mr. mcdonough discusses the importance of sound financial systems remarks by the president of the federal reserve bank of new york, mr. william j. mcdonough, at a presentation in mexico city, mexico on 22 / 7 / 98. introduction i am delighted to be here today in my second - favorite country in the world to address you on the very timely subject of the importance of sound financial systems. having worked closely with my friends in the public and private sectors here over the years, i know the importance of these issues to them. judging by the attendance here today, this interest appears very broad indeed, a positive sign for the continued revitalization and strengthening of mexico ’ s banking sector. my remarks today, necessarily, reflect my perspective as president of the federal reserve bank of new york, which supervises the majority of domestic and foreign bank assets in the united states, and as chairman of the basle committee on banking supervision, a position i accepted last month. these positions allow me a front - row seat on the wide range of developments taking place in international banking and banking supervision, a perspective which i hope to share with you today. to understand the importance of sound financial systems, one need only look at the impact of financial system breakdowns, of which, unfortunately, there are many recent examples. indeed, prior to the onset of the asian crisis, the imf had estimated that fully three - quarters of its member countries had experienced significant banking sector problems since 1980. banking problems have afflicted both industrial and emerging market countries, including the us, which weathered the savings and loans and banking problems of the 1980s and early 1990s. crises around the world have exacted a high price, with direct fiscal costs of associated resolutions typically starting at roughly 5 percent of gdp ( in the us case, such costs ran more than $ 100 billion ). to these substantial sums, one must add the less quantifiable, but no less real, consequences for the economy and financial system. a weakened financial sector cannot serve its role as intermediary - as banks seek to repair their balance sheets, restrict new lending, and shore up capital - leading to diminished growth prospects. in a number of asian countries today, exporters have difficulty obtaining trade financing from domestic banks, delaying the process of economic recovery and raising fears of a credit crunch in which even sound companies are driven into bankruptcy. banking sector problems reduce depositor confidence in the banking system and can trigger capital flight. banking system problems

short term need to account for the long - term consequences for market efficiency, particularly with respect to moral hazard. the highest priority at the outset of a crisis is usually to restore confidence in the banking system. to this end, authorities in a number of countries have implemented guarantees of bank deposits or broader bank liabilities, in some cases both domestic and foreign, followed by concrete actions to make deposit insurance schemes more explicit and bolster the insurance fund. to minimize the moral hazard implications of such arrangements, however, it is critical that guarantees be established for a defined transitional period, and that supervision of financial institutions simultaneously be stepped up. issues of moral hazard also need to be considered in authorities ’ actions in cases of financial institution insolvency. supervisors have adopted varying approaches to insolvent institutions, including mergers, purchases and assumptions, nationalization, and liquidation. while the authorities should have a general bias toward writing - off existing shareholders and removing management and directors of troubled institutions, such actions may need to be balanced against arguments that current owners and management may be best positioned to achieve an effective work - out. fourth, i think we should bear in mind that banking sector crises often are not just short - term aberrations, but usually are manifestations of longer - term structural problems. therefore, it is crucial that policymakers address not only the immediate stock of problem assets through “ bad bank / good bank ” vehicles, but also structural problems, or weaknesses in core profitability stemming from high overhead, low margins, and excessive regulatory costs. to the extent that underlying problems are not addressed, the banking sector will remain vulnerable to future instability. thus, at the same time as authorities seek to battle a crisis, they also may be compelled to undertake a range of longer - term reforms to banking sector infrastructure, most notably in areas of accounting, disclosure, capital, and supervision and regulation. these changes often involve bringing domestic standards in line with international standards, and can involve difficult trade - offs, in that, for example, fuller disclosure of problem loans may undermine depositor confidence. finally, the scale of banking sector problems in a number of countries has necessitated opening up the sector to significant foreign investment. clearly, such a course brings political tensions and possible domestic backlash. notwithstanding these concerns, foreign ownership is both inevitable and positive as foreign capital brings not only additional financial strength to a domestic banking sector, but also frequently needed technology and skills transfer. overall summary of initiatives what has been the success of responses to recent