Supervison vital for banking stability

By Vincent Lingga

HONG KONG (JP): A sound banking system, in addition to good governance, is the core of a crusade by World Bank and International Monetary Fund executives who are gathering here for their annual meetings.

The IMF contends that the Southeast Asian financial crisis, which erupted in July, could have been lessened if the Thai government had worked harder at cleaning up its banking sector.

IMF senior advisor David Burton said: "If greater attention had been paid at an earlier stage to banking and financial supervision, the crisis might certainly not have been as severe."

The crucial role of supervision was revisited at a seminar here yesterday when executives from the two Bretton institutions, financial analysts and bankers from around the world discussed issues related to building better banking.

IMF First Deputy Managing Director Stanley Fischer said banking issues were standard topics of discussions for virtually every country in the IMF's annual surveillance report.

U.S. Secretary of Treasury Robert E. Rubin reiterated the message of sound banking at a meeting of the Interim Committee, the IMF's top policy-making body, at the Hong Kong convention center.

Rubin said there were two lessons that could be learned from the recent financial turbulence in Southeast Asia.

First, the importance of sound and credible macroeconomic policies and second, the importance of strengthening financial institutions.

"A stronger, more resilient, financial system not only helps economies grow rapidly in good times but also cushions the impact of adverse shocks," Rubin said.

Both IMF and the World Bank have been spreading what they call the gospel of the Basle Committee's core principles of effective bank supervision.

The Basle Committee, which represents bank supervisors in developing and developed countries, composed the principles early this year and they are expected to be finalized during the annual meetings here.

The Basle principles go beyond the traditional scope of prudential regulations and the 1988 Accord on capital adequacy drawn up by the Basle-based Bank for International Settlement (BIS).

The principles, which will form the basis of the Banking Supervisors' Charter, include rules for consolidated reporting, disclosures, derivatives as well as the independence, resources, power and authority of banking supervisors.

They call for an empowerment of supervisors who can bring about an efficient resolution to problem banks.

The World Bank's director of financial sector development, Jonathan Fiechter, said: "But the real work comes in implementing the core principles."

Incentive system

Edward Kane from Boston University told the seminar yesterday that there should also be an incentive system driving the supervisory mechanism.

Kane suggested the establishment of an incentive compensation system to enhance regulatory performance.

"Incentives for supervisors to remedy problems promptly could be enhanced if ex-post monetary penalties are visited on top regulators not merely if losses happen to surface during their watch but also if what can be proved to have been anticipatable losses accrue within a certain period after the supervisors' departure from office," Kane said.

He suggested that a forfeitable fund of deferred compensation or pension payments be set up as a way to enforce the penalty.

"This compensation system could serve to bond the truthfulness of the regulatory performance measurements they report during their time in office."

David Folkerts-Landau of IMF said that governments should not automatically provide financial assistance to troubled banks.

"Banks that are deemed to be insolvent by supervisors should be forced to exit in a timely manner to prevent problems in individual banks from growing and contaminating other banks," Folkerts-Landau said.

An IMF study on financial stability issued here yesterday shows that while the danger of precipitating a general loss of confidence has generally made it difficult to close large banks it is almost always possible to make the owners and large creditors bear a substantial part of the financial burdens of losses.

Discussants at the seminar yesterday agreed that disruption to a local banking system posed a risk to the entire international financial system due to the globalization process and huge capital flows which made economies increasingly interdependent.

They reemphasized the great importance of a sound banking system for modernizing the international economic architecture.

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