Financial Risks, Stability, and Globalization

15 International Cooperation for Financial System Stability

Omotunde Johnson
Published Date:
April 2002
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The economic crises in the 1990s have galvanized international support for strengthening the international financial system. This task includes developing financial sector risk assessments and policies to lessen the likelihood of crises and reduce their severity when they do occur. Meeting these objectives for fostering sound financial systems calls for national authorities, international financial organizations, regulatory and standard-setting bodies, and the private sector to pool resources and expertise as part of a broad-based, international cooperative effort.

This paper summarizes the various initiatives, at the national and international levels, that are being pursued to improve the functioning of national and international financial markets. It takes stock of the progress that has been made in these areas and offers a view on the challenges that lie ahead.

National authorities, international organizations, and standard-setting and accounting bodies have intensified efforts to strengthen national financial systems. Many national supervisory agencies have enhanced regulatory oversight of their financial sectors. International organizations, such as the World Bank and the IMF, undertake joint financial sector assessments, including the implementation of internationally agreed standards and codes. Other work is under way to develop recommendations and establish mechanisms to support sound financial systems, including by upgrading analytical tools and data for the assessment of financial sector vulnerabilities and by facilitating best practices through the provision of technical assistance. This work involves bodies such as the Financial Stability Forum (FSF), the Bank for International Settlements (BIS), the International Organization of the Securities Commissions (IOSCO), the International Association of Insurance Supervisors (IAIS), the International Accounting Standards Committee (IASC), the International Federation of Accountants (IFAC), the United Nations Commission of International Trade Law (UNCITRAL), the Financial Action Task Force on Money Laundering (FATF), and the Organization of Economic Cooperation and Development (OECD).

These initiatives are brought together in various ways. Countries’ economic and structural reform programs are focusing on the health of the financial sector and on identifying development and technical assistance needs. Technical assistance activities led by the World Bank, the IMF, the BIS, national supervisory authorities, and regional development banks are targeting financial sector institution building. Surveillance activities, including regional initiatives taken by national authorities and regional organizations as well as IMF bilateral and multilateral surveillance activities, have been both strengthened and refocused on fostering financial sector soundness.

Notwithstanding the preliminary stage of these initiatives, some issues for consideration emerge from the experience of the past two years. First, the resource costs of the reform agenda are high, and it will be a challenge to mobilize resources. Next, the delineation of responsibilities will have to be agreed between all those involved to use resources efficiently without duplicating efforts. In this regard, there is broad agreement that the IMF’s core responsibilities include a focus on financial sector soundness and vulnerabilities. However, the precise way that this work will be integrated into the IMF’s surveillance, program, and technical activities remains to be fully worked out. A related challenge will be to balance the IMF’s role as confidential advisor to its members with the need to disseminate information to markets to reduce uncertainty. To maximize the ownership and the likelihood of successful implementation, these initiatives should be conducted as part of a consultative process among international and national institutions both in the private and public sectors. In this regard, countries’ own policy objectives and stages of development are key in choosing the standards to be implemented (and assessed). Finally, given the past volatility in mature and transparent markets, there is a question as to the degree that the dissemination of information will decrease uncertainty, foster less volatile financial markets, and reduce the need for public intervention.

Future challenges, however, also reflect developments in the financial industry and financial markets. The structure of financial markets and institutions is rapidly changing under the pressure of competition, technological advances, financial innovation, and regulation. The macroeconomic and financial implications of these developments are still unclear.

This paper is organized as follows. The first part presents a “bird’s-eye view” of the various initiatives launched to ensure more resilient domestic and international financial systems. The next section discusses the role of the IMF in fostering sound financial markets, and the last section examines some of the challenges in enhancing effective cooperation among international institutions and fora.

Overview of the Initiatives to Strengthen Financial Systems

The growing importance of financial sector reform in the context of rapid globalization of financial markets and the emergence of banking sector problems in a large number of industrial, emerging market, and developing countries since the 1980s has intensified calls for stronger surveillance over financial systems. This need was further underscored by the turbulence in emerging market economies in the 1990s, which also highlighted the importance of the linkages between financial systems and macroeconomic performance and policy.

In shaping the agenda for strengthening the operation of financial markets, the international financial community has underscored the importance of addressing financial sector vulnerabilities, assessing adherence to internationally accepted standards and codes, and improving policymakers’ transparency and accountability. Initiatives under way have involved national authorities and various international organizations requiring cooperation at both the national and supranational levels.2

This section reviews the main initiatives that focus on risk and vulnerability assessment of financial sectors. It then considers the assessment of standards and codes to foster sound financial markets.

Financial Sector Assessments

There is now broad international support for intensive work on financial sectors and financial markets, backed up by information on institutional arrangements, risk assessments, and the observance of best practices. The various initiatives—delineated below—focus on assessing the vulnerabilities of national financial sectors and international financial markets, and the roles of the various international organizations in promoting financial sector soundness.

The Financial Sector Assessment Program (FSAP) was established in May 1999 by the managements of the IMF and the World Bank to identify domestic financial system strengths and vulnerabilities with a view to prevent financial crises.3 Conclusions drawn from such assessments are intended to promote early detection of financial system weaknesses that may have wider macroeconomic implications and also to help national authorities develop appropriate corrective policy responses. The FSAP facilitates a more effective dialogue on financial sector issues with national policymakers and promotes the coordination of policy advice and technical assistance between the World Bank, the IMF, and regulatory and standard-setting bodies. Collaboration between the IMF and the World Bank helps optimize scarce resources and expertise and helps deliver coordinated advice on financial sector development consistent with macroeconomic developments and long-term policy objectives. With a view to enhancing effective collaboration between the two institutions, the Financial Sector Liaison Committee (FSLC) was established in September 1998.

The Basel Committee on Banking Supervision (BCBS) has worked with a team of Group of Ten (G-10) and non-G-10 countries to define a set of basic elements, referred to as the Core Principles, for an effective system of banking supervision. The BCBS, in collaboration with non-G-10 countries, has further advanced the capital adequacy framework and, in June 1999, released a consultative paper on updating the 1988 Capital Accord.4 Drawing on this work, Basel Core Principles Assessments (BCPAs) were established to judge the adequacy both of the rules for banking supervision and of the supervisors’ ability to monitor and limit major risks run by banks. BCPAs are undertaken as self-assessments by national authorities or conducted by IMF and World Bank staff. The BCBS is continuing to work on its Core Principles and recently hosted a workshop to review the results of assessments done to date and to consider the possibility of updating and revising the principles later in 2000. The Basel Committee on the Global Financial System (CGFS) has been reviewing ways to improve market disclosure, including a model template for public disclosure of the exposures and risk profile of regulated and unregulated institutions engaged in trading, investment, and lending activities.

The Financial Stability Forum, established in 1999 by the Group of Seven (G-7) industrialized countries, has focused its work on areas of special interest with respect to a sound international financial system. Working Groups on Offshore Financial centers (OFCs), Capital Flows, and Highly Leveraged Institutions (HLIs) presented their final reports at the FSF meeting in Singapore on March 25-26, 2000. These reports called for, among other things, strengthened management practices and risk-control procedures, enhanced regulatory oversight, and public disclosure of financial and nonfinancial institutions’ activities.5 The IMF Executive Board considered the OFC-related recommendations relevant to the IMF on July 10, 2000, noting that the discussion marked the beginning of a process of closer collaboration between the IMF and OFCs.6 The IMF Executive Board will also assess the other FSF recommendations relevant to the IMF.

Standards for Sound Financial Systems

The recent crises have also underscored the importance of developing, disseminating, and implementing the standards and codes that are pivotal to foster sound financial systems.

It is now generally agreed that the adoption of internationally accepted standards and codes of good practice can make an important contribution to sounder financial sectors and better functioning markets; it should lead to better informed lending and investment decisions and better and more accountable policymaking.7 In this regard, work on standards for data dissemination, banking supervision, accounting and auditing practices, securities and insurance regulation, payment systems, corporate governance, insolvency regimes, and transparency of fiscal, monetary, and financial policies has been initiated. Publication of the assessments of countries’ compliance with these standards should help reduce uncertainty and, hence, vulnerability.

There has been considerable work on data standards—that is, how how best to improve the timeliness, frequency, and quality of relevant data in order to assess effectively the vulnerability of domestic financial systems. The IMF’s work on data dissemination, which began in October 1995, was accelerated in response to the recent crises and the need for accurate data to support financial sector stability assessments. IMF member countries have been encouraged to adopt a two-tier voluntary standard: the Special Data Dissemination Standard (SDDS) and the General Data Dissemination Standard (GDDS).8 In this context, the SDDS has recently been strengthened, notably in the areas of external debt and international reserves. With respect to international reserves, provisional operational guidelines for a data template for the SDDS, developed in collaboration with national authorities and other international institutions, have been available since October 1999; SDDS subscribers are in the process of implementing these guidelines.9

There is also work under way to develop macroprudential indicators. The IMF, also in collaboration with other international organizations, is working to develop macroprudential indicators of financial sector vulnerability with the view to considering their integration into the SDDS.

Other organizations and fora are similarly engaged in efforts to develop and disseminate standards to promote financial sector soundness. The BIS has announced a number of initiatives to improve the coverage and analytical usefulness of its international banking statistics. These include preparation of consolidated statistics on an ultimate-risk basis; higher frequency reporting of consolidated debt statistics; and improved reporting by offshore banking centers. The FSF Working Group on Capital Flows has put forward a series of recommendations on how to upgrade data from national, creditor, and market sources, in particular with regard to external debt. The Inter-Agency Task Force on Finance Statistics (TFFS) is working to enhance the timeliness and coverage of the quarterly database on external debt by creditors.10 This database has been accessible on the Internet since March 1999.

The World Bank is experimenting with assessing implementation of standards in the areas of bankruptcy, accounting and auditing, and corporate governance. Although preliminary, the efforts under way within the Bank signal the potential for a more comprehensive coverage of standards than could be achieved by any one organization alone.

The BCBS has reviewed the existing set of supervisory standards, and developed guidelines for the banks’ interactions with highly leveraged institutions. The recently approved Basel Core Principles (BCP) methodology—prepared with input from the IMF and World Bank—is used by bank supervisors and external groups to assess countries’ adherence to sound banking principles. The IMF and the World Bank have prepared BCPAs in the context of FSAPs, for technical assistance programs, and on a stand-alone basis.

Finally, progress continues to be made—notably by international agencies and standard-setting bodies such as IOSCO, IAIS, IASC, IFAC, UNCITRAL, and the BIS Committee on Payment and Settlement Systems (CPSS)—in developing and refining standards in areas such as securities and insurance regulation, accounting and auditing, and payment systems, while work is under way on standards and principles for insolvency regimes.

Transparency reports, now referred to as Reports on the Observance of Standards and Codes (ROSCs), were devised to summarize the extent to which an economy meets internationally recognized standards covering banking supervision; deposit insurance; payment systems; insurance and securities regulation; data dissemination; and fiscal, monetary, and financial policy transparency.11 Support for the preparation of ROSCs has been widespread.12 Since early 1999, ROSC modules have been prepared by IMF and Bank staff as part of a pilot project and with the support of national and standard-setting bodies.13

The role that standards play in promoting financial system stability is now widely accepted. However, effective consultation and cooperation at the national and international levels will be necessary to ensure an appropriate design and acceptance of standards, which are key to the success of these initiatives. Also, identifying standards that are deemed critical to economic and financial stability with a view to sharpening financial sector assessments will be important in limiting the resource implications of such assessments on both international organizations and national authorities. Relatedly, strong demand for technical assistance to strengthen policies and institutions to meet internationally agreed standards has also emerged, posing resource issues for national authorities and international financial institutions.

The IMF’s Work in Fostering Sound Financial Markets

There is broad-based support for the IMF’s unique role, by virtue of its universal character, to help all of its members pursue financial sector soundness and, therefore, protect themselves and their neighbors from financial disruptions.14 Both the external evaluation of IMF surveillance and the IMF’s internal review concluded that the IMF should give priority to financial sector soundness, vulnerability assessment, and the important systemic and international issues in world finance.15

In the aftermath of the Asian crisis, the IMF has intensified its attention to the linkages between the soundness of the financial system and macroeconomic performance and has also increasingly examined financial system weaknesses that could have systemic or important regional implications. IMF surveillance, lending, and technical assistance activities are focused on identifying financial sector weaknesses, promoting sound policies, and assisting in strengthening institutions. In addition, as noted, the FSAP contributes to strengthening financial systems by providing expert examinations and by facilitating the integration of these assessments in a broader macroeconomic context.

The IMF’s multilateral surveillance of international economic and financial market developments—expanded considerably within the past two years—plays an important role in focusing the international community’s attention on the key financial market issues.16 Its purpose is to develop and disseminate knowledge on cross-country, regional, and financial market issues, particularly to better foresee and prevent destabilizing spillover effects. Efforts have been intensified to review more systematically the linkages between individual country and international capital market developments.17 Also, as part of the IMF’s strengthened multilateral surveillance, IMF missions visit member countries’ main financial centers, both in industrialized and emerging economies, to discuss developments in national and international financial markets with commercial and investment banks, securities firms, stock and futures exchanges, regulatory and monetary authorities, and credit-rating agencies. Discussions are also held with the staff of the BIS, the Commission of the European Union, and private market institutions, and their views are taken into account in the IMF’s bilateral surveillance and lending operations.

The IMF is devoting increasing attention to systematic participation in regional surveillance processes as a means of better identifying risks to international financial stability and coping with regional developments and spillover issues.18 The IMF is also participating in the regional initiatives of member countries, increasingly interacting with a variety of different fora, all of which have some role in regional macroeconomic management. A variety of mechanisms have been developed to ensure that surveillance is effective, and that peer pressure is brought to bear when needed. In Africa, the IMF provides analytical and technical support to the Southern African Development Community and the Common Market for Eastern and Southern Africa. In Asia, the IMF participates in the Manila Framework Group, which constitutes the main regional forum for mutual economic and financial surveillance. The IMF also provides technical and research input to the Asia-Pacific Economic Cooperation and the Association of Southeast Asian Nations. In addition, the IMF opened a regional office in Tokyo in 1997 whose mandate focuses on regional surveillance activities. IMF participation in regional fora in Latin America is at an early stage. In September 1998, the IMF convened a meeting of finance ministers and central bank governors to discuss regional policy issues and, in particular, the implications of the crisis in Brazil for Latin American member countries. Earlier this year, the IMF participated in the third meeting of Western Hemisphere finance ministers. In the Middle East, regional surveillance has focused, thus far, on the Gulf Cooperation Council through studies on regional issues.

Finally, as noted, assessing the observance of standards has also become central to the IMF’s improved financial sector surveillance and risk assessment. However, standards relevant to the functioning of domestic and international financial systems cover a wider range of areas—including securities and insurance regulation, accounting, auditing, bankruptcy, and corporate governance—than that generally encompassing the IMF’s core areas. Accordingly, effective financial sector surveillance requires effective cooperation with other organizations, so that the macroeconomic and financial implications of developments in areas outside the IMF’s core competence can be assessed.

Challenges to Cooperation: Issues for Discussion

The initiatives described in this paper aim at contributing to sounder domestic and international financial markets. The experience with these initiatives suggests that this is a resource-intensive and complex process, which will require continued cooperation among national and international institutions, agencies, and fora. No single institution can readily provide resources for the implementation of the range of initiatives required to support stable financial systems; to develop and to disseminate financial sector standards; to assess compliance with these standards; and to provide the required technical assistance. Thus, establishing priorities will be a key component of advancing the work in this area. Notwithstanding the preliminary stage of many of these initiatives, some issues for discussion emerge from the experience of the past two years.

The resource costs of the reform agenda are high for national authorities, international organizations, and regulatory and standard-setting bodies. Yet, the costs of financial crises are also high. There will continue to be a challenge to mobilize resources and allocate them efficiently, particularly in good economic times when the momentum for reform may wane. Relatedly, the delineation of responsibilities will have to be agreed between all those involved in order to utilize resources efficiently without duplicating effort.

There is broad agreement that the IMF’s core responsibilities include a focus on financial sector risk assessment and policies. However, the full integration of such risk analysis into the IMF’s surveillance, program, and technical assistance activities remains an uncompleted task. A related challenge will be to balance the IMF’s role as confidential advisor to its members with the need to disseminate information to markets to reduce uncertainty.

Efforts to strengthen domestic and international financial systems should be inclusive. That is, they should be conducted as part of a consultative process among international and national institutions both in the private and public sectors. The appropriate design and acceptance of these initiatives are key to their success. In this regard, countries’ own policy objectives and stages of development are key in choosing the standards to be implemented (and assessed).

Transparency to minimize or avoid contagion is now viewed as important for disciplined and less volatile markets. In this regard, transparency has several facets. In the first instance, it encompasses the timely provision of comprehensive information to the public, especially capital markets. This is a shared responsibility between the private and public sectors. Transparency also requires an appropriate degree of openness regarding public sector policies. The latter should include transparency in the IMF’s assessments. The IMF’s dual role as a confidential advisor to member governments and as the institution responsible for overseeing the international monetary system poses particular challenges for the institution while it tries to balance the legitimate need of the public and financial markets for information with the equally legitimate need for confidentiality with members.

Even with all these initiatives, there may be limits to what financial sector reform and transparency can produce in terms of gains from reduced market volatility and uncertainty. Mature, efficient, and transparent equity markets in the United States and other industrial economies with sound banking system regulations, supervision, and legislation still suffer from episodes of volatility and asset-price bubbles with potential spillover effects for the international financial system. There may remain a role for the public sector—at the national and international levels—to deal directly with market volatility and to help “innocent” parties cope with its consequences. The outstanding challenges, however, also reflect developments in the financial industry and markets. The structure of financial markets and institutions is rapidly changing under the pressure of competition, technological advances, financial innovation, and regulation, with still unclear macroeconomic and financial implications. Specifically,

  • competition is likely to produce a mix of highly specialized financial firms, both at the geographical and product level, and global and complex financial institutions;
  • technological advances will make cross-border financial activities easier and more profitable—hence, fostering the creation of global players, but exposing them to differences in regulation, market practices, and legal arrangements;
  • financial innovation, although vastly enhancing the capacity to spread and manage risks, could also create specific vulnerabilities. Additional trading platforms, in particular in over-the-counter markets, are increasingly segmenting markets, partly offsetting the impact of mergers among established exchanges, which are responding to the need to offer more attractive services to those market participants that are rapidly globalizing their activities; and
  • finally, developments in financial regulation, with its focus on tighter accounting (mark-to-market) and risk management practices, could make banks more sensitive to fluctuations in asset prices, as these will be quickly reflected into balance-sheet losses, and require portfolio reallocation at times of increased international financial fragility.

The changing structure of financial markets and institutions may have important, although still unclear, implications for market liquidity. In particular, the concern is twofold. First, a structural decline in market liquidity could ultimately complicate efficient pricing and risk management. Second, even if not structural, a reduction in market liquidity that turns out to be procyclical could seriously amplify fluctuations in financial cycles by weakening financial institutions’ intermediary capacity at times of heightened financial stress.


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The authors thank Mark Allen, John Hicklin, Omotunde Johnson, Russell Kincaid, Scott Brown, and Martin Parkinson for helpful comments and suggestions. The usual disclaimer applies.


The role of IMF credit facilities of the private sector in forestalling financial crises, as well as the need for a lender of last resort and stronger liability management by both governments and nonfinancial sectors, are topics that have also been at the core of the debate on strengthening the architecture of international financial systems. These topics are, however, beyond the scope of this paper.


In April 2000, the International Monetary and Financial Committee (IMFC) endorsed the decision to continue the FSAP and expand the coverage from 12 to 24 countries on a voluntary basis for the coming year, and expansion of the pilot is under way. To date, FSAPs have been initiated for 15 countries.


The recommendations were endorsed by the FSF in its meeting in Singapore on March 25-26, 2000 (see, and by the G-7 industrialized countries at their meeting in Washington, D.C, on April 15, 2000 (see


See for a summary of the Executive Board discussion.


See, for example, IMF (1999a and 1999c), and the Managing Director’s Report on Strengthening the Architecture of the International Monetary System (April 1999).


The GDDS was established in 1997 to guide countries in the provision to the public of comprehensive, timely, accessible, and reliable economic, financial, and socio-demographic data. The SDDS was established in 1996 to guide countries that have, or that might seek, access to international capital markets in the dissemination of economic and financial data to the public.


See IMF (1995, 1996, and 2000a).


Current members of the Task Force include the IMF (chair), the World Bank, the OECD, the European Central Bank (ECB), the BIS, the European Statistics Bureau (EUROSTAT), the United Nations Development Program (UNDP), the Commonwealth Secretariat, and the Paris Club.


The IMF has prepared a manual to assist member countries in the implementation of the Code of Good Practices on Fiscal Transparency, which was approved by the Executive Board in April 1998; the manual has been available since 1998 and was updated in April 1999. The IMF is in the final stage of preparing a supporting document to the Code of Good Practices on Transparency in Monetary and Financial Policies to help guide members in their implementation of the Code, which was approved by the Executive Board on July 9, 1999.


See G-22 (1998) and the April and September 1999 Interim Committee communiques. More recently, the experimental work on ROSCs has been supported by the decision of the G-20 to “undertake the completion of ROSCs and Financial System Stability Assessments (FSSAs)” (G-20 Finance Ministers and Central Bank Governors Meeting, Finance Canada Press Release, December 15-16, 1999). Similarly, Western Hemisphere Finance Ministers have recently endorsed ongoing work on standards and codes. They encouraged members to undertake FSAPs and committed themselves to support and participate in ROSCs (Joint Ministerial Statement, February 3, 2000).


A module is an assessment of an individual standard. It contains a description of country practices on the basis of questionnaire results and a dialogue with the authorities, followed by an assessment of these practices against the relevant international standard.


This entails, most prominently, the production and publication of the World Economic Outlook and International Capital Markets reports.


In light of the deepening and broadening of the Asian crisis in the fall of 1997, an interim WEO was prepared in December of that year; and an interim combined WEO and ICM report was prepared in December 1998 to assess the Russian and Long-Term Capital Management crises and their impact on global financial markets and macroeconomic prospects. Over the same period, the IMF’s Executive Board increased the frequency of discussions of financial market topics and various systemic issues that had been brought to the fore by spreading crisis conditions. Moreover, in an effort to seek guidance from outside experts, a conference was held on Key Issues in Reform of the International Monetary System in May 1999.


Special modalities were set up for regional surveillance over the euro area, involving annual consultations with individual member countries and semiannual discussion with European Union institutions responsible for common policies. In the CFA franc zone, regional surveillance involves regular policy discussions with the regional authorities of the West African Economic and Monetary Union and the Central African Economic and Monetary Community, including with the central banks of the respective areas. Surveillance of regional issues is also being stepped up in cooperation with the institutions of the Eastern Caribbean Currency Union.

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