High-Level Expert Group Meeting
19-20 April 1991
Paris, France
Chaired by Valery Giscard D’Estaing
1. On 19 and 20 April 1991, the InterAction Council
convened in Paris a High-level Expert Group on "The Role
of Central Banks in Globalized Financial Markets", chaired
by Mr. Valéry Giscard d'Estaing. The meeting was attended
by four other members of the InterAction Council -- Maria
de Lourdes Pintasilgo (Portugal), Malcolm Fraser
(Australia), Manuel Ulloa (Peru) and Olusegun Obasanjo
(Nigeria) -- and fourteen experts. The list of
participants is annexed to this report as are the terms of
reference.
2. In recent years, considerable changes have taken place
in domestic and international capital markets:
deregulation, disintermediation, the creation of new
financial instruments, the use of futures markets, a
blurring of frontiers between financial intermediaries,
computer-based instant dissemination of information and
arbitrage operations closely linking markets, instruments
and currencies.
3. In many respects, these changes were advantageous and
represent a positive trend. Under the pressure of
competition, the cost of financial services to potential
users was reduced. Individuals, enterprises and countries
were enabled to find at any time financial instruments
tailored to their own requirements. The large-scale
internationalization of capital markets and banking
activities has brought about benefits in terms of access,
transaction costs and an efficient and market-based
allocation of resources.
4. But these changes have created an environment in which
emerged new problems, both domestically (such as the S and
L's situation in the United States) and internationally,
as exemplified by periodic defaults, failures, and rescue
operations in the interbank money or currency markets and
in other markets which were made more fragile by the rapid
development of new financial instruments (e.g. floating
rate notes, highly leveraged transactions, swaps). More
fundamentally, the growing interconnection between markets
may lead to the proliferation of a crisis originating in a
specific market with cumulative and mutually reinforcing
downward adjustments in all markets on a worldwide basis
-- such as in the 1987 market crash. All these conditions
have increased the potential for systemic risks.
5. As a consequence, shifts by major countries may have
large -- and disproportionate -- repercussions on emerging
financial markets, banking systems and development
strategies in developing countries and on the management
of economic policy in small and open economies, which may
see their domestic stabilization efforts impaired by
developments in international capital markets and their
currencies being overwhelmed by excessive capital
flows.
6. Central banks and other regulators have already taken
measures to enhance their capacity to deal with any such
crisis in the new financial environment through better,
more appropriate and coordinated regulation: the Basle
concordat allocating supervisory responsibilities, the
internationally agreed capital adequacy requirements (the
"Cooke ratios"), the new relationship between bank
regulators and market regulators domestically and between
market regulators internationally, the coordinated
responses to international liquidity crises (e.g. through
collective endeavours in exchange rate management and in
the common response of central banks to provide liquidity
to the system in the 1987 crisis).
7. Some of these developments have, by themselves, raised
new concerns, notably at end-1987 a risk of an oversupply
of liquidity fueling inflation or current fears -- which
might prove exaggerated -- of overcautious lending
policies by banks ("credit crunch"). This occurs at a time
when new challenges have to be addressed: a need to
increase savings and financial flows to meet the
requirements of developing countries, Eastern and Central
European countries, and Gulf reconstruction; a need to
restore access to the market for countries emerging from
debt reschedulings; a need to aim at greater transparency
and stability in futures markets, including oil future
markets, with their growing importance for both
oil-producing and consuming countries.
8. In the process of globalization, the world is also
moving toward a tripolar system of three large blocs
centred around the dollar, the European currency (ECU) and
the yen. This itself may ultimately prove to be an interim
stage toward an even broader or more closely linked global
system. Meanwhile, however, each of the three major blocs
will have considerable capacity to influence conditions in
the others, thus reinforcing the need for closer policy
coordination in the interest of a stable world economy.
9. The InterAction Council should send a signal to all the
relevant national and international authorities that the
time is ripe for the adoption of a comprehensive approach
concerning the role of central banks and supervisors in
the new financial environment. aiming at stability.
transparency and efficiency.
THE CASE FOR A TEN
10. To this end, the High-level Expert Group formulated a
ten point strategy which the InterAction Council may wish
to endorse. This strategy aims at greater transparency,
stability and efficiency in financial markets through an
adaptation of the role of central banks and other
supervisors.
I. Ensuring the independence of central banks
11. The best encouragement to stability in financial
markets and to adequate private savings is the perception
of monetary policies steadily oriented toward price
stability. This is best accomplished through independent
central banks with a clear mandate to that effect. It has
been agreed that the new European System of Central Banks
(ESCB) should have these characteristics but there is a
need to reform accordingly the statutes of individual
European national central banks. This is an example to be
followed by central banks in Eastern and Central Europe
and more broadly by non-OECD central banks.
12. An important lesson gained from economic policy
management over the past two decades is indeed the primary
importance of price stability as the ultimate objective of
monetary policy, to be conducted by independent central
banks taking a long-term view and being immune from day to
day reactions to economic and financial developments.
Another lesson is that a short-run trade-off exists
between lower inflation and securing employment
opportunities but that central banks should not aim at
addressing conflicting goals. Hence, central bank efforts
towards price stabilization need to be complemented by
governmental fiscal policies and by structural policies to
improve the labor and product markets in order to minimize
the social costs involved in the process of disinflation.
A convergence of objectives for medium-term inflation
rates at the lowest possible levels in the United States,
the European Community and Japan and the perception of
monetary policies steadily oriented towards achieving such
objectives will by itself encourage stability in financial
markets. To ensure the independence of central banks is
crucial in gaining and maintaining market credibility in
their task of achieving price stability.
13. While deregulation makes coordination of monetary and
exchange rate policies both more necessary and more
difficult, independent national central banks would not
necessarily ensure greater coordination between them
(although, arguably, they might be more likely to
collaborate effectively than Governments). But if the
ESCB, the Bank of Japan and the US Federal Reserve all
pursued an identical goal, namely zero inflation, equally
effectively, their actions would be likely to be more
consistent with each other.
II. Adapting monetary policies to the new financial
environment
14. In their pursuit of reasonable price stability in a
globalized world with its deregulated financial
environment, central banks have to face difficult choices
in targeting the appropriate objectives. In view of
continuing worldwide financial innovations, monetary
aggregates, overall credit expansion or the monetary base
are less reliable in their definition and more loosely
related to economic aggregates. Interest rates may also
prove inadequate, partly because, with globalized markets,
they are more and more influenced by external forces
outside of the purview of central banks. Basically, in the
new financially environment, most central banks should aim
at the stability of their exchange rates against a major
currency, provided this "anchor currency" is sufficiently
stable. And in the management of major currencies, an
added weight may have to be given to direct price
indicators (price indexes, commodities prices and
securities prices -- which means long-term interest
rates). Moreover, in the framework of international policy
coordination target zones for exchange rates should be
established and considered in formulating central bank
policies. Efforts should be made to maintain the zones
through intervention and through policy adjustments to the
extent possible taking account of domestic conditions.
15. In this endeavour and in the management of their
interventions on domestic money markets and foreign
exchange markets, central banks would have to further
strengthen their ability to collect adequate information
and to make use of the most recent technological
developments in financial markets.
III. Using the move toward a single European currency
to strengthen the international monetary system
16. The move toward a single European currency should pave
the way for a three-polar international monetary system
(dollar, yen and Ecu), with the Ecu substituted for
individual European currencies in the definition of the
special drawing rights (SDR), in foreign exchange reserves
and in swap agreements between central banks. To offset
any destabilizing effects of such a move, measures would
have to be taken to broaden the Ecu-denominated -- and the
yen-denominated -- financial instruments markets, in order
to provide for the same transparency, depth and liquidity
as in the dollar-denominated financial instruments
markets. Also, it might be desirable to establish target
zones for the tripolar currency regime which would foster
the convergence of the domestic price stability objectives
at the lowest possible levels and the adoption of coherent
budget and structural policies of the countries
concerned.
17. For other currencies, individual choices might then be
made between a link -- in nominal or real exchange rates
-- with one of the three leading currencies (provided this
"anchor currency is sufficiently stable) or with a basket
of the three, either standardized -- the SDR -- or
adjusted to individual national requirements.
18. In a move from the current G-7 to a G-3, particular
responsibilities ought to be given to a small group of
countries which would have to agree on a general approach
to exchange rates evolution and to use monetary and fiscal
policy in a way that can be interpreted by capital markets
as stabilizing. In assuming these responsibilities, aiming
at a convergence of economic policies and inflation rates,
the G-7 and then the G-3, should at the same time affirm
world leadership and ensure close cooperation with the IMF
and with other OECD countries in Europe and in the
Pacific, with the Central and Eastern European countries
and with the developing countries.
19. In this connexion, the role of the International
Monetary Fund (IMF) should be re-evaluated and reinforced
with a view to ensuring an adequate surveillance over the
economic policies of richer countries. Globalization and
liberalization has freed industrialized countries from the
need to seek assistance from the IMF contrary to the
present situation of developing countries. The main role
of the IMF should be to ensure that the international
financial system functions efficiently implying relative
stability in exchange rates and lower interest rates, and
to provide liquidity, at a reasonable cost which should
not be higher than that of capital markets, to countries
engaged in an adjustment process.
IV. Streamlining bank regulation and
supervision
20. Diversity prevails in the supervision of banks even
among the major countries. In the United States, a number
of separate agencies are in charge of deposit insurance
schemes and of overall supervision -- split between the
Treasury and the Fed -- either at the federal or
individual state levels. In some countries, the
supervision is primarily exercised by a body distinct from
the central bank -- a state agency for Germany -- while in
other countries, such as the United Kingdom, the
supervision is conducted by central banks. In France, bank
supervision is the primary responsibility of the Banking
Commission, of which the Governor of the Bank of France is
the Chairman and a high-ranking Finance Ministry official
the Vice-Chairman. In Japan, banking supervision is
carried out by the Ministry of Finance and the Bank of
Japan. The latter's authority is rather contractual and is
generally based on individual agreement with its client
banks, in accordance with the purpose of the Bank of Japan
law.
21. While respecting national choices, emphasis should be
put in the future on the streamlining of bank regulation
-- one single national regulator -- and the independence
of bank supervision -- either an independent central bank
or a specific agency. In all cases, central banks, either
alone or concurrently with other agencies, should monitor
the financial soundness of the banking system as a
whole.
22. The same objective should be pursued -- by developing
countries and Eastern European countries in order to give
to their banks added credibility in the international
capital markets.
V. Strengthening the supervision of other major
intermediaries in capital markets
23. While central banks and other bank regulators have
developed recognised fora for coordinating supervisory
policies and requirements internationally (the Basle
Committee on Bank Supervision), coordination of the
supervision of non-bank financial intermediaries (or
non-bank financial institutions) remains extremely loose:
no agreed capital adequacy standards; no consolidation
requirements; gaps in supervisory coverage; and the
absence of an agreed division of supervisory
responsibilities for internationally active
conglomerates.
24. More effective mechanisms for coordinated supervision
of internationally active securities intermediaries, with
a more clearly defined and coherent allocation of
supervisory responsibilities, need to be developed in
coming years. These will at the same time have to bring
within a coherent overall framework of supervision and
control the interrelationships between different
functional supervisors -- particularly between banking,
securities and insurance regulators. The establishment of
the equivalent of the Basle Committee on Bank Supervision
would appear to be appropriate.
VI. Adopting a set of standards for regulation
25. Based on this endeavor by regulators, governments
themselves -- at least in the OECD area and in offshore
centers -- should agree on a set of standards to be
applied to the regulation of financial markets and
financial intermediaries. This set of standards should be
based on six principles:
a) Transparency: The regulations governing a particular
market should be fully apparent to participants in the
market and to potential market entrants. The mechanism
through which regulations evolve should be open,
permitting dialogue between the international industry,
officials and legislators.
b) Neutrality: De facto and de jure foreign firms should
be treated like domestic firms, both in entry and in
operation.
c) Inclusiveness: The entire financial system should be
regulated. Gaps in the international regulatory structure
may present opportunities to financial firms or their
clients to transact business at lower cost to themselves
but at greater risk to the financial system as a whole.
d) Regulatory independence: While the value of an
independent central bank, free from political pressure, is
increasingly being accepted, the value of independence for
other financial regulators concerned with safety and
soundness is equally important but yet less widely
accepted.
e) Mutual recognition: Any financial services firm may do
business in other countries when so permitted in its home
country, thus contributing, through competition, to reduce
the costs of regulation imposed on the financial services
industries.
f) Harmonized standards.
VII. Avoiding systemic risks
26. Supervision aimed at a prudent behavior of individual
banks and market operators would not, however, bring to
markets the required stability if risks of chain-defaults
and systemic risks are not at the same time addressed. It
has been a subject of intense study in recent years,
notably by the Bank for International Settlements (BIS)
and the OECD.
27. Central banks should stand ready, as ever, to provide
liquidity in system ("lender of last resort") and to take
concerted action exchange markets when necessary. While
their traditional stance of constructive ambiguity about
their future actions has advantages in retaining freedom
of action and in minimizing the moral hazard of
encouraging intermediaries to take excessive risks in
expectation of being rescued, this should not, of course,
serve as an excuse for inaction between crises.
28. In particular, in order to reduce the chances of their
needing to intervene in a crisis, central banks should
urgently promote a comprehensive programme for the
strengthening of payment and settlement systems, including
the development of robust, legally valid delivery versus
payment systems in securities markets. This should in due
course extend to the development of effective payment and
settlement systems in a common European currency under the
aegis of ESCB, and in their integration with dollar and
yen systems. Market regulators and central banks should
also pursue the implementation of fully reliable systems
aimed at a strict registration of orders and quotations in
spot and forward capital markets and of derivative
instruments, and the development of early warning
indicators.
VIII. Ensuring a better integration between the
financial world and the real economy
29. Added stability in financial markets is not an end in
itself but an instrument to enhance stability and growth
in the real economy. To ensure a better integration
between the financial world and the real economy, two main
concerns would have to be addressed:
a) Financial deregulation should not unduly take precedent
over overall economic efficiency which notably implies,
domestically, flexibility in labor markets and,
internationally, renewed efforts to dismantle trade
barriers.
b) Adequate signals must be given by financial markets to
the real economy, with a particular emphasis on the
following essential elements:
- the promotion and dissemination of information and rating on an open basis, avoiding individual appropriation of information by tightening insider rules and stressing a long-term approach;
- the adoption of an adequate set of rules allocating domestic jurisdiction for mergers, acquisitions and concentrations.
- Volatility and the hope of rapid financial gains should not distract industry from the long term painstaking search for greater efficiency and productivity.
30. The futures markets, both in financial instruments and
commodities such as oil, warrant an in-depth study as to
their impact, requirements, regulation and supervision.
IX. Adapting present policies
31. Stability through adequate supervision, capital
adequacy requirements and market surveillance is a
long-term strategy. which, in its implementation. should
pay due regard to current circumstances. In particular,
three immediate concerns must be addressed:
a) The concerns about and risks of a US domestic and
international credit crunch, in the present debt
recession, should not warrant a loosening of regulatory
requirements, but should be kept in mind when formulating
monetary policies without jeopardizing price stability.
b) The risks of a worldwide shortage of savings as a
result of the capital requirements of Eastern Europe, the
developing countries, the Gulf countries and for
environmental purposes. This requires action by major
countries on budget deficits and might warrant additional
incentives for private savings, notably for equity
investments.
c) The risks of an ever-postponed access to market of
countries emerging from a debt crisis, which might warrant
further impulses for project financing, equity market
promotion, securitization and co-financing with
multilateral institutions.
X. Addressing the specific concerns of non-OECD
countries
32. The concern for the specific issues confronting
non-OECD countries should go beyond present circumstances
and must be tailored to the requirements of individual
countries or groups of countries.
a) The Soviet Union is simultaneously striving to move
from a centrally-planned economy to a market economy and
from a fully integrated system to a more decentralized
one, a new federalism. This implies a coordinated effort
in the move towards the convertibility of the ruble in
order to ensure at the same time the coherence of the
domestic evolution and the gradual insertion of the USSR
financial markets into the globalized markets.
b) Most Central and Eastern European countries are
undertaking major reforms to transform their economies
into market-based economies and, in that context, they are
pursuing severe adjustment policies. As part of these
efforts, they are developing financial markets and intend
to introduce internationally accepted supervision
standards, in order to ensure a healthy development of
their financial systems and also to be better able to
attract foreign direct investment. The progress already
made in several of those countries toward the
convertibility of their currencies and toward their
insertion into the globalized markets should be
consolidated and extended to all the countries of the
area.
c) Developing countries are themselves extremely diverse,
with the newly industrialized countries of Asia moving
toward the OECD; the Latin American countries emerging
from a debt crisis and a period of instable policies; the
African countries striving to meet the basic needs of
their population; the oil producing countries notably in
the Middle East in the wake of the Gulf crisis; and China,
India and Pakistan with their specific characteristics.
Because of the difficult global environment affecting
credit and liquidity, an additional allocation of SDR,
with its pattern of distribution different from the quota
system. has been suggested.
33. Long-term strategies, foreign aid and investment and
the emergence of a new entrepreneurship are the key
answers to the problems of developing countries. Thus, the
traditional role of the regional developing banks and the
World Bank needs to be strengthened if the problems of the
developing countries ought to be properly addressed. But
adequate and stable financial markets could contribute to
these endeavors. In the long term attention would have,
for instance, to be paid to an extension of the
supervisory standards in OECD countries to banks and
markets throughout the world. Some regional groupings with
a network centered around a regional financial market,
such as Singapore for the ASEAN countries, might prove
advisable. At the very end, financial markets should serve
the cause of development itself in ensuring a proper
allocation of resources, notably through stock markets
tailored to individual countries needs and offering, by
their interconnection, sufficient liquidity to attract
foreign investors, to disseminate stocks in the portfolio
of institutional investors and, thus, to ensure a healthy
development of their financial systems.
34. If there are three major currency blocs, with exchange
rates within each of these blocs fixed (pegged to an
anchor currency) as irrevocably as possible, a
compensatory mechanism or some measure of support should
be created within each bloc, to soften volatility of
capital flows and other short-term disturbances. For
instance, Europe might then encourage flows of capital to
Africa while African countries strengthen their banking
systems and create a framework aiming at attracting
foreign investment and capital. Vis-a-vis Latin America,
the debt strategy could be an instrument of the financial
modernization itself, notably through debt-equity
swaps.
35. Obviously, due to political risks involved, capital
markets cannot meet all the capital requirements of
non-OECD countries and there needs to be renewed emphasis
and enlargement of the role of official capital flows,
including those from multilateral institutions.
36. Nevertheless, private capital flows to non-OECD
countries have a major role to play. To ensure their full
efficiency, privatization, deregulation and liberalization
should go hand in hand with added stability and vitality
in capital markets.