Mr. Macfarlane speaks to banking supervisors on the challenges for the world's economic policymakers  (Central Bank Articles and Speeches, 21 Oct 98)
Central bank: rba | Type: speech | Date: 1998-10-21

Mr.

Macfarlane speaks to banking supervisors on the challenges for the world's economic policymakers Talk by the Governor of the Reserve Bank of Australia Mr. I.J.

Macfarlane, on the occasion of the 10th International Conference of Banking Supervi held in Sydney on 21/10/98.I would like to start by adding my voice to those who have already welcomed to this Conference and to the city of Sydney.

It goes without saying that there could more propitious time for the international leaders in the field of bank supervision to When we first started planning this Conference a couple of years ago, we did not know it would attract a lot of interest or would be greeted with a yawn.

We now know it is and we in the Reserve Bank, and our colleagues at the Australian Prudential Regu Authority, with whom we are jointly hosting the Conference, are sure that you will be very interesting couple of days.It is hard to pick up a newspaper these days without seeing the word 'c prominently displayed in a headline somewhere.

First, we had the Asian crisis, then it being an emerging markets crisis, and now we hear so much talk of a world financial cr interesting that, so far, the focus is on the word 'financial' and not on the more g 'economic'.

It is also interesting that these troubling financial events are no longer emerging market economies.

One consequence of these two trends is that the contrast b economic health and concerns about the financial sector is as marked in the world powerful economy - the United States - as elsewhere.

There is a big challenge, therefo bank supervisors of the world, and it seems to be equally large whether they are dealin least, or the most, sophisticated of the world's banking systems.I see two main challenges for the world's economic policymakers - one for short term and one for the medium term.In the short run, the challenge is to get through the current crisis - to m more dominoes fall through contagion.

The region at risk is clearly Latin America, eve many of these countries are now running infinitely better macroeconomic policies tha have been imagined a decade ago.

It would be tragic for them to be blown off course spread of financial turbulence that they had no significant part in the making of.

It more countries to question the wisdom of adopting sound macroeconomic policies an opening their economies.One helpful recent development is the acceptance that there should be behin scenes discussions between a potential borrower and the IMF.

If an IMF package does pr be necessary in the case of Brazil, for example, it will already have had its voice h will know exactly what the conditions are in advance.

It thus should be able to sign One and so avoid the situation that occurred in Asia where countries put themselves in of the IMF without knowing what the conditions would be.

Thus, the handling of the Br situation seems to be benefiting from one of the lessons of the Asian rescue packages.What can bank supervisors do to assist in the resolution of the present si Given that a major part of the problem is an increase in risk aversion by lenders and 'credit crunch', it seems to me that bank supervisors will inevitably have a very big i the outcome.

I would like to endorse the remarks I recently heard Bill McDonough mak bank supervisors will have to be extremely careful not to inadvertently encouragebecome even more risk averse than they currently are.

This will require great sensitiv part of supervisors, and I am sure you will all rise to the challenge.The second big challenge to all of us involved in international finance is a better system for the long run.

None of us should be happy about how events have u over the past five years, and none of us could deny the claim that the internationa system is prone to periods of extreme financial turbulence that leave lasting economic cAt first, this instability was attributed to deficiencies in the financial in some emerging market economies.Soon, however, more thoughtful people saw the source of the instability as the combination of two things - large movements of short-term capital taking place in that had small and not very well developed financial infrastructures.We now know that there is a third important factor at work as well - ba developed countries (often in conjunction with hedge funds) have been taking much bigge than their supervisors or their shareholders thought.How do we go about devising a better system or, in current parlance, designi new international financial architecture?

Obviously, this will be a very large task, an offer a few observations here this morning.First, we all recognise that access to the international capital market balance, bestowed enormous benefits on participating countries, particularly dev countries.

The world is a much better place when it is outward looking - historical epo large international transfers of capital were taking place were those where living around the world were rising fastest and where poverty declined most.

I, for one, saddened if a number of countries responded to the current turmoil in international m cutting themselves off from the international marketplace thereby forgoing the benefit use of foreign savings can bring.

It goes without saying that Australia is completely its policy of permitting the free movement of international capital and sees no cas change.On the other hand, it is simplistic to insist on the totally free movement in all countries and in all circumstances.

To do so would be to ignore the lesson f crises, to further risk the stability of the system and to invite a reaction which woul worse off.

We need to devise a system for maximising the benefits to be gained international capital while limiting the risks.

For example, I think Chile was probably and certainly within its rights, for a time to impose a tax on capital inflow which im severely on very short-term flows.

(Note, however, that Chile did not impose cont outflow.) Like Chile, the world economy has to reach a proper balance, and I think increasing recognition that it will involve a few trade-offs.Within developed countries, a number of institutions have been designe encourage investment and risk-taking - the joint stock company, the concept of limited bankruptcy laws and, of course, central banks as lenders of last resort.

These are all necessary parts of a developed financial system, and help provide the right balance encouraging enterprise while at the same time preventing individual financial distr turning into widespread financial panic.

All these things, by the way, have the by-pcreating an element of moral hazard.

Internationally, on the other hand, despite all globalisation, a borderless world and the integration of financial markets, there reluctance to go very far down the path of finding an international equivalent to the laws or the lender of last resort.

The main objections have traditionally been tha interfere with the free movement of capital and that it would create a moral hazard.That attitude now appears to be changing, and the recent discussions of sector burden sharing can be viewed as, in some sense, an international equivalent to bankruptcy arrangements.

In a company bankruptcy, failure to follow the right approach in a 'fire sale' of assets: in a national financial crisis, it results in a flight excessive fall in the exchange rate.

The third Working Party Report to the G22 on Inte Financial Crises addresses the problem where, in a crisis, all individual creditors lo own private interests and, in so doing, create a situation which is worse for them as a for the debtor country).

This is the problem known colloquially as 'everyone rushing fo at once'.

The Report makes a number of helpful suggestions, all of which revolve aro recognition that a tripartite agreement between creditors, debtors and probably the IMF the best way of resolving a crisis once it has begun.

The agreement would involve some standfast followed by a workout which would include rollovers of debt and rescheduling. a very promising approach, but as recently as last year in the Asian crisis was dismi grounds that it represented an interference with the free flow of capital (which it doeI should take this opportunity of saying how useful Australia has found t Meetings.

For a group that has only been in existence for a little over six months an met twice at ministerial level, it has achieved a lot.

The three Working Party Reports constructive effort to date in laying out some practical steps towards improving the i financial architecture.

I have already said how useful I thought the third Report was, also a lot of good sense in the first one which deals with transparency and disclosure second one which deals with an improved financial system supervision.Both these subjects - disclosure and supervision - have relevance for t topical subject of hedge funds.

In fact, the first Report recommends that 'a working formed as soon as possible to examine the modalities of compiling and publishing data international exposures of investment banks, hedge funds and other institutional investWe regard this cautiously worded recommendation as a big step forward, in for the first time to my knowledge, an official international body has proposed bring funds into the disclosure net.

But I wonder if it is still too cautious.

The big macr have become, to some extent, an extension of the proprietary trading arms of major bank is, in fact, a continuum running from commercial banks to investment banks to hedge fun it is hard to see why some of this should be within the supervisory net and some with alone would argue for some degree of supervision - for example, limits on gearing - ra just disclosure.

The case becomes stronger when we take into account the fact that the Fed has had to organise a support package for a large hedge fund on the grounds that i would have had systemic consequences (both nationally and internationally).

If, like ba are important enough to have systemic consequences, it is hard to see why they should supervision of some form or another.I want to conclude by sympathising with you as bank supervisors because of inherent difficulty of the task you face.

To some extent, the biggest challenge is countries furthest behind world best practice up to standard, and the Core Principlesuseful step in this direction.

But as recent events have reminded us, even in the count most developed systems of bank supervision, we still continue to be surprised by the c the best and the brightest to take risks the magnitude of which even they do not unders makes the task extremely hard for bank supervisors - you all have to run very hard just with developments in markets, and perhaps, the nature of risk itself.