Financial Reform Agenda: An Interim Report

By Don Alexander, MBA
Associate, RSD Solutions Inc.
(Mr. Alexander is also a lecturer at NYU and SunySB)

Five years after start of crisis, the global financial system is still under stress.  A host of regulatory reforms are under way to make the financial system safer, and are aimed to make markets and institutions more transparent, less complex, and less leveraged.  However, policymakers have failed to address other issues such as "shadow banks" and "too important to fail" institutions.

The IMF in its latest Global Financial Stability Report (GFSR) summarizes current reform progress in The Reform Agenda: An Interim Report on Progress Toward a Safer Financial System (Sept. 25^th).  The report suggests that there is still a lot of work to do and some difficult issues left to tackle. 

Most reforms are in the banking sector and impose higher costs to encourage banks to reduce risky activities. Basel III requirements of better-quality capital and liquidity buffers should enable institutions to better withstand financial distress.  The new banking standards may encourage certain activities to move to the nonbank sector, where those standards do not apply. Alternatively, big banking groups with advantages of scale may be better able to absorb the costs; as a result, they may become even more prominent in certain markets, making these markets more concentrated.

Although the intentions of policymakers are clear and positive, the reforms have yet to effect a safer set of financial structures, in part because, in some economies and regions, the intervention measures needed to deal with the prolonged crisis are delaying a ‘reboot’ of the system. These intervention measures are aimed at preventing a collapse of the financial system and supporting the real economy, but can provide time to allow damaged financial systems to recover. 

The report added that despite improvements along some dimensions and economies, the structure of intermediation remains unchanged.   Financial systems remain overly complex, banking assets are concentrated, with strong domestic interbank linkages, and the too-important-to-fail issues are unresolved.  reforms in some areas still need to be further refined, far more work needs to be done to implement them, and that the system, in many cases, remains vulnerable, overly complex, and activities are too concentrated in large institutions. Reliance on non-deposit funding is very high, linkages across domestic financial institutions are very strong and complex, innovative financial products are taking on new forms to circumvent regulations.

Other issues to address include: the pros and cons of the restrictions of certain bank business activities, monitoring systemic risk and supervising shadow banking, the need to simplify products and reduce complex organization structures, the regulation of over-the-counter derivatives, and cross-border regulation and resolution for large financial institutions.  In addition, the report noted the success of the current and prospective reforms depends on enhanced supervision, incentives for the private sector to adhere to the reforms, the political will to implement regulations, and the resources necessary for the task of making the financial system simpler and safer.

The low interest rate environment is crucial for now; however, it may also be creating new vulnerabilities in the future.  Regulators and supervisors must be alert about the possible side-effects of these crisis-related measures so that they do not wake up to new risks down the road, due to long implementation lags and the crisis is ongoing.  Have you evaluated your exposure?

www.imf.org/external/pubs/ft/gfsr/index.htm -