Ajith Nivard Cabraal: Ensuring stability and integrity of the world's
financial system over the next few years
Keynote address by Mr Ajith Nivard Cabraal, Governor of the Central Bank of Sri Lanka, 27th
International Symposium on Economic Crime, Jesus College, University of Cambridge,
Cambridge, 5 September 2009.
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Chairman, Professor Barry Rider, Distinguished Delegates,
Ladies and Gentlemen;
I am delighted to be here this afternoon at the historic University of Cambridge to deliver one
of the closing addresses at your 27th International Symposium on Economic Crime. Thank
you very much for your invitation, which I am honoured to accept. I am also happy that this
year, 2009, marks the 800th Anniversary of this great institution. Therefore, I would like to
take this opportunity to congratulate the University of Cambridge on reaching this amazing
milestone, and extend my best wishes for the centuries ahead.
Mr. Chairman, at your invitation, I would, today, discuss the ways and means of ensuring the
stability and integrity of the world's financial systems in the future.
As in the case of all serious and complex reviews, our starting point should necessarily be to
critically examine the basic and underlying reasons for this crisis. In that regard, there is now
reasonable global consensus that the origin of the turmoil could be traced to excessive risk
taking due to pure and simple greed; recklessness driven by intense, unadulterated greed;
leading to the creation of massive "bubbles" in many developed economies, that were not
supported by a robust, representative real asset base. No doubt, such risk taking had often
been fuelled by lax and short-sighted regulation. To make matters worse, many rating
agencies too, tacitly and indirectly, encouraged the excessive risk taking by assigning top
ratings to toxic financial instruments, thereby helping to blow up the bubble even bigger. The
bubble creating drivers had also been strongly supported by the global ability to transact
business at unbelievable speeds and in mind-boggling volumes. This capacity provided the
scope to move capital, wealth and resources across borders instantaneously, almost without
restrictions or regulatory oversight, at the press of a button. But whatever may have been the
drivers, the end result was that this greed and its ill-effects created and nurtured massive
"bubbles" in many developed economies; and the subsequent puncturing of these massive
bubbles has now revealed just how hollow and empty the financial structures that we relied
upon, had been.
However, even at that stage, the usually conservative multi-lateral "watchdogs", rating
agencies and experienced academics could not realize, let alone predict, that the world's
financial system was fast reaching breaking point! Perhaps, from everyone's point of view,
the going was too good to obstruct; the expansion was too exciting to discourage; the
resulting luxuries and wealth were too wonderful to hold back. No wonder therefore, that the
financial world continued to happily tootle along this unrealistic path, at break-neck speed.
Logically, the accident had to happen, and happen it did, and what an accident that was! A
crash landing that was sudden and unbelievably disastrous, not only to the developed world,
but to all economies of the globe!
Mr. Chairman, the events of the recent past clearly suggest to us that the world's financial
and economic communities have, albeit unintentionally, placed the entire civilized world's
systems and structures at intense risk, and perhaps even endangered the gains of civilization
built over several centuries. However, to the eternal credit of the world's political and
economic leaders, we could be relieved that we have been able to face that shock and
emerge out of it, bruised and battered no doubt, but fortunately, with our systems still
reasonably intact.
Nevertheless, the major down-turn suffered by the world economy as a result of these
shocks is yet to be fully overcome. The tight liquidity crunch that is suffocating our credit
markets; the stubborn toxic assets that won't go away; the suspicions with which banking
and financial institutions view each other, are yet continuing, although there are signs of
some abatement. The embarrassing summersaults that various governments had to perform
by unceremoniously ditching some of their most sacred and fundamental policies, have also
been better understood, by many communities.
Now, what is needed is to move forward decisively within this new paradigm. To do so
effectively, we have to essentially place some barriers to deal with unsustainable risk taking.
The freedom of the wild ass that supported unfettered and reckless economic actions to
create things out of nothing has to be dealt with. At the same time, we need to revisit some of
the fallacies that developed over the last decade or so, including those that indirectly said:
"Don't worry too much about a few bubbles"; "markets are always right", "innovation should
not be discouraged"; "state intervention is dangerous", etc. In a way, some of these positions
perhaps prompted a kind of an unconscious regulatory anarchy! The resulting subdued
regulatory reactions were of course exploited by the greedy market and the rest is history!
This time round therefore, the wisdom of such concepts and absolute reliance on them,
would need to be critically reviewed.
What then should we do? Maybe, we could start by making a "Wish-list", and then moving
towards making a "To-do list" to realize such wishes.
What could we wish for? First, perhaps we should wish for effective "immunization"
mechanisms to safeguard national financial systems from the contagion effects of globalized
viruses and cross border toxic elements. Second, we could wish for lesser volatility in
markets, greater credibility of regulatory and enforcement systems, and more responsible
and prudent lending standards. Third, let's wish for much higher attention being paid by all
stakeholders towards risk management, better governance practices and more relevant
disclosures; and Fourth, we could wish for top priority being given by regulatory authorities,
rating agencies and auditors towards risk and risk mitigation, with tough and decisive action
being taken in the event of any unhealthy developments.
These, in my view, would be the broad wishes, but each of these "wishes" would probably
have a series of sub-wishes to expand the scope of the main wishes, and consequently
many more could be added, depending on various national and international imperatives.
Mr. Chairman, as with all good wishes, it is easy to wish, but a lot more difficult to make the
wishes come true! Unfortunately, even the highly creative financial community will not be
able to perfect some "mantras" or conjure up some suitable derivatives to make these wishes
come true! Necessarily therefore, a lot of painstaking work will need to be done in order to
translate these and other wishes into reality.
Let me now dwell briefly on a seven point framework, which in my view, would be useful to
ensure stability and integrity of the world's financial system over the next few years.
First, as a global financial community, we should establish pragmatic standards in relation to
the creation and sustenance of globalized financial instruments, (particularly complex,
structured finance products). Any drug, before it is introduced into the market, has to undergo
a quality testing process because a substandard drug, if allowed to be marketed, could hurt
people badly. If so, why shouldn't financial products that could hurt the global system, not be
subjected to stringent pre-tests? Accordingly, we need to develop institutions to recognize
and approve norms for derivative frameworks and structures.
Second, we have to ensure greater transparency in reporting and valuation methods.
Notwithstanding the robust application of international accounting standards and other
globalized approaches, we still have too many subjective features in our valuation and
reporting systems, and these need to be addressed. It must also be noted that even after
years of debate, many of the advanced financial markets still use their national financial
reporting frameworks.
Third, we need to develop financial and business professionals who would regard their own
reputations and integrity ahead of that of their institutions. In order to ensure that this
happens, we may need to put in place, rewards schemes, laws and sanctions that support
and encourage such behaviour.
Fourth, we have to ensure that individual national regulatory authorities would take a greater
interest in safeguarding the quality of the balance sheets of the financial institutions within
their purview, without conveniently abdicating that responsibility to a mythical "global"
regulator.
Fifth, we have to build long-lasting and stable partnerships amongst central banks and
regulators. By doing so, we could put in place a mechanism to ensure the effective
supervision of conglomerates, particularly in the case of cross border institutions that are
today described as those that are "too big to fail".
Sixth, we need to create large pools of global or regional funds that could be conveniently
accessed by regulators in times of impending crisis for purposes of bail-out, so that crises
are not allowed to spin out of control. In this regard, it may perhaps be easier for central
banks in a particular region or a regional economic zone to provide leadership for the
creation of such funds for the mutual benefit of the participating countries.
Seventh, we have to develop mechanisms that ensure that there is greater transparency in
rating methodologies and rating decisions. Credit rating agencies should be compelled to
elaborate on their rating methodology and ensure strict compliance with Standards of
Conduct which should be carefully reviewed in the light of the present gaps. We should also
consider introducing serious penalties for inappropriate rating practices.
There may, of course be some overlap of policy actions when we implement these
strategies; but, by and large, if these are focused upon diligently, there is a reasonable
likelihood that it would be possible to realize some of our key wishes and with it, ensure the
stability and integrity of our financial systems.
Mr. Chairman, in a strange and a paradoxical sort of a way, it is somewhat "fortunate" that
the current financial crisis shocked (and indeed, almost ruined) the worlds financial system,
at the present stage of evolution of the worldwide financial landscape. If, on the other hand,
this crisis had not impacted us at this time of history and consequently we had happily
progressed at the same pace for a further 10 years or so, and then in 2017 or 2018 this
shock had hit us, can anyone imagine the magnitude of the disaster at that time? In fact, I am
quite sure that, if that eventuality had taken place, this crisis would have been too much for
the world's financial system to bear, and the resulting catastrophe would have crippled the
world's financial systems, as well as the world's political, security and social systems with
disastrous consequences. Perhaps some keen film maker might even consider doing a
simulation of such a scenario, and then making a gripping and horror filled movie, allowing
those of us with horror appetites to experience such a dreadful tragedy!
Mr. Chairman, while we are putting into effect various initiatives to improve our processes
and procedures to respond to the crises, we must also be conscious that we should not
throw the baby out with the soiled bath water. Yes, the bath water has been terribly muddied
and needs to be replenished. However, at the same time we must realize that the baby
although rather dirty, is still quite wonderful. The world's current financial system with all its
imperfections, can still deliver enormous value. Already, the bold and far reaching steps
introduced by many governments and regulatory authorities as well as by the "victims" of
destability, have shown us that the "baby" could recover and grow. In fact, many economies
are showing signs of recovery and are seeing light at the end of their respective tunnels. In
the light of these developments, we must maintain our energy levels and optimism. Even in
the midst of the crisis, we have observed many systems that are solid, and frameworks and
institutions that are strong, reliable and credible. These institutions must be recognized and
encouraged to provide the leadership and direction to bring stability and credibility back,
quickly. It is also time for the productive sectors of economies to re-invigorate themselves
and deliver higher outputs, so as to support a faster turn-around.
Mr. Chairman, it is also now abundantly clear that the world must collectively approach the
present unprecedented threat. Already, the integrated actions of several governments and
central banks, by virtue of the successes achieved so far, have proved this point. But there is
a lot more to be done. In that endeavour, the consolidation of the thoughts and ideas of
academics, activists, practitioners, regulators, and policy makers at fora such as the one you
have so efficiently organized, would undoubtedly enrich this process and policy debate.
These in turn, will surely accelerate the global recovery.
Mr. Chairman, in good times, we normally take the stability and integrity of our systems for
granted. Perhaps one of the key lessons from the current crisis is that we should never, ever,
take stability and integrity as being "given" conditions, in the future. But, let's remember that
memories are short. This global crisis will almost certainly be forgotten in a few years time. It
is also likely that if we enjoy a strong run of growth and prosperity for a few years, our minds
too will probably dismiss thoughts of destability. Today's grim discussions would then be
relegated to the drab background, and in its place, the glitz and glamour of fast growth,
handsome profits, stunning incentives, and fabulous wealth would reign supreme.
Unfortunately, Mr. Chairman, if and when that happens, the world would unconsciously drift
into the danger zone yet again. Needless to say, if we do not want such an eventuality to
take place, the price would be intense vigilance on the part of the regulators, governments,
media and the academia. I know that is going to be tough, but in the interest of all
stakeholders, I sincerely hope it works and that the academia, governments, media and
regulators would face up to that challenge.
May I therefore, at the concluding session of this important Symposium at the historic
University of Cambridge make an appeal to the global financial community to continue to
keep the events of 2007/2009 fresh in mind, continue to protect and improve our systems,
and continue to build sustainable frameworks to deliver prosperity to the people of the world.
Thank you.