Barbro Wickman-Parak: The IMF's role - new thinking in the wake of the
financial crisis
Speech by Ms Barbro Wickman-Parak, Deputy Governor of the Sveriges Riksbank, at a
meeting at Global Challenge, Stockholm, 5 October 2012.
* * *
I would like to thank Ms Maria Wallin Fredholm and Ms Emelie Mannefred, from the Riksbank's Financial Stability
Department, for their assistance in the writing of this speech.
The 188 member countries of the International Monetary Fund (IMF) will gather in Tokyo for
the Fund's annual meeting next week. When I began working with IMF issues at the
Riksbank in 2007, my impression was that the IMF was suffering from an identity crisis. The
Fund's lending to countries in crisis appeared to have played out its role and major staff cuts
were underway. In short, the mood was rather subdued in the corridors of the IMF.
The financial crisis led to an abrupt change. The IMF was forced to quickly provide action
programmes and funding for crisis countries. Before the crisis, the IMF's lending amounted to
approximately USD 9 billion, the largest part of which went to Turkey. Today, the IMF's
lending amounts to around USD 112 billion, and the absolute largest part of this sum now
goes to countries in Europe. The media spotlight often falls on the Fund when it rides to the
rescue with crisis-management measures like this. But the every-day, important and tireless
surveillance work of the IMF seldom attracts any headlines.
The IMF continuously monitors all of its member countries, for example through its Article IV
consultations. These include in-depth analyses of the development of the economy, points
out risks and gives advice on areas such as fiscal policy, labour-market policy and monetary
policy. The knowledge of individual countries that the IMF has built up during years of regular
surveillance is a precondition for quickly being able to warn against and counteract risks and
to launch tailor-made action programmes when countries need financial support.
The IMF extended its financial surveillance a number of years ago, but there is still more to
be done. In the Nordic-Baltic IMF constituency,1 of which Sweden forms a part, we have
been a driving force on several important issues in this area. As a small, open economy with
a large financial sector, Sweden has every reason to support the IMF in its efforts to develop
its surveillance and analysis of financial risks at the global level. In my opinion, the IMF is the
organisation that is best suited to taking responsibility for the surveillance of the global
financial system.
The IMF's role as a global supervisor is one of the issues that will be discussed in Tokyo next
week. And this is also what I will discuss in my speech here today. A new policy area,
macroprudential policy, is emerging in the wake of the financial crisis. How this policy should
actually be carried out in practice is a complicated issue and I believe that the IMF can play
an important role in this context too.
The financial crisis revealed major problems
The era in which we were said to be living in the best of all possible worlds, popularly known
as "The Great Moderation", came to a disastrous end in 2007. Following a long period of
steady growth and stable low inflation, we had been lulled into the belief that this would never
change. We believed that the financial markets were excellent at converting savings to loans
and distributing risks so that they were taken by agents who both wanted and were able to
bear them. The risks that were mainly discussed were the imbalances in the global economy
in the form of countries with large current account surpluses and those with corresponding
deficits. Those who raised questions about the stability of the global financial system and the
risks relating to a rapid expansion of credit found it difficult to be heard in this situation.
The financial crisis brought into focus the inability of the international community to prevent
and manage crises in the global financial system. There were several problems. First, there
was a lack of knowledge about the links and the contagion risks in the financial system.
Second, regulation and crisis management were handled at the national level, despite the
rapid internationalisation of the financial markets. Third, surveillance focused on individual
institutions and if these were stable separately it was often concluded that the system as a
whole was stable. An important reason for these shortcomings was that there was an unclear
allocation of roles and no organisation with an explicit mandate to oversee, identify and
analyse risks in the global financial system.
The IMF was also criticised for its actions in the run-up to the financial crisis. The IMF's own
independent review body, the Independent Evaluation Office (IEO), has said that before the
crisis the IMF, like many others, was convinced that the risk of serious crises was practically
non-existent.2 This was apparent, for example, in the overconfidence in the health and
resilience of the major financial institutions. Risks that are generally related to construction
booms and financial innovations were toned down, as was the need for strong regulations to
prevent such risks. It was not until the spring of 2008 that the IMF's Global Financial Stability
Report warned against emerging vulnerabilities among the major financial institutions, but by
that time the crisis was already a fact.
In response to the crisis, more distinct frameworks for the oversight and supervision of the
financial system at the national and regional levels are now being developed. For example, in
2010 an agreement was reached between central banks, finance ministries and supervisory
authorities in the Nordic-Baltic region on cooperation in the fields of financial stability, crisis
management and crisis resolution. Intensive work is also underway at the European level to
put an effective supervisory structure in place. It is good and important that interlinked
regions arrive at their own solutions. But the financial systems are interlinked throughout the
world, as illustrated not least by the recent crisis. It is thus also important to address the
question of financial surveillance at the global level.
Legitimacy is about influence, but also about being effective
Several bodies work with financial stability at the global level in different ways. These include
the Financial Stability Board (FSB), the Basel Committee, the IMF and the G20. However,
none of these bodies has any formal, overall responsibility for global financial stability.
As I have said, it became clear in connection with the crisis that the global public institutions
were not strong enough and lacked momentum. The measures that were implemented, for
example swap lines and liquidity lines,3 were often initiated by central banks. Important
decisions, for example the decision to triple the IMF's resources, were also taken by the G20
acting alone, despite the fact that many more countries were affected by these decisions. But
the G20 took on a leading role in the crisis in the responsibility vacuum that prevailed. The
G20 consists of 19 major countries and a representative of the EU. Although Sweden has
always contributed financially to the IMF when this was needed, we were not allowed to
participate and influence the decisions this time; they filtered down to us from the G20
through the EU. The decisions were thus made by a small circle even though they affected
all of the IMF's then 186 member countries.
In order for decisions that concern the global economy to have an impact and be
implemented effectively, the countries affected by the decisions must feel that they can
participate and that they are able to influence the decisions. Legitimacy is thus a precondition
for effectiveness. The world cannot and should not be governed by only the largest and
strongest countries. The cooperation between the countries of the world that is required to
safeguard global financial stability should take place in strong and effective global institutions
with a broad membership.
This is why an institution like the IMF is important to small countries like Sweden. It is a
rulebased organisation that ensures the influence and equal treatment of the member countries.
It is against this background that I believe the IMF is the organisation that is best suited to
being responsible for overseeing, identifying and analysing risks in the global financial
system.
Greater focus on financial surveillance
My view is that the IMF has taken several steps in the right direction in its work with financial
surveillance during the years that I have followed its activities.
For example, the IMF has begun to integrate the analysis of financial stability with the
traditional macroeconomic analysis of the member countries. Now, for instance, the financial
economists of the IMF also take part in some of the annual country reviews (the Article IV
consultations). The Baltic countries, among others, are able to testify to how effective this is.
When Latvia experienced problems, the IMF was quickly able to put together a reform and
support package thanks to its sound knowledge of the country. This shows that it is important
to have knowledge of both the macroeconomic and financial developments, and seen in
retrospect the Latvian programme is a good example of this.
A further major step forward is that the Financial Sector Assessment Programmes (FSAPs),
which was previously voluntary, was made compulsory by a decision in 2010 for the 25 most
systemically-important countries - including of course the United States, the United Kingdom,
Japan and the Euro Area, but also Sweden. Oversight programmes of this type are highly
systematic and entail assessing the financial system on the basis of a set of robustness
criteria. The Governor of the Riksbank, Stefan Ingves, was by the way one of the architects of
the FSAP programme during his time at the IMF. In this context it can be mentioned that
before the crisis the United States did not think it needed an FSAP assessment, but such an
assessment was conducted in 2010.
Another example of an attempt to integrate the macroeconomic analysis and the financial
analysis is that since the autumn of 2011 the IMF has published a consolidated surveillance
report in which the main messages from all of the surveillance reports are summarised
together with recommendations on how to manage the risks.4
To further improve and strengthen the surveillance of the financial sector, the IMF recently
presented a more detailed strategy for how to conduct this surveillance in the future. The
aims of the strategy are for the IMF to improve its understanding of macro-financial relations,
to become better at identifying contagion risks across national borders and to increase its
cooperation with other organisations. This is no easy task and the work involved is far from
complete. This is something that the IMF will need to develop on an ongoing basis.
The Nordic-Baltic constituency has pushed for the IMF, alongside its surveillance of
individual countries, to also regularly conduct the regional surveillance of countries with
closely interlinked economies and financial systems. This is of course particularly relevant for
Sweden as our banks have such large commitments in the other Nordic countries and in the
Baltic countries. Although, as I mentioned above, our countries have increased their
cooperation in the field of financial stability, a recurring and comprehensive regional analysis
and examination of these issues would be of great value. Important steps have been taken in
this direction and we are looking forward to an even sharper regional focus in the Fund's
ongoing financial surveillance.
Capital flows require more analysis...
The question of whether capital flows should be deregulated or not was the subject of lively
discussion in the 1990s before the outbreak of the Asian crisis. After the crisis, some
countries believed that one of its causes was that certain countries were asked to liberalise
capital flows too early. The issue has therefore been very sensitive since then. Today,
however, most countries agree on the positive effects of free capital flows - that is that they
contribute to increased economic growth by enabling resources to be used more efficiently.
The issue of free capital flows has now appeared on the IMF's agenda once again. The
sudden stop in capital flows during the initial phases of the crisis and the subsequent rapid
increase in capital inflows into emerging-market economies have focused attention on the
problem of volatile capital flows. Massive inflows can lead to overheating and asset-price
bubbles and as there are no clear guidelines a number of emerging-market economies have
chosen to manage massive inflows by introducing a range of capital controls. The member
countries have therefore given the Fund the task of drawing up guidelines on how countries
should manage such capital flows. This work has been underway for the last 12 months and
a proposal for a comprehensive framework will be discussed by the IMF's Executive Board at
the end of October. According to the proposed guidelines, countries should in the first
instance review their fiscal and monetary policies in order to manage or counteract major
capital flows, and as a complement to this they should use various macroprudential-policy
tools. As a final resort they may introduce capital controls. The idea is that the IMF should
give advice on how these tools should be designed in order to be effective.
No organisation has played a clear role in the liberalisation of capital flows. This is a major
difference compared to the liberalisation of trade, where the World Trade Organisation
(WTO) played and still plays a prominent role. I think it is positive that the issue of capital
flows is once again on the IMF's agenda as it is an important issue that requires careful
analysis as volatile capital can cause serious problems.
...as clearly demonstrated by the crisis in our region
The need to analyse capital flows became clear in connection with the crisis in our region
too. If capital flows had been systematically analysed prior to the crisis, we would have seen
that capital flows to the Baltic countries were dominated by bank loans from Nordic parent
banks to their Baltic subsidiaries and not, for example, by more sustainable direct
investments. Perhaps this would have led the alarm bells to ring sooner and louder.
In our constituency we have carried out an empirical study of Iceland's and the Baltic
countries' experience of capital flows and capital controls before and during the crisis. The
aim of the report is to help the IMF to collect "best practices" but also to identify "bad
practices". According to the study, there were clear shortcomings in the policies conducted in
Iceland and the Baltic countries and in the supervision of the financial system throughout the
region. However, even if the countries had managed to conduct a much tighter fiscal policy,
they would still not have been able to do anything about the major capital inflows. Other tools
would have been needed for this, for instance various kinds of macroprudential-policy tools.
If such tools had been made available at an early stage, it may have been possible to slow
down the dramatic expansion of credit that proved to have such devastating consequences.
The IMF can play an important role in the work with macroprudential policy
Macroprudential policy has come increasingly to the fore in the effort to find ways of
preventing crises in the future. Macroprudential policy entails preventive work aimed at
analysing and counteracting risks in the financial system. This includes the development of
methods and forms of cooperation to discover and assess potential threats to stability in the
financial system. I believe that the surveillance- and analytical capacity of the IMF means
that the organisation can play an active role in this context by systematically collecting,
analysing and providing information on the lessons learned in different countries and regions.
I also believe that the IMF can support the exchange of information between authorities on
the development of methods and models in the field of systemic risks.
The range of possible tools and the division of responsibility between authorities and
countries are now being discussed intensively within the framework of macroprudential
policy. The tool that is attracting most attention at the moment consists of the countercyclical
capital buffers that form part of the new Basel regulations. This means that the banks will be
forced to hold more capital in periods when a credit boom risks triggering problems in the
financial system. When the risks subsequently subside, the capital requirements can be
eased. A tool that can be seen as a complement to the countercyclical buffers is variable risk
weights for different types of loan. Another proposal is to introduce a mortgage cap, for
example by limiting the size of the mortgage in relation to the market value of the property,
as we have done in Sweden since the autumn of 2010.
But which tools are the most effective in which situations? It is hard to say. The area is
relatively new and there is therefore a lack of experience and research in the field. This
means that we will have to test our way forward for several years. There are a lot of reports
that explain why macroprudential policy is needed and the tools it may entail. But not a lot
has been written about how it should actually be conducted in practice. This is of course
because the policy area is new and we still have a lot to learn. I believe that the IMF can
contribute here too by increasing our knowledge about which tools are most appropriate in
which situations and by issuing recommendations to countries on how they should actually
conduct macroprudential policy and implement various tools.
The IMF's Articles of Agreement should reflect a clearer surveillance mandate
One way to strengthen the IMF's surveillance is to ensure that the IMF's Articles of
Agreement cover what the Fund actually does. According to the articles that set the
frameworks for the IMF's work, the Fund's bilateral financial surveillance should ensure that
"Each member shall avoid manipulating exchange rates or the international monetary system
in order to prevent effective balance of payments adjustment or to gain an unfair competitive
advantage over other members." The articles were written in a different era and, as we have
seen, the IMF has been carrying out financial surveillance and analysis that is broader than
stipulated in the articles for a number of years now.
The modernisation and clarification of the IMF's articles is now needed to enable the Fund to
fully take on the task of supervising the global financial system, but this will require a long
process. However, a first step towards a more formal mandate was taken in July 2012 when
the IMF's Executive Board adopted the Integrated Surveillance Decision (ISD). This
agreement stipulates, for example, that the Fund's bilateral surveillance should be conducted
on the basis of a broader perspective than set out in the articles. The links between countries
and how their economic policies can affect the global economy should now be included in the
surveillance. The ISD thus underlines the multilateral dimension of the Fund's bilateral
surveillance.
It is positive that there is now a board decision on how the IMF should work. But the
longterm goal should still be to change the Articles of Agreement so that they reflect what the IMF
actually does. This is also an issue that we are pursuing in our constituency. Until financial
stability is covered by the articles, the members will have no obligation to discuss financial
stability issues with the IMF and even less of an obligation to explain their choices in cases
where they do not follow the Fund's recommendations.
Summary and concluding remarks
As I said earlier, it is important to clarify the IMF's role in the surveillance of the global
financial system. My view is that the IMF is an institution that is well equipped to perform an
independent and stringent analysis of the international financial system. An important aspect
to discuss in this context is how to make the best use of the Fund's risk analyses, advice and
recommendations.
First, it is important for the IMF to present clear and focused recommendations on global
financial stability that are not too general. The IMF's consolidated surveillance report has this
aim. The report is wide ranging and may easily become toothless, but it has the potential to
play a greater role in this context.
Second, the IMF's advice and recommendations will be ineffectual if the member countries
do not comply with them. The follow-up of these recommendations must therefore be
improved. The IMF has now said that the follow-up of advice and recommendations will
become a permanent feature of the annual country reviews. Sweden welcomes this initiative
and looks forward to its full implementation. The follow-up could also comprise
recommendations on macroprudential policy, which would also help to achieve the aim of
global financial stability.
Third, moral suasion is the only tool that the IMF can use to influence things. It is perhaps
also logical that this is the case. International organisations seldom have any other
mechanisms for exerting pressure. It is therefore important that the Fund is able to "speak
truth to power" even when speaking to large and powerful countries if it is to have any
chance at all to influence things.5
The notion that the global financial system was largely invulnerable was, as I have said,
firmly refuted by the outbreak of the financial crisis. The crisis clearly demonstrated that the
surveillance of the global financial system was inadequate and one of the reasons for this
was an unclear division of roles between various international bodies.
This led to the G20 assuming a leading role and many important and necessary decisions
were taken, but this was done on an ad hoc basis by a limited number of countries. This is a
problem; such decisions should be taken in a legitimate way for their impact to be effective.
All of this has led to the idea of setting up some form of predetermined structure for how to
act when a potential crisis is identified. The IMF staff recently attempted to concretise the
possible form of such a structure. This was presented as a global stabilisation mechanism in
which the IMF would act as kind of whistle-blower by using its surveillance activities to
identify events that risk triggering market unease, which in turn could lead to problems in the
financial system. In addition, the IMF could propose measures that aim to reduce the risk of
problems spreading from country to country, mediate contacts between countries and central
banks to arrange swap lines, involve regional financing arrangements and, of course, also
provide loans itself.6 However, proposals of this type find it difficult to "take off". This because
although the economy is globalised, policy remains largely national. Governments want to
retain their national sovereignty and central banks their independence.
So, to sum up, many good proposals are now under discussion and we need to continue to
clearly pursue our issues here. But building supranational structures is complicated, as the
on going development of institutions in the euro area reminds us. And there it is a question of
"only" 17 countries and governments that have to compromise and reach agreement. Of
course this process becomes even more difficult if a lot more countries are involved.
However, I believe that issues like this will continue to arise in the period ahead, unless
globalisation declines and the trend is towards more protectionism. Every new crisis will give
impetus to the debate, and perhaps resistance will eventually be overcome.