Christian Noyer: The G20 and the role of emerging markets in the new
financial architecture
Opening speech by Mr Christian Noyer, Governor of the Bank of France, of the Session "The
G20 and the role of emerging markets in the new financial architecture", at the Money and
banking conference 2009, Central Bank of Argentina, Buenos Aires, 31 August-1 September
2009.
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I am delighted to introduce this final session devoted to the lessons learned from the crisis
regarding the international financial architecture and the role of emerging markets in this new
configuration.
The strong and rapid transmission of the crisis from the United States to other industrialised
countries, and subsequently to emerging countries, has clearly highlighted the contrast
between:
- on the one hand, the heightened exposure of the international economic and financial
system to the risk of systemic crisis, due to the increased interdependence between
players of developed and emerging economies and financial systems.
- and, on the other hand, our crisis prevention and management instruments, which
have proved to be largely inappropriate or insufficient.
Therefore, in order to prevent a similar crisis from occurring in the future, these instruments
must be strengthened. This entails a reform of the international financial architecture. The
mechanisms and content of international cooperation must be reviewed with the aim of
devising crisis prevention and management tools that better take account of the greater
interdependencies between the economic and financial systems of advanced and emerging
countries.
Against this backdrop, the strong political impetus given by the Heads of State and
Government of the G20, at its summit in London on 2 April, is most welcome. Indeed, it is fair
that the road map for reforming the international financial architecture was set out by a group
that ensures equal representation between industrialised and emerging countries. Work on
implementing this road map is now underway and I would like to comment on the progress
being made in three areas that I believe essential for achieving the defined goal:
- strengthening financial regulation in a multilateral framework,
- developing multilateral surveillance,
- and enhancing the legitimacy and resources of the institutions that are at the heart of
the international financial architecture.
1. Strengthening financial regulation in a multilateral framework
Before discussing the work being carried out in the area of regulation, I would like to highlight
some recent welcome developments in terms of the governance of international standard
setters.
Indeed, following the decision taken at the London summit to broaden the membership of the
Financial Stability Forum (FSF) - re-established as the Financial Stability Board (FSB) - to
include all G20 members, Spain and the European Commission, and to enhance its mandate
to promote financial stability notably by developing its collaboration with international
standard setters, membership of the latter was also recently expanded to increase the
representation of emerging countries.
The Technical Committee of the International Organisation of Securities Commissions
(IOSCO), charged with regulating the securities markets, broadened its membership to
include Brazil, China and India, while the BIS Committee on Payment and Settlement
Systems and the Basel Committee on Banking Supervision (BCBS) extended their
memberships to encompass 9 and 14 new countries respectively, the majority of which are
emerging economies.
Nevertheless, there is a need now to ensure that a good balance is struck between the
legitimate enlargement of these bodies to reflect our economic reality and the effective and
efficient mechanisms those organisations have shown so far. For example, the Basel
Committee must now find ways of adapting in order to function as a 27-member body,
compared with a 13-member body beforehand.
I would now like to turn to the work in progress in the areas of prudential regulation,
accounting standards and the scope of regulation.
As far as prudential regulation is concerned, the primary imperative is to improve the quality
of capital and to harmonise its definition. And this move should go hand in hand with the
quick and full geographical extension of Basel II because this framework is designed
precisely to ensure that requirements are proportionate to risks and indeed it would certainly
have helped if it had been implemented as initially planned before 2008. Beyond that, should
we add a simple measure to our arsenal that enables us to assess leverage with a view to
helping anticipate the formation of asset price bubbles? I am rather doubtful myself, for
several reasons. First, in the absence of single accounting standards, a comparison between
banks belonging to different accounting universes will mean absolutely nothing. Second, that
sort of ratio did exist in the United States and proved of no help, precisely in the country
where the crisis emerged. Finally, in the present circumstances, it could add to the
reluctance of banks to be active lenders in the interbank money market, therefore reducing
market liquidity and still increasing the over-reliance of the banking sector on the central
bank counterparty.
That said, it is essential to enhance the counter-cyclical nature of capital requirements. For
instance, implementing a forward-looking provisioning system and an additional capital
requirement at the cycle peak would be effective measures to make capital requirements
more contra-cyclical. In this regard and especially in the light of the profits announced by the
major banking groups and the large payouts to traders, CEOs or shareholders in the form of
dividends, I would like to stress that these profits should primarily be used to bolster capital
ratios and allow banks to focus on their core task of financing the economy.
All in all, I praise international standards in the field of prudential rules. The ones already
developed over many years and which the crisis is now leading us to adapt, or the new ones
under scrutiny, are only meaningful and will only produce their desired effects if they are
applied by all countries and, needless to say, first of all by those that negotiated them. From
that viewpoint, the adoption of the Basel II framework by the United States looks to be one of
the most important and urgent issues.
It is also very important to improve and harmonise accounting standards. The views of G20
countries sometimes differ as to the role of accounting. For instance, one contentious issue
is marking-to-market and the extent to which fair value accounting should be applied. It is
vital that the accounting choices of standard setters better take on board the financial stability
dimension, since they have an impact on the latter.
Lastly, the crisis has also highlighted the limitations of self-regulation; it is also essential that
the regulation of all systemically important institutions and markets be proportional to their
potential impact on financial stability. However, in order to implement such an approach,
agreement would have to be reached at the international level on a standard definition of the
systemic nature of an entity, which clearly does not depend on its size alone. Moreover, the
consistency and the appropriate balance of such potential specific rules with the general
rules must also be ensured. For instance, for banks, it is important to allow for the fact that
the size of an institution is already taken into account in the prudential ratios, since capital
requirements are proportionate to exposures. It is also important to bear in mind that the
diversification of business lines, which goes hand in hand with a certain size of institution,
may be a factor of resilience that should not be discouraged. This is an important and
delicate task that has been entrusted to the FSB.
2. Developing multilateral surveillance
I will now turn to collective surveillance. Let me start with the following simple observation:
the crisis did not emerge from where we were expecting. Our warning systems, both at the
national and regional levels, let us down. Above all, we did not have an overall,
across-theboard view of the vulnerabilities. We omitted to take into account the interactions between
global economic imbalances, international financial stability and national regulation and
supervision.
The crisis took us by surprise because it broke out at the heart of the system, i.e. in the US
financial sector. Unlike other recent financial crises and in particular the Asian crisis at the
end of the 1990s, contagion spread from the industrialised countries to the rest of the world.
Surveillance instruments, in particular those of the IMF, were chiefly designed to detect a
balance of payments crisis, whereas this crisis first affected the financial systems. We were
prepared for a foreign exchange crisis, i.e. a sovereign solvency or liquidity crisis, but we
were hit by a liquidity and solvency crisis in advanced countries' financial institutions.
Therefore, one lesson from the crisis is that surveillance must be strengthened across the
board, including macroeconomic, financial and regulatory areas. It must be both macro- and
microeconomic, incorporating systemic risk in particular.
In Europe, this issue is going to be addressed by a dedicated committee now named the
European Systemic Risk Committee that will operate in close collaboration with the
European System of Central Banks.
At the global level, the IMF and the FSB have been invited to step up their cooperation to
develop early warning exercises. However, the surveillance tools that international
institutions have at their disposal or could develop cannot claim to provide exhaustive
analysis. Drawing from their own specific expertise, it is therefore important for these
institutions to compare their analyses with each other and with other multilateral institutions
and national authorities in order to correctly identify all the sources of vulnerability and
significant risks of contagion.
This work on multilateral surveillance should also act as a safeguard against temptations,
which would be extremely detrimental: just when supervision needs to become more
international to deal with interdependent risks, we must avoid national myopia through
domestic regulation. This is clearly the case in the area of liquidity. What could also be
helpful in this respect is the enhancement of the surveillance of financial systems of all
countries in the framework of the Financial System Assessment Program (FSAP), as well as
the publication of their conclusions.
3. The last area of reform that strikes me as particularly important is enhancing
the legitimacy and resources of the financial institutions at the heart of the
international financial architecture
For international cooperation to function, institutions must be efficient and accepted by all
economic players. This means that they must have clear mandates, appropriate resources
and governance that correctly reflects today's multipolar and interdependent economic and
financial world.
In this area, the G20 also agreed on robust measures aiming in particular to adapt the
resources and functioning of the Bretton Woods institutions. For instance, while we have
observed an increasing number of bilateral initiatives, such as swaps offered by major
currency issuers, such as the Fed and Eurosystem, as well as, in a very different context, by
China, these mechanisms cannot alone constitute a coherent insurance system. This is why
the G20 decided to triple IMF resources to USD 750 billion, which is unprecedented. The
intervention tools were also reformed. A multilateral instrument for the prevention and early
management of crises was also created, the Flexible Credit Line (FCL); Mexico, Poland and
Argentina have already signed up and this has without doubt reduced the risk of contagion.
In addition, the Poverty Reduction and Growth Fund was established for the poorest
countries. This clearly reflects the IMF's commitment to reforming its assistance and
solidarity framework to help the most vulnerable countries. Similarly, the adequacy of the
resources of multilateral development banks was reviewed and, for example, the capital of
the Asian Development Bank was tripled.
In order to enhance the legitimacy and efficiency of key players in the international financial
architecture, the bolstering of resources must go hand in hand with a reform of their
governance. As a European, I am perhaps not the best person to give my views on the
governance of financial institutions, and of the IMF in particular because, for emerging
countries to be given a fair representation, it is most often the representation of European
countries that is called into question. You may therefore be tempted to interpret my
suggestions negatively. I would, however, first like to say that the representation of European
countries should not be contested: Europe is a diverse continent that encompasses small,
new, and even emerging countries alongside large and established developed nations.
Overall, it is somewhat under-represented in a community that is still made up of sovereign
states. And, above all, it seems to me that this is the wrong question or solution given our
current challenges: while the issue at stake here is improving dialogue with a view to
achieving concerted and operationally-applicable solutions, I do not believe that anyone
really asserts that the optimal way to enhance the future of our financial cooperation is to
alter the composition of the 24- or 25-strong IMF Executive Board by 3 or 4 members.
Nevertheless, I consider that a number of principles should guide this desired reform:
governance today should be adapted to a multipolar financial world. While all members
should be represented in proportion to their involvement and responsibilities, more than the
complex calculations of quotas and voting rules, we should fundamentally focus on the
functioning and mandate of the IMF. In this respect, senior officials should be appointed
strictly on the basis of their expertise and the IMF's mandate should be expanded. Focusing
on exchange rate developments alone is no longer sufficient, and if the IMF is to be able to
contribute to ensuring international financial stability, it must pay greater attention to capital
account developments. Furthermore, this contribution cannot simply be a matter of
complying with a rigid and uniform body of rules. It must take account, in a balanced manner,
not only of each country's level of development but also the systemic risk that it constitutes
within the global financial system.
By the same token, for member countries, this requires effective participation in multilateral
bodies aiming to foster the development of the international financial system, either through
capital account liberalisation or provision of liquidity where necessary, as the crisis has
clearly shown. Neither can we escape from the fact that the international status of certain
countries' currencies affords them a specific role or may affect them adversely.
In all of these matters, beyond the stereotypical vision of the different interests of developed
and emerging countries, I wish to recall that in fact we have converging interests: since we
are closely linked in terms of finance and trade, it is in our collective interest to participate in
the surveillance of financial systems within an enhanced multilateral framework.
To conclude, I would like to reiterate that the new financial architecture that we are in the
process of defining should not be hidebound but gradually adapted to address the major
developments in the international economic and monetary system. In this regard, the
possible emergence of a "multicurrency" international monetary system deserves particular
attention. Naturally, the US dollar remains the world's foremost reserve currency. Similarly,
the euro plays a major role. However, the increasing prominence of other currencies,
provided of course that they become fully convertible and tradable without any restriction,
suggests that a new situation may materialise in which a growing number of currencies could
enjoy international currency status. The possibility of using widely a supranational currency,
such as the SDR, has also been proposed and is firmly supported by several emerging
countries (although the SDR lacks in fact most of the properties of a true currency). If such a
"multi-currency" world did emerge, bearing in mind that international currency status cannot
be dictated but is the result of market forces, we would then have to adapt the international
financial architecture accordingly.