Mr White discusses the Asian crisis and the Bank for International Settlements
A paper presented by Mr William R White, Economic Adviser, Head of the Monetary and
Economic Department, Bank for International Settlements, at the conference on "Asia and the
future of the world economic systems", organised by the Royal Institute of International
Affairs and held in London on 17-18 March 1999.
The Asian crisis, perhaps even more than the Mexican crisis which preceded it, has raised
some fundamental issues about the workings of the international financial system. In the
course of the Willard process1 and in many other fora, the behaviour of private sector agents
who are internationally active has been widely analysed with a view to devising prescriptions
and policies that might reduce the incidence of destabilising activity on their part. The role of
the public sector has also been an object of scrutiny, with the IMF and the World Bank
receiving particular attention given the size of the public resources they command and their
influence over the governments of emerging market economies. Before proceeding to the
specific subjects on which I have been asked to comment by the organisers of this conference,
it seems to me worth pointing out that the Bank for International Settlements has also been
caught up in these deliberations, although the implications for us may be less significant than
for others.
A. A new role for the BIS or an old one?
The most recent Communiqué issued by the Finance Ministers and Central Bank Governors of
the Group of Seven2 announced the establishment of a new Financial Stability Forum. The
Forum will bring together representatives from each of the G7 countries,3 the principal
international financial institutions and the various international committees whose work
focuses on financial stability. The objective would be to ensure a constant dialogue between
all those in the public sector concerned about international financial stability, with a view to
ensuring closer coordination of the work being undertaken and an enhanced (moral) authority
for any decisions taken as to best practices in this area. The BIS will be represented in the
Forum along with other international financial institutions, and many of the international
committees also represented on the Forum meet regularly at the BIS. In addition, the BIS
General Manager will serve (in his personal capacity) as the Chairman of the Forum and its
secretariat will be based in Basle.
In some ways, both the process of consultation and the substance of the work being proposed
are rather similar to what has been going on in Basle for many years.4 As to the former, what
is increasingly referred to as the "Basle process" involves groups of national officials coming
together to discuss international issues of common interest with a view to reaching decisions
about recommended forms of behaviour. The Basle Concordat5 and the Basle Accord6 are
probably the best known examples of the genre. Once a consensus has been reached in such
fora, national officials must return to their home grounds, where sovereignty still reigns, and
convince local lawmakers and commercial interests of the desirability of following the
international norms agreed upon. Central bankers and regulators have followed such processes
for years in Basle, and the new Forum will in a sense extend this process to include
governments themselves. As to the latter, the work undertaken in Basle under the auspices of
central bank Governors has a scope and substance which should ensure it makes a useful
contribution to the deliberations of the Forum.
A useful conceptual framework for describing this work is a four-dimensional matrix, whose
first two dimensions consist of a traditional flow-of-funds table with columns (the
institutional sectors involved in the international financial system) and rows (the various
markets). The third dimension is the infrastructure which supports the first two dimensions
(payment and settlement systems, legal infrastructure, etc.), while the fourth dimension
comprises the simultaneous clearing conditions in all the markets subject to sectoral budget
constraints. In this conceptual framework, failures or shortcomings with respect to any of the
first three dimensions will have implications for market clearing conditions which will in turn
feed back on the real economy. It was the recognition that financial instability has such
macroeconomic implications which led policymakers to coin the new phrase
"macroprudential policies" - namely, policies designed to strengthen each dimension of the
international financial system referred to above (institutions, markets and infrastructure) thus
helping to limit the damage should some shock hit any part of the system.
It is more a product of historical circumstance than design that the Basle community
comprises relevant committees of national experts7 in each of the three defined areas. Within
the first sectoral dimension is the Basle Committee on Banking Supervision (BCBS), whose
work is by now well known. More recently Basle has also become home to the secretariat of
the International Association of Insurance Supervisors (IAIS). An offer has also recently been
made by the Swiss Government, with support from the BIS, to relocate the secretariat of
IOSCO to Basle. But, in any event, that group (representing the international investment
dealing community) interacts regularly with the Basle Committee and the IAIS in the form of
the Joint Forum, the Secretariat of which is also located at the BIS. As for the second
dimension of the matrix (markets), the Euro-currency Standing Committee (ECSC) has had a
long record of deliberations, publications and data collection pertaining to the evolution of
international financial markets and possible systemic implications. The third dimension is
infrastructure, and in this domain the Committee on Payment and Settlement Systems (CPSS)
has been increasingly active in recent years.8 Finally, the way in which the market clearing
conditions bring together the dimensions referred to above has recently been reflected in the
renaming of the ECSC. Reflecting the new mandate given to it in February 1999 by the
Central Bank Governors of the Group of Ten countries, this committee is now to be called the
Committee on the Global Financial System (CGFS). This name is intended to emphasise a
new focus on how those dimensions of the international financial system ultimately come
together in a market framework, and how steps might be taken to make that framework more
stable.9
The active prospective involvement of the Basle community in the Financial Stability Forum
is only one aspect of its response to the Mexican and Asian crises. The Monetary and
Economic Department of the BIS, which traditionally provides analytical and statistical
support to the work of the various Basle-based committees, will also focus more intensively
on such issues. Moreover, with the establishment last year of the BIS Financial Stability
Institute, there is now another vehicle for the practical dissemination of the best practices
established both by the relevant BIS committees and other groups concerned with
international financial stability. These are admittedly small contributions by a relatively small
international financial institution, but they may go some way to helping avoid a repetition of
the dramatic events we have seen in international financial markets since mid-1997.
The subject matter assigned to me today seems to fall neatly into two categories. The first of
these (monitoring capital flows, currency boards and foreign exchange controls) has to do
with resolving the so-called "impossible trinity" problem. Since a country cannot
simultaneously have free capital flows, a fixed exchange rate and an independent domestic
monetary policy, what should be given up? The second topic (reform of capital adequacy
ratios, regulating the regulators) has inter alia to do with minimising the fallout when
macroeconomic problems do emerge. How can regulation make the system more stable in
principle and how can we assure that those principles are being applied in practice? The rest
of this paper deals with these two issues. It will come as no surprise if I also choose to
highlight the particular contributions which have already been made, or are in the process of
being made, by the Basle-based committees in response to both the Mexican and Asian crises.
B. Monitoring short-term capital flows and responding to them
A belief that has recently grown in strength is that increased transparency on the part of all
economic agents would sharply improve the functioning of markets and lead to greater
financial stability.10 It is hard to object to this at the level of principle, though it is
disconcerting that much of the impetus for this belief comes from a misapprehension. It has
been frequently asserted that the size of the inflows into the Asian countries later affected by
the crisis would have been much smaller had individual investors been made aware of the
aggregate exposure of these countries. It is hard to believe that the basic problem was a
shortage of information given that the international financial statistics collected semiannually
by the BIS and the OECD (based on banking statistics and trade credits) were widely
available. These data clearly indicated both growing debt levels and a very high proportion of
short-term debt in the case of many countries. Indeed, concerns based on these figures (albeit
sotto voce) were raised as far back as 1995 in the quarterly publications of the BIS as well as
in successive BIS Annual Reports.
Perhaps reflecting the availability of such information, some non-bank financial institutions11
and equity investors seemed to begin moving out of Asian markets much sooner than
internationally active banks, whose eventual response was both sharp and highly disruptive.
Informal enquiries about the banks' behaviour would appear to indicate that a shortage of
information about international exposures was not the basic problem. Indeed, while in some
cases credit officers failed to detect the risk, in other cases the senior management of banks
seems to have overridden the specific recommendations of their credit officers. While this
may still have been sound strategic practice, given the limited exposure of individual large
banks, the collective impact on the debtor countries was severe. This in itself would indicate
that some form of market failure took place, though not necessarily one based on a shortage of
information.
To say that a lack of information was not the heart of the problem is not to say that the
available data were ideal. Indeed, after the Mexican crisis, the (then) ECSC made considerable
efforts to improve the semiannual banking statistics collected by the BIS. Steps were taken to
expand the number of reporting countries, and the reporting and publication lags were reduced
from more than six to less than five months and still further reductions are planned. In
addition, steps were taken to reclassify the exposure of national banking systems on the basis
of "ultimate risk" to deal with the problem of loans booked by emerging countries in
international financial centres. In another development, the Inter-Agency Task Force on
Finance Statistics12 has agreed to build on and replace the existing set of BIS/OECD external
debt statistics with a new set13 of debt statistics which is jointly issued by the BIS, IMF,
OECD and World Bank. It brings together for the first time the best international comparative
data currently available on external debt. This data will be published quarterly from 15 March
14
onwards, on as timely a basis as possible.
The monitoring statistics referred to above are drawn in very large part from the on-balance
sheet positions of a limited number of (albeit important) creditor institutions. An obvious
shortcoming is that they do not pick up the off-balance sheet positions of any institutions, nor
the aggregate positions of non-regulated financial institutions.15 The former problem can be
rectified with time, under current legislation. However, the latter problem is thornier and is at
the heart of the debate about the role of hedge funds in the Asian crisis. Many Asian-Pacific
authorities (including representatives from Australia, Hong Kong and Malaysia) feel strongly
that hedge funds set out systematically to destabilise their currencies and their financial
markets.16 However, other evidence is less compelling in support of this hypothesis17 and,
even if accepted, would not necessarily lead to the conclusion that such funds should be
regulated. As the US authorities consistently point out, many other institutions also engage in
highly leveraged position taking, including the proprietary trading desks of both regulated and
unregulated institutions. The implication of this fact is that the authorities might have to
12
This Task Force, which is chaired by the IMF, comprises the BIS, the European Central Bank, Eurostat, the OECD,
the United Nations and the World Bank.
13
The data are not in the strict sense because all of them have been published elsewhere before. Moreover, as
new
indicated in the text, by far the largest part of the information is provided by the BIS international locational and
consolidated banking statistics. For a description of the exact relationship between the BIS locational and
consolidated banking statistics, see BIS (1998b), pp 32-43.
14
These data can be found at www.bis.org/publ/r db9901.htm or at www.oecd.org/dac/debt.
regulate this kind of activity at all types of institutions, in turn raising the issue of how to
prevent it from simply moving offshore.
What does seem to have been agreed in the international community is that it would be
desirable to have more information about the activities of highly leveraged investors who are
internationally active. Not only does this seem prima facie a good thing, but some authorities
also consider such information a fair counterpart to the provision of more information by
public sector authorities about their own off-balance sheet activities.18 Currently, three
avenues are being actively explored within the Basle community. The Basle Supervisors are
primarily concerned about the health of banks and wish to be assured that the loans made to
highly leveraged institutions are subject to the proper kind of credit analysis. A subgroup of
the BCBS (the Brockmeijer working group) has already published two documents, one
outlining deficiencies in past banking practices and the other suggesting guidelines for good
practice in the future.19 The CGFS has two initiatives under way. One is a reprise (under the
same chairman) of the 1994 Fisher Report20 which acted as a catalyst for enhancements to
disclosure practices by financial institutions in relation to market and credit risk exposures
arising from their trading activities, including those involving off-balance sheet instruments.
The primary objective of this exercise is to encourage further improvements in disclosure so
as to ensure that market participants have an adequate basis for an appreciation of the risks
they are running in dealing with, investing in or lending to, financial institutions. The second
CGFS initiative is to examine what kind of aggregate information about exposures would help
to improve the functioning of markets, taking as a starting-point the BIS international banking
statistics.
Having adequate knowledge about short-term capital flows is one thing. Establishing an
exchange regime to minimise their disruptive effects, while maintaining their longer-run
efficiency benefits, is quite another. As already stated, a country cannot have completely
liberalised capital flows (assuming a high degree of substitutability between domestic and
foreign assets), a fixed exchange rate regime and an independent monetary policy. The events
in Asia and more recently in Latin America have highlighted the need for trade-offs, but have
not provided guidance as to optimal solutions. Indeed, what is of particular interest is how
quickly opinions have reversed about the desirability of specific options. This in turn raises
the fundamental issue of how much any of us really understand.
Consider first the issue of capital controls. It was less than two years ago that the IMF was
vigorously pursuing the issue of revising Article VIII of the Fund's statutes to allow the Fund
to promote actively the liberalisation of the capital account in emerging market economies.21
Today, there is a much greater willingness to recognise that some capital controls may have a
18
One feature of the Asian crisis was that a number of governments supported their currencies extensively using
forwards and other forms of off-balance sheet intervention. This information was hidden from the public and,
when revealed, indicated that the true level of reserves was much less than thought. This contributed to the aura of
panic and the sudden desire on the part of creditors to withdraw. To provide an example of proper behaviour in
this regard, the G10 countries agreed to adhere to a template on foreign exchange exposure drawn up by a
subgroup of the ECSC. This template will serve as the basis for the statistics to be submitted to the SDDS database
operated by the IMF.
19
See BIS: BCBS (1999a) and (1999b).
20
See BIS: ECSC (1994).
21
It is worth reminding ourselves that the postwar Bretton Woods agreements were designed to discourage such
flows. Keynes and others were concerned that capital flows would cause problems which would lead countries to
retaliate in the form of trade protectionism. Since, in light of the experience of the 1930s, the fear of protectionism
was of primary concern, it was considered at that time to be an acceptable trade-off to give up the benefits of a
more open capital account.
useful role to play. References are frequently made to the Chilean experiment and their careful
use of controls over short-term capital inflows. Concerns about a possible prolongation of the
current crisis through a devaluation of the Chinese renmimbi are assuaged through reference
to the fact that China still has capital controls. Even the Malaysian experiment, as flawed and
potentially dangerous as it was,22 does not seem to have had the dire consequences predicted
by many at the time. A consensus also seems to be forming that, if controls are required to
deal with a crisis, they should be directed to incoming capital only, should favour longer-term
over shorter-term inflows, and should be accompanied by clear indications as to when they
might be removed. Note that the new consensus does not extend to questioning the
longerterm benefits of international capital flows.
When we turn to the issue of exchange rate regimes, a similarly rapid change of views seems
to have occurred. Prior to the Russian and Brazilian crises, a constant refrain was that
countries using a fixed exchange rate regime to stabilise inflationary expectations also needed
an "exit strategy". This last point was in recognition of the fact that real exchange rates tend to
rise during a disinflationary process, leading to a deteriorating current account which in turn
undermines the credibility of the fixed rate regime. Since the onset of the Brazilian crisis, we
have been hearing an increasing number of references to the desirability of imposing a
currency board in Brazil. Going even further down this path, the Argentinians, who already
have a currency board, have hinted at dollarising the economy if the Argentine peso comes
under further attack. Both suggestions have validity to the extent that dedication to an
"immutable" fix reinforces the credibility of the regime and leads to a stronger domestic
currency and lower interest rates.23
Yet, such policies are also the very antithesis of the exit policies of such recent fashion. The
question remains unanswered as to what will happen if the current account continues to
deteriorate under such a regime and the unemployment rate continues to rise because of
excessively high domestic labour costs? Since domestic legislatures are always sovereign,
fears would remain that the exchange regime policies could be reversed. At the very least, a
substantial credit risk premium might be expected to remain for borrowers from such
countries, at least until they set their "house" in order. This having been said, it remains within
the realm of the possible that a combination of initial sharp currency depreciation, imposition
of a still more credible exchange rate regime, sticky domestic wages (even as prices rise) and
fiscal probity might be sufficient to deal with the longer-term competitiveness problem.24
What is also surprising in light of the Asian experience is that the merits of voluntarily
adopting a regime of floating, the polar extreme to the immutable fix, has not received more
attention.25 This is particularly surprising given the (albeit questionable) hypothesis that most
22
The greatest danger arising from the unilateral Malaysian imposition of controls on outgoing capital was that it
would increase investors' fears that the same policies might be followed elsewhere. In practice, it took the Russian
default and effective declaration of non-convertibility to initiate a withdrawal of international investors from
emerging markets more generally.
23
The gains could be particularly great for Brazil since the government's internal debt is large and very short-term.
Thus, lower interest rates lower debt service and the deficit and this presumably would make the currency stronger
contributing to a virtuous circle of lower interest rates in turn. The stronger currency would pay a further dividend
in that a significant proportion of the government's internal debt service is indexed to the US dollar. This highly
interactive and non-linear system could also operate in reverse were confidence not to return.
24
Szapáry (1998) makes similar observations with respect to eastern Europe.
25
In the Financial Times of 22 February 1999, reporting on the G7 meeting of Finance Ministers and Central Bank
Governors on the preceding weekend, 28 items were listed as being on the G7 timetable for reform of the
international financial system. The only reference to exchange rates was "Considering necessary elements for
Asian countries suffered enormously from pegging their currencies too tightly to the US
dollar. In the early 1990s, as the dollar weakened against the yen, pegged Asian currencies
became over-competitive. This led to massive capital inflows (especially from Japan),
domestic overheating and an unprecedented increase in production capacity in many areas.
The fact that the peg against the dollar was considered inviolate also encouraged domestic
residents (including banks) to borrow abroad in foreign currencies at low interest rates. All of
these tendencies were to create major problems later, problems which might have been
avoided had the domestic currencies been allowed to appreciate in the face of capital inflows.
Later (from early 1995), dollar strength against the yen coincided with a period when the
prices of products extensively produced in Asia were already under pressure globally. The
combination proved unsustainable and the peg had to be given up on the downside in an
environment of full-blown crisis with attendant (and domestically painful) requirements for
both fiscal and monetary tightening.26
There is, of course, no single right answer to the choice of an exchange rate regime either for
emerging or industrial economies.27 The right answer for a single country depends on that
country's particular circumstances. However, clarifying the criteria for making choices would
now seem a particularly ripe area for fruitful analysis in the case of emerging market
economies. Clearly, some important mistakes have recently been made in this area. And the
wide variety of recommendations being made to different countries by academics and others
argues for an assessment of the criteria on which those recommendations are being made.
C. Improving international banking regulation and supervision
Regulation and supervision are not the same. The former has to do with setting out rules,
while the latter has to do with ensuring that the behaviour of financial institutions is overseen
and that the rules are followed. We must distinguish as well between principles and practices
in both areas. For example, it has been relatively easy28 to lay out certain Core Principles of
Banking Supervision, but the next stage of ensuring their global implementation will be much
more difficult and time-consuming. In light of some of the banking problems which emerged
in Mexico and more recently in Asia, let us consider some recent advances in the area of
international banking regulation and supervision.
Perhaps the best-known of all the international banking regulations are the Basle Capital
Adequacy Ratios. These ratios are now being re-examined by the BCBS with a view to having
a consultative document in the public domain in April 1999. While developments (such as
securitisation and advances in credit risk modelling practices) in industrial countries gave the
main impetus for this review, the re-examination was also motivated by the Mexican and
Asian developments. In particular, it has been pointed out by some analysts that the
preferential treatment of bank loans made to counterparties in countries which are members of
the OECD29 may have contributed to both Mexico and Korea attracting more short-term
capital than was healthy. Further, it has been suggested that the low capital requirements
imposed on short-term interbank loans also shifted lending into such categories, increasing the
likelihood of a sudden and dangerous reversal.
Without wishing to deny these suggestions, it is important to note that there are alternative
(perhaps even complementary) explanations of the behaviour of internationally active banks
in the Asian crisis. An important consideration, affecting Japanese and continental European
banks in particular, appears to have been the search for return abroad in light of heightened
competition and shrinking margins at home.30 While acceptance of this explanation might also
have implications for a revision of the Capital Accord, the implications would be of a
decidedly different nature.31
A second factor which may have influenced bank behaviour was the existence of safety net
provisions provided by public sector entities, both domestic and international. For example,
consider the case of Korea. Once it became clear the domestic authorities would not let
Korean banks fail, interbank loans funded from abroad bore Korea's sovereign credit status.
Moreover, given that the loans were short-term and denominated in dollars or yen, there was
no explicit won currency risk. Finally, in light of the Mexican, Thai and other international
rescue packages, there was a perception that there was no liquidity risk either. In such
circumstances, it was perhaps not surprising that internationally active banks were willing to
lend as much as they did at ever narrowing risk spreads. This interpretation of events has
public policy implications with respect to safety nets, as much as they do for the specification
of capital adequacy ratios.
Developments in international banking and capital markets in the years spanning the Mexican
and Asian financial crises contributed to a desire to revisit the credit risk baskets in the Capital
Accord, and indeed the whole approach to credit risk which underlies that Accord. The
biggest losses in banking traditionally arise from credit risk. The Basle Supervisors will, as
noted, be issuing a consultative document with a view to having a revised Capital Accord as
soon as possible. They will also soon be issuing a paper which investigates the potential use of
in-house credit models to replace or augment more traditional regulatory measures of capital
requirements. While the problems inherent in this approach are even more daunting than in
the use of such models to evaluate exposure to market risk, technology is advancing so rapidly
that it merits keeping an open mind.
Applying capital ratios in practice is also not as simple as one might like, in large part because
there continues to be much uncertainty about the accounting definitions which underlie these
calculations. This certainly applies in many emerging markets, and this fuzziness perhaps
explains why there seems to be no clear relationship between actual movements in capital
ratios and subsequent crises.32 Yet it must be said that there remain problems in certain
industrial countries as well, with Japan being a particularly important example even if
progress has been made recently. There continue to be important international differences in
the provisioning for future losses and the definition of non-performing loans. Moreover, what
counts as capital has also been changing as financial institutions have creatively issued new
liabilities which may or may not be a charge on future earnings. Both these issues have been
actively addressed33 by the Basle Committee, though more work will be necessary to attain
truly harmonised global standards.
Considering now the principles of banking the preparation of the Core Principles
supervision,
of Banking Supervision was an enormous step forward in at least four ways. The Principles
were comprehensive; they addressed all banks and not just those which are internationally
active; they were drawn up in association with representatives of emerging markets; and they
were designed to provide a checklist of good practice, not only by national supervisors but
also other interested parties in both the public and private sectors.34 Moreover, the
dissemination of these Core Principles has already had an influence extending far beyond the
Principles themselves, in that the process is serving as a model for the creation of similar sets
of core principles in a wide range of other areas. The IAIS (insurance) has already laid out a
set of core principles as has IOSCO (investment dealers), and the CPSS (payment and
settlement systems) is in the process of doing the same. Finally, a perusal of the various
recommendations of the working groups associated with the Willard process indicates that
core principles and international standards of best behaviour have become the flavour of the
month.35 Whether all these principles can be effectively transformed into action in all of these
areas having a bearing on financial stability remains to be seen.
Turning principles of good behaviour into good practices in the financial area will certainly
not be an easy task. Principles provide guidelines of behaviour, but what is also required is an
incentive system to ensure that actions follow words. At the present time, four complementary
sets of processes in the supervisory area look promising: a code of transparency for national
supervisors; peer pressure; tightened residency requirements; and market discipline. The first
three of these provide incentives for national supervisors to enforce the Core Principles. The
fourth provides incentives for owners and managers of banks to act in accordance with these
Principles. While the specifics of the processes pertain to implementation of best practice in
the area of banking supervision, similar incentives might be applicable in other areas as well.
The first process, directed, inter alia, to ensuring implementation of the Core Principles of
Banking Supervision, has been the preparation of another code - namely, a Code of Good
Practices on Transparency in Monetary and Financial Policies. This Code, which is being put
together by the IMF in association with the BIS and relevant international committees of
regulators, deals in part with the need for transparency in the formulation and conduct of all
policies (deemed Financial Policies) having implications for financial stability. If information
about how the supervisors are behaving is a necessary condition for ensuring that the banks
are behaving properly, this Code of Transparency seems a useful initiative. The Code of
Transparency is still in the process of being finalised, but in its current form it is based upon a
sensible if (to some) radical framework. Akin to what is increasingly being accepted in the
realm of monetary policy, the draft Code suggests there should be transparency with respect to
the supervisors' mandate, the effectiveness of their powers, and their democratic
accountability to other bodies. In effect, this Code of Transparency tries to ensure that the
supervi