Financial regulators must agree binding international codes of conduct to prevent chaos when crises hit banks operating across national borders, the International Monetary Fund has warned.
In a major study of the lessons learned from the financial crisis, the IMF also accepted blame for missing the dangers arising from weakly regulated financial institutions and admitted it had failed to provide global leadership.
But the fund argued that global economic imbalances, notably the huge current account deficit in the US and corresponding surplus in China, had played only a secondary role in creating the crisis.
The IMF stopped short of calling for a global financial supervisor, saying that mechanisms of information sharing and risk assessment between national regulators generally worked well in normal times. But it said that the response to the Icelandic bank runs and the collapse of Lehman Brothers showed the need for more cooperation and binding agreements on who would bear the burden when crises hit.
The IMF’s admission of blame focused on the damage wreaked by the so-called “shadow banking system” – a set of lightly regulated financial institutions including investment banks, hedge funds and mortgage companies that were not subject to strict banking regulation. “The Fund warned about global imbalances but missed the key connection to the looming dangers in the shadow banking system,” the study said.
Henceforth, it said, such institutions needed to be regulated by their function rather than their form, with companies that posed risks to the whole financial system brought within prudential rules that would cover bank-style capital and liquidity requirements. While rules were being tightened on institutions that were already regulated, “an extension to the regulatory perimeter still seems necessary,” the IMF said.
Many economists and ministers have pointed to the huge global current account imbalances as a key cause of the crisis, through encouraging the US to borrow heavily to fund its consumption. But Olivier Blanchard, the IMF’s chief economist, said that the reckless creation of risky assets could have occurred even without the imbalances.
”The macroeconomic causes of the crisis are a factor after the failure of market discipline and weaknesses in regulation,” Mr Blanchard said. “My view is that global imbalances contributed indirectly to the crisis.”
The governance of the IMF itself is on the agenda of the meeting of the Group of 20 large economies in London in April. The IMF report says that the fund has failed to provide leadership in response to systemic global risks.
“The Fund has not been effective in this role, reflecting its rigid power structures and formalistic ways that shifted the policy debate to smaller and more flexible groups,” the report said. The review of “quotas” that determine voting power at the IMF, currently scheduled for 2013, should be brought forward, the report said.
Gordon Brown, the UK prime minister who will chair the G20 meeting, has reversed his previous position and come out in favour of a shift of power within the fund to the emerging market countries who are currently under-represented on its board. Previously he backed a common European position which maintained heavy over-representation of European countries relative to their size in the global economy.