective endeavours in exchange rate management and in the common response of central banks to provide liquidity to the system in the 1987 crisis).
7. Some of these developments have, by themselves, raised new concerns, notably at end-1987 a risk of an oversupply of liquidity fueling inflation or current fears - which might prove exaggerated - of overcautious lending policies by banks ("credit crunch"). This occurs at a time when new challenges have to be addressed: a need to increase savings and financial flows to meet the requirements of developing countries, Eastern and Central European countries, and Gulf reconstruction; a need to restore access to the market for countries emerging from debt reschedulings; a need to aim at greater transparency and stability in futures markets, including oil future markets, with their growing importance for both oil-producing and consuming countries.
8. In the process of globalization, the world is also moving toward a tripolar system of three large blocs centred around the dollar, the European currency (ECU) and the yen. This itself may ultimately prove to be an interim stage toward an even broader or more closely linked global system. Meanwhile, however, each of the three major blocs will have considerable capacity to influence conditions in the others, thus reinforcing the need for closer policy coordination in the interest of a stable world economy.
9. The InterAction Council should send a signal to all the relevant national and international authorities that the time is ripe for the adoption of a comprehensive approach concerning the role of central banks and supervisors in the new financial environment. aiming at stability. transparency and efficiency.
THE CASE FOR A TEN-POINT STRATEGY
10. To this end, the High-level Expert Group formulated a ten point strategy which the InterAction Council may wish to endorse. This strategy aims at greater transparency, stability and efficiency in financial markets through an adaptation of the role of central banks and other supervisors.
I. Ensuring the independence of central banks
11. The best encouragement to stability in financial markets and to adequate private savings is the perception of monetary policies steadily oriented toward price stability. This is best accomplished through independent central banks with a clear mandate to that effect. It has been agreed that the new European System of Central Banks (ESCB) should have these characteristics but there is a need to reform accordingly the statutes of individual European national central banks. This is an example to be followed by central banks in Eastern and Central Europe and more broadly by non-OECD central banks.
12. An important lesson gained from economic policy management over the past two decades is indeed the primary importance of price stability as the ultimate objective of monetary policy, to be conducted by independent central banks taking a long-term view and being immune from day to day reactions to economic and financial developments. Another lesson is that a short-run trade-off exists between lower inflation and securing employment opportunities but that central banks should not aim at addressing conflicting goals. Hence, central bank efforts towards price stabilization need to be complemented by governmental fiscal policies and by structural policies to improve the labor and product markets in order to minimize the social costs involved in the process of disinflation. A convergence of objectives for medium-term inflation rates at the lowest possible levels in the United States, the European Community and Japan and the perception of monetary policies steadily oriented towards achieving such objectives will by itself encourage stability in financial markets. To ensure the independence of central banks is crucial in gaining and maintaining market credibility in their task of achieving price stability.
13. While deregulation makes coordination of monetary and exchange rate policies both more necessary and more difficult, independent national central banks would not necessarily ensure greater coordination between them (although, arguably, they might be more likely to collaborate effectively than Governments). But if the ESCB, the Bank of Japan and the US Federal Reserve all pursued an identical goal, namely zero inflation, equally effectively, their actions would be likely to be more consistent with each other.
II. Adapting monetary policies to the new financial environment
14. In their pursuit of reasonable price stability in a globalized world with its deregulated financial environment, central banks have to face difficult choices in targeting the appropriate objectives. In view of continuing worldwide financial innovations, monetary aggregates, overall credit expansion or the monetary base are less reliable in their definition and more loosely related to economic aggregates. Interest rates may also prove inadequate, partly because, with globalized markets, they are more and more influenced by external forces outside of the purview of central banks. Basically, in the new financially environment, most central banks should aim at the stability of their exchange rates against a major currency, provided this "anchor currency" is sufficiently stable. And in the management of major currencies, an added weight may have to be given to direct price indicators (price indexes, commodities prices and securities prices - which means long-term interest rates). Moreover, in the framework of international policy coordination target zones for exchange rates should be established and considered in formulating central bank policies. Efforts should be made to maintain the zones through intervention and through policy adjustments to the extent possible taking account of domestic conditions.
15. In this endeavour and in the management of their interventions on domestic money markets and foreign exchange markets, central banks would have to further strengthen their ability to collect adequate information and to make use of the most recent technological developments in financial markets.
III.Using the move toward a single European currency to strengthen the international monetary system
16. The move toward a single European currency should pave the way for a three-polar international monetary system (dollar, yen and Ecu), with the Ecu substituted for individual European currencies in the definition of the special drawing rights (SDR), in foreign exchange reserves and in swap agreements between central banks. To offset any destabilizing effects of such a move, measures would have to be taken to broaden the Ecu-denominated - and the yen-denominated - financial instruments markets, in order to provide for the same transparency, depth and liquidity as in the dollar-denominated financial instruments markets. Also, it might be desirable to establish target zones for the tripolar currency regime which would foster the convergence of the domestic price stability objectives at the lowest possible levels and the adoption of coherent budget and structural policies of the countries concerned.
17. For other currencies, individual choices might then be made between a link - in nominal or real exchange rates - with one of the three leading currencies (provided this "anchor currency is sufficiently stable) or with a basket of the three, either standardized - the SDR - or adjusted to individual national requirements.
18. In a move from the current G-7 to a G-3, particular responsibilities ought to be given to a small group of countries which would have to agree on a general approach to exchange rates evolution and to use monetary and fiscal policy in a way that can be interpreted by capital markets as stabilizing. In assuming these responsibilities, aiming at a convergence of economic policies and inflation rates, the G-7 and then the G-3, should at the same time affirm world leadership and ensure close cooperation with the IMF and with other OECD countries in Europe and in the Pacific, with the Central and Eastern European countries and with the developing countries.
19. In this connexion, the role of the International Monetary Fund (IMF) should be re-evaluated and reinforced with a view to ensuring an adequate surveillance over the economic policies of richer countries. Globalization and liberalization has freed industrialized countries from the need to seek assistance from the IMF contrary to the present situation of developing countries. The main role of the IMF should be to ensure that the international financial system functions efficiently implying relative stability in exchange rates and lower interest rates, and to provide liquidity, at a reasonable cost which should not be higher than that of capital markets, to countries engaged in an adjustment process.
IV. Streamlining bank regulation and supervision
20. Diversity prevails in the supervision of banks even among the major countries. In the United States, a number of separate agencies are in charge of deposit insurance schemes and of overall supervision - split between the Treasury and the Fed - either at the federal or individual state levels. In some countries, the supervision is primarily exercised by a body distinct from the central bank - a state agency for Germany - while in other countries, such as the United Kingdom, the supervision is conducted by central banks. In France, bank supervision is the primary responsibility of the Banking Commission, of which the Governor of the Bank of France is the Chairman and a high-ranking Finance Ministry official the Vice-Chairman. In Japan, banking supervision is carried out by the Ministry of Finance and the Bank of Japan. The latter's authority is rather contractual and is generally based on individual agreement with its client banks, in accordance with the purpose of the Bank of Japan law.
21. While respecting national choices, emphasis should be put in the future on the streamlining of bank regulation - one single national regulator - and the independence of bank supervision - either an independent central bank or a specific agency. In all cases, central banks, either alone or concurrently with other agencies, should monitor the financial soundness of the banking system as a whole.
22. The same objective should be pursued - by developing countries and Eastern European countries in order to give to their banks added credibility in the international capital markets.
V. Strengthening the supervision of other major intermediaries in capital markets
23. While central banks and other bank regulators have developed recognised fora for coordinating supervisory policies and requirements internationally (the Basle Committee on Bank Supervision), coordination of the supervision of non-bank financial intermediaries (or non-bank financial institutions) remains extremely loose: no agreed capital adequacy standards; no consolidation requirements; gaps in supervisory coverage; and the absence of an agreed division of supervisory responsibilities for internationally active conglomerates.
24. More effective mechanisms for coordinated supervision of internationally active securities intermediaries, with a more clearly defined and coherent allocation of supervisory responsibilities, need to be developed in coming years. These will at the same time have to bring within a coherent overall framework of supervision and control the interrelationships between different functional supervisors - particularly between banking, securities and insurance regulators. The establishment of the equivalent of the Basle Committee on Bank Supervision would appear to be appropriate.
VI. Adopting a set of standards for regulation
25. Based on this endeavor by regulators, governments themselves - at least in the OECD area and in offshore centers - should agree on a set of standards to be applied to the regulation of financial markets and financial intermediaries. This set of standards should be based on six principles:
a) Transparency: The regulations governing a particular market should be fully apparent to participants in the market and to potential market entrants. The mechanism through which regulations evolve should be open, permitting dialogue between the international industry, officials and legislators.
b) Neutrality: De facto and de jure foreign firms should be treated like domestic firms, both in entry and in operation.
c) Inclusiveness: The entire financial system should be regulated. Gaps in the international regulatory structure may present opportunities to financial firms or their clients to transact business at lower cost to themselves but at greater risk to the financial system as a whole.
d) Regulatory independence: While the value of an independent central bank, free from political pressure, is increasingly being accepted, the value of independence for other financial regulators concerned with safety and soundness is equally important but yet less widely accepted.
e) Mutual recognition: Any financial services firm may do business in other countries when so permitted in its home country, thus contributing, through competition, to reduce the costs of regulation imposed on the financial services industries.
f) Harmonized standards.
26. Supervision aimed at a prudent behavior of individual banks and market operators would not, however, bring to markets the required stability if risks of chain-defaults and systemic risks are not at the same time addressed. It has been a subject of intense study in recent years, notably by the Bank for International Settlements (BIS) and the OECD.
27. Central banks should stand ready, as ever, to provide liquidity in system ("lender of last resort") and to take concerted action exchange markets when necessary. While their traditional stance of constructive ambiguity about their future actions has advantages in retaining freedom of action and in minimizing the moral hazard of encouraging intermediaries to take excessive risks in expectation of being rescued, this should not, of course, serve as an excuse for inaction between crises.
28. In particular, in order to reduce the chances of their needing to intervene in a crisis, central banks should urgently promote a comprehensive programme for the strengthening of payment and settlement systems, including the development of robust, legally valid delivery versus payment systems in securities markets. This should in due course extend to the development of effective payment and settlement systems in a common European currency under the aegis of ESCB, and in their integration with dollar and yen systems. Market regulators and central banks should also pursue the implementation of fully reliable systems aimed at a strict registration of orders and quotations in spot and forward capital markets and of derivative instruments, and the development of early warning indicators.
VIII. Ensuring a better integration between the financial world and the real economy
29. Added stability in financial markets is not an end in itself but an instrument to enhance stability and growth in the real economy. To ensure a better integration between the financial world and the real economy, two main concerns would have to be addressed:
a) Financial deregulation should not unduly take precedent over overall economic efficiency which notably implies, domestically, flexibility in labor markets and, internationally, renewed efforts to dismantle trade barriers.
b) Adequate signals must be given by financial markets to the real economy, with a particular emphasis on the following essential elements:
the promotion and dissemination of information and rating on an open basis, avoiding individual appropriation of information by tightening insider rules and stressing a long-term approach;
the adoption of an adequate set of rules allocating domestic jurisdiction for mergers, acquisitions and concentrations.
Volatility and the hope of rapid financial gains should not distract industry from the long term painstaking search for greater efficiency and productivity.
30. The futures markets, both in financial instruments and commodities such as oil, warrant an in-depth study as to their impact, requirements, regulation and supervision.
31. Stability through adequate supervision, capital adequacy requirements and market surveillance is a long-term strategy. which, in its implementation. should pay due regard to current circumstances. In particular, three immediate concerns must be addressed:
a) The concerns about and risks of a US domestic and international credit crunch, in the present debt recession, should not warrant a loosening of regulatory requirements, but should be kept in mind when formulating monetary policies without jeopardizing price stability.
b) The risks of a worldwide shortage of savings as a result of the capital requirements of Eastern Europe, the developing countries, the Gulf countries and for environmental purposes. This requires action by major countries on budget deficits and might warrant additional incentives for private savings, notably for equity investments.
c) The risks of an ever-postponed access to market of countries emerging from a debt crisis, which might warrant further impulses for project financing, equity market promotion, securitization and co-financing with multilateral institutions.
X. Addressing the specific concerns of non-OECD countries
32. The concern for the specific issues confronting non-OECD countries should go beyond present circumstances and must be tailored to the requirements of individual countries or groups of countries.
a) The Soviet Union is simultaneously striving to move from a centrally-planned economy to a market economy and from a fully integrated system to a more decentralized one, a new federalism. This implies a coordinated effort in the move towards the convertibility of the ruble in order to ensure at the same time the coherence of the domestic evolution and the gradual insertion of the USSR financial markets into the globalized markets.
b) Most Central and Eastern European countries are undertaking major reforms to transform their economies into market-based economies and, in that context, they are pursuing severe adjustment policies. As part of these efforts, they are developing financial markets and intend to introduce internationally accepted supervision standards, in order to ensure a healthy development of their financial systems and also to be better able to attract foreign direct investment. The progress already made in several of those countries toward the convertibility of their currencies and toward their insertion into the globalized markets should be consolidated and extended to all the countries of the area.
c) Developing countries are themselves extremely diverse, with the newly industrialized countries of Asia moving toward the OECD; the Latin American countries emerging from a debt crisis and a period of instable policies; the African countries striving to meet the basic needs of their population; the oil producing countries notably in the Middle East in the wake of the Gulf crisis; and China, India and Pakistan with their specific characteristics. Because of the difficult global environment affecting credit and liquidity, an additional allocation of SDR, with its pattern of distribution different from the quota system. has been suggested.
33. Long-term strategies, foreign aid and investment and the emergence of a new entrepreneurship are the key answers to the problems of developing countries. Thus, the traditional role of the regional developing banks and the World Bank needs to be strengthened if the problems of the developing countries ought to be properly addressed. But adequate and stable financial markets could contribute to these endeavors. In the long term attention would have, for instance, to be paid to an extension of the supervisory standards in OECD countries to banks and markets throughout the world. Some regional groupings with a network centered around a regional financial market, such as Singapore for the ASEAN countries, might prove advisable. At the very end, financial markets should serve the cause of development itself in ensuring a proper allocation of resources, notably through stock markets tailored to individual countries needs and offering, by their interconnection, sufficient liquidity to attract foreign investors, to disseminate stocks in the portfolio of institutional investors and, thus, to ensure a healthy development of their financial systems.
34. If there are three major currency blocs, with exchange rates within each of these blocs fixed (pegged to an anchor currency) as irrevocably as possible, a compensatory mechanism or some measure of support should be created within each bloc, to soften volatility of capital flows and other short-term disturbances. For instance, Europe might then encourage flows of capital to Africa while African countries strengthen their banking systems and create a framework aiming at attracting foreign investment and capital. Vis-a-vis Latin America, the debt strategy could be an instrument of the financial modernization itself, notably through debt-equity swaps.
35. Obviously, due to political risks involved, capital markets cannot meet all the capital requirements of non-OECD countries and there needs to be renewed emphasis and enlargement of the role of official capital flows, including those from multilateral institutions.
36. Nevertheless, private capital flows to non-OECD countries have a major role to play. To ensure their full efficiency, privatization, deregulation and liberalization should go hand in hand with added stability and vitality in capital markets.
Chairman: Valery Giscard d'Estaing (France)
Members of the InterAction Council
Maria de Lourdes Pintasilgo (Portugal)
Malcolm Fraser (Australia)
Manuel Ulloa (Peru)
Olusegun Obasanjo (Nigeria)
Coordinator of project
Paul Mentré (France), Inspecteur general des finances
Experts
Stephen Axilrod (United States), Vice-Chairman, Nikko Securities Co. International New York; formerly Federal Reserve Board
John Heimann (United States), Vice-Chairman, Merrill Lynch Capital Markets; former Comptroller of the Currency
Victor Gerashchenko (USSR), Chairman, Gosbank USSR
Michael E. Hewitt (United Kingdom), Director of Central Banking Studies, Bank of England
Moeen Qureishi (Pakistan), Senior Vice-President, Operations, The World Bank
I.G. Patel (India), former Director, London School of Economics
Robert Raymond (France), Directeur-General du Credit, Banque de France
Donald B. Riefler (United States), Financial Consultant; formerly Morgan Guaranty
Elcior Ferreira de Santana Filho (Brazil), Chief of Staff, International Directorate, Central Bank
Kumiharu Shigehara (Japan), Director of the Institute for Monetary and Economic Studies, Bank of Japan; former Director of the Policy Studies Branch, OECD
Imre Tarafas (Hungary), First Deputy President, Bank of Hungary
Josef Tosovsky (CSFR), Chairman, Czechoslovak State Bank
Norbert Walter (Germany), Chief Economist, Deutsche Bank AG
Secretariat
Dragoljub Najman, Executive Secretary, InterAction Council, Paris
Hans d'Orville, Coordinator, InterAction Council, New York
Jens Fischer, Chief of Staff, Office of former Chancellor Helmut Schmidt
Uwe Plachetka, Office of former Chancellor Helmut Schmidt
Documents specifically prepared for the High-level Expert Group:
- Stephen Axilrod "Domestic Policy Objectives, Globalization and International Cooperation";
- John Heimann "Turmoil in the Financial System";
- Milton Hudson (Morgan Guaranty) "The Credit Crunch in the US";
- Paul Mentré "The ESCB and the New Financial Environment".
The High level Group also took note of the conclusions reached by the Group of Thirty ("Interdependence of Capital Markets and Policy Implications", September 1990), the Basle Committee on Bank Supervision ("Interbank Netting Schemes", November 1990), the OECD Study Group ("Systemic Risks in Securities Markets", February 1991) and the Committee for the Monetary Union of Europe ("The EMU: The Political Dimension", March 1991, including contributions by Toyoo Gyooten and Fred Bergsten on the relations between the Ecu, the yen and the dollar).
In the increasingly globalized financial - bond, share, currency, daily money etc. - markets, central banks are one of the last vestiges of national sovereignty. The globalization has accelerated and intensified through the creation of Euro-currencies and the development of off-shore financial centers which are beyond the jurisdictional reach and control of any of the national central banks and regulatory or supervisory authorities. The ability to manage international financial activities has been further hampered by the gradual erosion of the authority of the International Monetary Fund and a number of intranational shortcomings (e.g. the emergence of junk bonds, persistent national budget deficits, undercapitalization of commercial banks and the trends towards universal banking).
To cope with this situation, several approaches are conceivable:
Reinforcement of the independence of national central banks and strengthening and unification of supervisory activities at the national level;
Strengthening of the cooperation among the most important central banks (US Federal Reserve System, Bank of Japan and the emerging system of central banks in Europe), especially with respect to the supervision of activities and behavior of private commercial banks and the feasibility of establishing an international institution with supervisory authority;
Ensuring that the objectives pursued by central banks are consistent with the new environment of globalized financial markets and that the central banks are operationally equipped to carry out their responsibilities;
International harmonization of rules to ensure compatibility with social, environmental and development policy objectives, notably in developing countries.
The High-level Expert Group willbe asked to examine the desirability and feasibility of these and any other suitable approaches capable of re-establishing a global monetary and financial system. The Group shall recommend possible courses of action that may be advocated by the lnteraction Council, which will consider these proposals at its ninth session to be held from 30 May to 2 June 1991.
