V IMF Initiatives
- Paul Hilbers, Alfredo Leone, Mahinder Gill, and Owen Evens
- Published Date:
- April 2000
IMF surveillance of member countries’ economies under Article IV of its charter has always included, to some degree, the surveillance of financial systems, primarily with the aim of ensuring the effective functioning of monetary and exchange policy. Article IV staff reports have, on occasion, contained special annexes dealing with financial sector developments, but in-depth surveillance by the IMF of financial systems was generally limited, with the focus being primarily on the IMF’s provision of technical assistance in specific areas identified by member countries or previous IMF missions.
Reports and Publications
Within the framework of multilateral surveillance, the IMF Research Department has published the International Capital Markets report annually since 1980. This report summarizes and analyzes developments in international financial markets, including financial market indicators that may signal vulnerabilities in the global financial system. The report draws, in part, on a series of informal discussions with commercial and investment banks, securities firms, stock and futures exchanges, regulatory and monetary authorities, and the staffs of international organizations such as the BIS, the European Commission, the International Swaps and Derivatives Association, and the OECD.
Similarly, the IMF Research Department regularly analyzes developments of market-based indicators, including international bond issuance, international loans and loan facilities, stock market and bond indices (including spreads), and ratings by international rating agencies. These data, which reflect market sentiment toward a country’s economy, and particularly its financial system, may serve as useful indicators of financial system vulnerability.67
In 1996 the IMF published Bank Soundness and Macroeconomic Policy, its first major analysis of the interaction between these two topics.68 The analysis highlights the issues posed by current or potential banking system unsoundness in four policy areas: the design and implementation of stabilization programs, the use of monetary instruments, the implications for fiscal policy, and the management of international capital flows. It outlines key structural policy issues relevant to maintaining a sound banking system and examines how the IMF might better incorporate banking sector considerations into its surveillance, program design, and technical assistance work. The book also contains a survey of indicators for predicting bank unsoundness, primarily those based on individual bank supervisory information, as used by supervisory authorities and central banks.
In January 1998, the IMF published a survey entitled Toward a Framework for Financial Stability.69 The survey sets out, among other things, guidelines on the quality of information indicating financial system vulnerabilities to be used for supervisory reporting and public disclosure. The guidelines are based on internationally accepted standards, where they exist, and refer to both qualitative and quantitative information. Issues covered are, for example, accounting and valuation rules, loan portfolio review and classification, treatment of collateral, and loan loss provisioning. Adherence to internationally accepted minimum standards in these areas is considered an essential precondition for the use of macroprudential data as useful indicators or vulnerability.
Surveillance Procedures and Operations
Financial System Surveillance
In 1998, the Monetary and Exchange Affairs Department (MAE) issued an internal guidance note designed to facilitate discussions on financial system issues between the IMF staff and the national authorities in the context of Article IV surveillance. It suggests specific areas for discussion including the following topics:
- Sectoral indicators of the health of the banking and financial system. Indicators of the health of the financial system identified as high priority include the foreign exchange exposure of financial institutions, sectoral credit concentration, exposure to large holdings of securities, the aggregate ratio of nonperforming loans to total loans, the aggregate risk-based capital ratio, and central bank credits to banks and other financial institutions as a proportion of their capital or their liabilities.
- Macroeconomic factors that impact the financial system. This is a set of indicators concerning macroeconomic developments that could affect the financial system, with the following indicators considered as high priority: lending booms, asset price booms, high corporate leverage ratios, contagion effects, rises in the ratio of the external account deficit to GDP, low or declining aggregate growth rates, and volatility in exchange and interest rates.
- Elements for the assessment of the institutional and regulatory frameworks. The focus here is on assessing the adequacy of a broad range of public policies and frameworks affecting the financial system and the incentive structure, and the likelihood of the authorities to adhere and enfold: best principles and practices; In this context, Article IV missions are asked to look at the structure of the financial system, public disclosure and the accounting and legal frameworks, incentive structures and safety nets, prudential regulations and supervision, and liberalization and deregulation processes.70
- Main effects of financial system distress. The guidance note highlights the main macroeconomic effects of financial system problems in terms of direct monetary effects, direct fiscal effects, quasi-fiscal effects, and other macro-economic impacts. The guidance note also recommends that these effects be assessed, incorporated in macroeconomic estimates and projections, and discussed with the authorities. In case contingent liabilities are identified, it is suggested that IMF staff prepare alternative scenarios of possible additional monetary and fiscal effects.
Complementing the guidance note, MAE transmitted to area and functional departments, a set of related tables and questionnaires. These tables and questionnaires focus on the structure and performance of the financial sector and the legal and regulatory framework for banking supervision. In addition, there is a summary table that may be included in Article IV reports. The tables and questionnaires are designed to be either sent to the country in advance, and then discussed during the mission, or completed during the Article IV mission itself. MAE then collects the information obtained from the tables and questionnaires and enters it into a databank for future reference (the databank now contains about 20 countries). Both the guidance note and the accompanying tables and questionnaires are being used by all missions involved in monitoring financial sectors under IMF surveillance.
Financial Sector Assessment Program and Financial System Stability Assessments
Based on the guidance note and building on work already conducted in various countries in the context of Article IV surveillance and the use of IMF resources missions, MAE has recently established an enhanced monitoring mechanism for financial systems through in-depth FSSAs. FSSAs are conducted within the framework of the joint World Bank-IMF FSAP.71 These assessments are designed to provide an instrument to highlight strengths, risks, and vulnerabilities in the financial sector, as well as the linkages between financial system developments and macroeconomic outcomes in the context of IMF surveillance, program design, and related technical assistance. They also involve an assessment of observance of standards, core principles, and good practices in the financial sector, as needed.
The key structural and institutional components that contribute to financial system stability are grouped into four categories: official oversight and regulations, systemic liquidity developments and policy, arrangements for crisis management and restructuring, and major risk exposures, including systemic risks in the payment, clearing, and settlement systems. These components are to be reviewed and assessed in a comprehensive manner, taking into account the macroeconomic environment and the broader structural reforms that are under way. This process is aimed at:
- identifying potential vulnerabilities of financial institutions and markets to macroeconomic shocks;
- evaluating the macroeconomic consequences of financial system vulnerabilities and reform; and
- developing and sequencing key structural reforms and restructuring actions to promote financial system stability.
The appropriate sequencing of these reform components is to take into account the technical and operational linkages among them and their macroeconomic impact.
Both recent IMF initiatives—the guidance note and the FSSAs—have at their core an analysis of MPIs. Therefore, the analysis of MPIs forms an integral part of the IMF’s financial system surveillance. The set of indicators that the IMF has identified so far, through its work on financial systems over many years, primarily encompasses the indicators discussed in Section II. The IMF Executive Board has recently endorsed additional research and analysis within the IMF to identify additional indicators that can be useful either generally or in the context of particular country circumstances. This work also aims at selecting a more limited set of MPIs that could be monitored by the IMF on an ongoing basis as pan of its surveillance activities. It is expected that the experience with FSSAs will contribute to further progress in the analysis of MPIs.