Banking Soundness and Monetary Policy

1 Indroductory Remarks

Charles Enoch, and J. Green
Published Date:
September 1997
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I am very pleased to welcome you to the Seventh Seminar on Central Banking, organized by the IMF Institute (INS) and the Monetary and Exchange Affairs (MAE) Department. These biennial seminars have become a tradition, and we in the International Monetary Fund (Fund) benefit greatly from this opportunity to bring together senior central bankers and policymakers to exchange ideas and develop collective thinking on current issues.

There can be no doubt that the theme of this year’s seminar, “Banking Soundness and Monetary Policy in a World of Global Capital Markets,” falls squarely within that category! But perhaps it would still be worthwhile to say a few words about the Fund’s interest in this subject and the developments, prompting us to intensify our work in this crucial area.

In recent years, it has become clear that the forces of globalization—especially financial market liberalization and the exponential growth of the international financial markets—have a major impact on the conduct of monetary policy, and on macroeconomic policy more broadly. In particular, large private capital flows have become a major challenge for policymakers. These flows have increased the availability of capital for investment, bringing many benefits to recipient countries and the global economy. But they have also placed increasing demands on the institutions that intermediate them, since open capital accounts require sound financial systems.

These considerations have led us to focus on the structure of financial markets and their importance for the transmission of monetary policy and for sound macroeconomic policy formulation more generally. Here, I must give credit to Manuel Guitián, the head of the Monetary and Exchange Affairs Department, for calling attention to this “neglected dimension” of monetary policy in early 1994 and initiating a major research effort within his department. Then came the crisis in Mexico, an international wake-up call that financial sectors matter and that financial turbulence in one country can—and sometimes does—spill over into other countries.

Here at the Fund, financial sector issues took on added importance as we took steps to strengthen surveillance over members’ policies and performance in response to the Mexican crisis. In particular, we began to look much more closely at the sustainability of financial flows, to the soundness of banking systems, to countries where financial market tensions could have major spillover effects, and to countries at risk of adverse market reactions. Moreover, recognizing that markets function better when they have more timely and reliable information, we developed a set of standards to guide members in the dissemination of economic and financial data to the public.

These developments, in turn, have lent increased urgency to our work on financial issues. For example, our International Capital Markets report has been giving financial issues greater scrutiny. In addition, early in 1996 we presented to our Executive Board a set of papers on bank soundness and macroeconomic policy, which dealt with this issue at length. These papers were well received by the Board, which supported further efforts to develop IMF surveillance of financial sectors.

Banking system soundness is essential for macroeconomic stability, as well as for economic growth and prosperity, all of which are at the core of the Fund’s mandate. Both our multilateral surveillance over the global economy and international financial markets and our bilateral surveillance over individual countries must, therefore, help promote stable macroeconomic and structural environments in which banks can operate. In this work, we must seek to identify problems early and put measures in place to maintain or restore financial system soundness, using all the mechanisms at hand: policy discussions, program design, and technical assistance.

The Fund’s Interim Committee’s declaration in September 1996, entitled “Partnership for Sustainable Global Growth,” also highlighted the importance of banking soundness. Since then, the staff of the Fund have been working on several additional papers. All this work is being undertaken in close consultation with the World Bank, which is also increasing the attention it gives to financial sector issues.

Developing the framework for sound and efficient financial systems in our increasingly integrated global economy requires a global effort. You may remember my call for action at the Group of Seven (G-7) presidential summit in Lyon last summer, in which I urged a major international initiative to develop a broader and more effective framework for ensuring the safety and soundness of national banking systems and the international monetary system. I am encouraged by the number of important measures that have been undertaken since then involving emerging-market economies. These include a Group of Ten (G-10) Working Party on Financial Stability in Emerging Markets; a special working group of the Basle Committee on Banking Supervision to develop appropriate international banking guidelines; and similar work by the International Organization of Securities Commissions, among others. The Fund is cooperating closely with all these institutions, and these initiatives will benefit the entire membership of the Fund.

This seminar, then, is one step in the process of developing collective thinking on this important topic. By focusing additional attention on the necessary framework for sound banking, the Fund hopes to strengthen members’ regulatory and institutional structures for sound banking and financial intermediation. To do this effectively, we need a broad consensus on what is most important and how to accomplish it. This will not be an easy task and will require an enormous coordination effort. But it also provides an excellent opportunity to develop a consensus for real reform—reform that is needed in order for countries to take full advantage of the opportunities that globalization offers.

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