Jean-Pierre Roth: The role of the International Monetary Fund in promoting
financial stability - a Swiss perspective
Speech by Mr Jean-Pierre Roth, Chairman of the Governing Board of the Swiss National Bank, at a
meeting with directors of the most important Swiss firms in Argentina, Buenos Aires, 16 November
2004.
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1. Introduction
I am delighted to be here in Buenos Aires to address such a distinguished audience, and I thank
Ambassador von Muralt for organizing this event. For the next 20 minutes or so I would like to speak
about the International Monetary Fund's role in promoting international financial stability, and this from
a Swiss perspective.
I know that talking about IMF policy can be difficult here in Argentina. However, the Argentine case
should not hamper our discussions. It should invite us to reflect on what the Fund has achieved so far
in promoting international financial stability and what its present challenges are.
Promoting and safeguarding international financial stability was part of the mandate of the IMF in
1944, when the institution was established. It is still, in my mind, the core mandate of the IMF today.
There should be no doubt that a strong and resilient international financial system is crucial for global
growth and prosperity. This is even more so the case after the structural changes of the last decade, in
particular the worldwide information technology revolution that led to a strong increase in the size and
sophistication of international capital markets. In a globalized world, it is even more imperative for the
Fund to focus on promoting stability as a global public commodity. We have enough experience to
know how costly it can be if things go wrong.
Saying that Switzerland treasures a stable international environment is in many respects an
understatement. Given the openness of our economy and the fact that we host an important financial
centre, international financial stability for us has all the connotations of a vital national interest. To put
things into the right perspective, allow me to mention a few figures that show how interconnected our
economic well-being is with global developments. In 2003, Swiss exports of goods and services
amounted to 44 percent of GDP. The GDP contribution of our heavily internationally oriented financial
sector reached 10 percent. This figure rises to 14 percent if we also include the insurance sector.
Swiss banks occupy a leading international position, particularly in the area of wealth management.
The value of total assets managed in domestic banks as at the end of 2003 amounted to
US$ 2.7 trillion. According to various estimates, this corresponds to about one-third of the world's total
private wealth managed abroad. Last, but not least, the banking and the insurance sectors combined
employ approximately 185,000 people, the equivalent of 6 percent of total Swiss employment,
whereas the fiscal contribution of the banking sector alone amounts to about 13 percent of total tax
revenues.
Under the circumstances, it should come as no surprise that Switzerland fully supports the IMF in
attaching the highest priority to stability and crisis prevention. The main tool in this endeavour is clearly
surveillance. Surveillance remains the most important activity of the Fund as its first line of defense
against turmoil. However, this activity is hardly known to the wider public. Unlike an agreement on a
multi-billion rescue package, efforts to prevent a financial crisis never hit the headlines. Surveillance is
relatively unknown, probably also because it is a very complex animal, hard to explain, and with
dozens of connotations.
I have neither the time nor the desire to elaborate on all the elements of present-day Fund
surveillance. However I believe that some points are worth emphasizing. In the first part of my
presentation I shall begin with some remarks on transparency, both in the context of the Fund and with
regard to its role in promoting market discipline. I shall then elaborate a bit on surveillance in financial
markets. In the second part of my presentation, I shall take up issues linked to crisis resolution.
However, much effort goes into crisis prevention, crises cannot be completely ruled out in an open and
dynamic global economy; the IMF, therefore, needs to be and to remain an efficient "fire-fighter". I
shall elaborate on this "fire fighter" role of the Fund, on the limits of its action, and on what is
necessary to preserve efficiency and credibility in this context.
2. Surveillance and crisis prevention
Let first me turn to crisis prevention. I shall start with a general remark. Surveillance is the backbone of
crisis prevention. However, for surveillance to be effective, it must not only be correct, it must also be
implemented. Implementing stability-oriented policies and efficiently monitoring domestic markets and
institutions is the primary responsibility of the member country. The Fund can only help countries that
are willing to help themselves. As any Argentinean would say, it takes two to tango. The Fund's role is
limited to providing the best possible objective advice built upon the best possible analytical expertise.
This is not to say, of course, that Fund advice is always correct or appropriate. Though Fund staff is
highly qualified, it can make mistakes. Indeed, mistakes have been made most often due to a poor
understanding of the country-specific circumstances.
It is therefore crucial to maintain a high-quality dialogue between authorities and staff at all times. The
more the interaction between a country and the Fund is frank, constructive and based on mutual trust,
the bigger the chances are of a valuable and usable outcome. Though Switzerland joined the IMF in
1992 only, we can already record some very good experiences in this regard. Most appreciated, for
instance, were the discussions that took place between our experts at the Swiss National Bank and
Fund staff in the period of the formulation of the new monetary concept that was introduced in 2000.
The second point I want to raise is that if mistakes cannot be avoided, at least we should learn from
them. It is the sovereign prerogative of any state to deal with that issue within its own borders, and I
shall not elaborate on that. The Fund, on the other hand, is an international public institution and is
constantly confronted with the need to justify its actions. Though strictly speaking it remains
accountable only to its members' authorities, in reality, the legitimacy bar has been raised in recent
years. A wider section of society is more and more eager to engage the Fund in the various aspects of
its activity. I think this is a most welcome development: the Fund has become an institution much more
ready to listen than before. A milestone in this respect has been the institutionalization of the process
of evaluating Fund activity with the creation of an Independent Evaluation Office in 2001. This office is
now fully operational. It has already produced very valuable analyses, and I am sure that its
evaluations will greatly contribute to improving the future way of doing business of the Fund.
The prerequisite for a constructive enlarged debate is of course transparency. And transparency has
taken a "quantum leap" in the last decade, to use the words of the Managing Director Rodrigo de Rato.
Switzerland has always pushed to help the IMF in opening up and overcoming its questionable
reputation of being a secretive institution. We are happy with the results. The transformation from an
institution that used to publish virtually nothing to an institution that publishes virtually everything took
place in a very short period of time. We like to believe that our influence in this policy change was not
negligible, not least with our unilateral decision in 1994 to publish the Fund report of the first Swiss
Article IV consultation against all the then-existing rules. This was a precursory move that, although it
earned our executive director a few moments of severe and formal reproof from the Board, had the
merit to de-dramatize the publication debate by showing that the world would not come to an end if
more information was disseminated about national policies. Subsequent developments have proved
that much more could be done without jeopardizing the fine trade-off between openness and
maintaining the Fund's role as a confidential advisor to its members.
Transparency is important not only for legitimacy reasons. In the new information-technology world, it
has become a crucial element of stability. Transparency, together with more reliable information,
facilitates a smoother functioning of markets and helps them in assessing risks more accurately,
thereby strengthening market discipline. Stronger market discipline through transparency must be the
new rule. Globalisation forces us to change. This means, for instance, that the range of action has
considerably shrunk for those countries - rich or poor - that are active on financial markets. Structural
and balance sheet weaknesses, inappropriate exchange rate regimes as well as inconsistent
macroeconomic policies must be addressed openly, and without hesitation or delay, to avoid market
reaction. In some cases, a loss of confidence may fuel a snowballing effect that can easily lead to
fullblown capital account crises with high economic and social costs and serious risks of a contagion.
By changing the rules, globalization forced the international community to change the framework of
surveillance itself. This came under the general heading of reforming the architecture of the financial
system. It is an ongoing, very ambitious project with many ramifications. Switzerland strongly supports
it as well as all the related initiatives. I think we can safely say that a lot has already been achieved.
The structure of the international financial system is today more robust and in a better position to
withstand future challenges. Part of this project was to provide more information about countries and
their policies to help investors make the right judgments. A number of standards and codes were
defined to include data dissemination, fiscal transparency, and monetary and financial policy
transparency. Another aspect of the reform was strengthening Fund surveillance through its renewed
focus on financial markets. Much more attention is today paid to the structure of national financial
systems and the institutional preconditions that have to be in place for countries to fully benefit from
capital account liberalization. A key initiative in this regard is the Financial Sector Assessment
Program (FSAP), a health check-up of national financial sectors made in collaboration with the World
Bank. Switzerland volunteered to undergo such a check-up in 2002. Once more, it was a useful and
gratifying experience to interact with outside experts. And the reason I am saying this has nothing to
do with the fact that the Swiss financial center came out of this surveillance exercise with very high
marks.
3. Financial crisis resolution
Let me now turn to the second part of my presentation, the Fund's role in crisis resolution. Here I have
no direct Swiss experience to report on since my country, fortunately, never had to resort to financial
support from the Fund. I will therefore speak from the perspective of a medium-size shareholder that
believes that financial crises are market failures with potential systemic risks and that the Fund can
and should play an important role in resolving them.
The nature, scale and spread of financial crises have changed dramatically since the Tequila turmoil in
Mexico in 1994. Financial integration and capital account liberalization brought about a huge increase
in financial flows. Emerging economies did benefit from this new reallocation of international savings
and some staggering economic results were obtained (annual GDP growth between 1986 and 1996
for countries in South-East Asia averaged close to 8 percent). However, the new financial setting also
made emerging countries particularly vulnerable to sudden changes in market sentiment. Losses in
investors' confidence could erupt much more quickly and spread across markets in a matter of days.
Unfortunately, the economic and social costs of the new crises also increased substantially.
I think we can safely say that the Fund, like anybody else, was caught by surprise by the virulence of
the turmoil that hit Asia in the 90s. When Thailand and even more so Korea were on the verge of
financial collapse the Fund looked very much like those generals always ready to fight the previous
war. Not even its financial means were adequate, and governors were rushed to decide a speedy
45 percent increase in quotas in January 1998 to supplement the rapidly depleting Fund resources. It
didn't take the Fund long, however, to react, to pick up the challenge and, all things considered, to
come out of that difficult situation relatively unscathed. No-one should claim that everything went
smoothly, though, or that no mistake has ever been made. From the side of the Fund, too, it was a
particularly bumpy trial and error process.
Quickly restoring market confidence became the name of the game. How? This is the difficult
question. I shall not elaborate on the design of the various programs over that period. A very
extensive, at times quite critical, economic literature on this matter, with pieces signed by the best
pens in the profession, is readily available for those of you interested in more details. What I shall
retain from that experience is that the key to the Fund's results were its willingness and ability to react
flexibly to the various circumstances, its readiness to recognize mistakes and change the course of
action when necessary, and all this while sitting on a ticking time bomb.
This flexibility bids well also for the future. The importance of adaptability in tackling future financial
turmoil can never be sufficiently stressed. In a rapidly changing world, any silver bullet can soon lose
its shine. No piece of advice is sure to preserve its value over time. What we must ensure, more than
defining a set of measures written in stone, is preserving the capacity of the institution to quickly
generate appropriate new responses to handle new situations.
Financial support is the second aspect of the Fund's role in crisis resolution. With the emergence of
the new capital account crises, the need for Fund resources has sharply increased. The access limits
to Fund resources that were conceived to tackle the more traditional "current account crises" became
obsolete overnight. The decision-making process tilted completely from rules toward discretion.
Multi-billion packages not only became common place; over the years, the burden of financing was
increasingly put on the IMF. In many respects the situation became unsatisfactory.
One can easily understand that setting strict limits to Fund financing may not be appropriate in capital
account crises, as it may restrict the institution's room for maneuver too severely. The Fund's business
is to take calculated risks, and in the new environment of integrated markets, there are cases where
heavy financing of a country's balance of payments difficulties is justified. In Korea, for instance, it was
a success. The 50billion dollar rescue package supported a rapid turnaround in confidence and
economic performance. This being said, however, one point should be very clear. The IMF is not, and
should not be, in a position to always fully offset the volume of private flows. For one thing, Fund
resources are limited. For another, the systematic relief of debtors' and private creditors'
responsibilities through Fund financing would create problems of moral hazard. An excessive bail-out
of negligent investors would also be perceived as unfair by those who are left behind to bear the cost
of the crisis.
The most important aspect in decisions on exceptional access to Fund resources does not concern
amounts. It is rather an issue of whether lending is justified altogether. To help to take this decision
- and also to increase the predictability of Fund action - a framework was developed. According to this
framework, the Fund should grant exceptional access if three basic conditions are fulfilled. First, there
must be a high probability that the debt will remain sustainable; second, the country must have good
prospects of regaining access to private capital markets; and third, the policy program of the member
country must provide a reasonably strong probability of success. This must include not only the
member's adjustment plans, but also its institutional and political capacity to deliver this adjustment.
This also means that the cooperation between authorities and the Fund must be good and capable of
generating constructive team-work.
It has been easier to define this framework than to implement it. To some extent, this is not surprising,
as one cannot avoid that a strong element of judgment will influence the assessment of the three
above-mentioned conditions. And when there is room for judgment, there is always room for political
interference. Moreover, if we add the fact that the alternative to large financing very often is the
prospect of a full-blown crisis, with unpredictable but certainly high - and possibly systemic costs - it is
not difficult to understand why the international community has often condoned sub-optimal decisions.
One way to improve the situation and to eliminate this decision bias towards excessive Fund financing
would be to find ways to involve more consistently the private sector in the resolution of crises and
thereby in burden sharing. Once again, this is easier said than done. Progress in this respect has
been disappointingly slow to emerge.
Should we conclude that it is too difficult for the IMF to say no? I would definitely not go that far. While
recognizing that capital crisis decisions may be too important to leave only to experts, bending the
rules too often can also have serious consequences. One consequence is that the credibility of the
institution will eventually suffer, and this will negatively affect its efficiency to the detriment of the
membership as a whole. The second is that by granting too many resources under too uncertain
conditions the financial soundness of the IMF will be jeopardized. The financial soundness of the Fund
may well constitute in itself the topic of another speech. Let me just tell you that, although the IMF
financial situation remains strong, recent developments in markets and in Fund lending have
increased the risks for the institution.
Shareholders of the Fund, through the Executive Board, have the responsibility that the Fund takes
sensible decisions. They have an equally important responsibility to safeguard the credibility and
soundness of the institution. This can best be done by ensuring that, to the extent possible, the game
is played according to the rules. To best pursue its mandates, the Fund must not only be competent
and financially sound, it must also be able to preserve its own independent judgment. With this caveat,
I would have no problem sharing the very widespread belief that if the Fund did not exist, we would
have to invent it.