Directorate for Financial and Enterprise Affairs

Colloque on “Refondation du système monétaire et financier international”

 

Remarks by Angel Gurría, Secretary-General OECD

 

Paris, 16 mars 2010

Ladies and gentlemen:

It is a great pleasure to open, with Ambassador Karoutchi, the colloque on “Refondation du système monétaire et financier international”.

The themes of the conference go to the heart of the policy debate on what type of economy we want to build. France and the other economies need to restore self-sustained growth to create jobs. We need to reform international finance so that it plays its essential role in supporting economic activity -- and does not provoke another systemic crisis.  But we have to ask ourselves, do we have the right global governance mechanisms to address these issues in an effective way? 

The economic, social and human costs of the crisis have been enormous. The OECD estimates that in 2009 GDP in the OECD area contracted by 3.5%. Unemployment reached a post-war high of 8.8% in December.

The crisis would have been worse, had it not been for resolute policy action. Central banks slashed interest rates and injected vast amounts of liquidity in financial markets. Governments cut taxes and hiked spending to support vulnerable social groups and to boost public investment. These support measures were essential for averting a global economic collapse. 

Economic growth is now coming back, although the recovery remains fragile. GDP grew somewhat more strongly than anticipated in the United States and Japan in the last quarter of 2009, but remains weak in the euro area. Strong activity in key large emerging markets has been an important engine of growth throughout the crisis.  

 The main challenge we face going forward is how to ensure that a solid recovery takes hold. This is important because the effects of the crisis – dramatic as they have been in the short term -- will also be felt in the years to come. We estimate that OECD countries have lost about 3% of their potential output as a result of the crisis. This loss is in part due to a durable increase in unemployment. Structural reforms to increase employment and improve labour productivity will therefore be crucial to put the world economy back on a strong, sustainable and jobs-rich growth path.

The economic downturn has also wreaked havoc in public finances. Budget deficits have ballooned in the wake of the crisis and the gross public debt in the OECD as a whole could exceed GDP by 2011. This has become a major worry in Europe.  Large consolidation efforts will therefore be needed almost everywhere in the OECD area.  Sound public finances need to be restored, including through tax reforms and better tax compliance, without hampering the recovery. 

The financial crisis that erupted in September of 2008 has also exposed weaknesses in the financial system.  There were many inter-connected causes – excess liquidity in global financial markets, excessive leverage, investors’ search for yield and disregard of risk, mistaken credit ratings, low lending standards, lack of transparency and regulatory arbitrage via the use of over-the-counter (OTC) derivatives.  I will not try to name them all.  But certainly in many jurisdictions there were major failures in regulation, supervision, tax enforcement, corporate governance and risk management. 

The G20 leaders have asked for rapid action to address a broad range of problems that caused the financial crisis. The new Financial Stability Board and the organisations that it works with – including the OECD – have leapt into action.  What has been done so far?

Financial institutions will be required to increase disclosure, including of off-balance sheet positions.  Stronger rules for higher and better quality bank capital, and improved management of liquidity should be agreed by the end of this year and implemented by 2012. Exchanges will improve transparency and risk management through the introduction of centralised clearing of credit default swaps (CDS) and trading over-the-counter (OTC) derivatives, which should also be completed by the end of 2012. 

Governments have increased oversight of credit rating agencies. They are implementing better co-operation among supervisors and contingency planning for cross-border crisis management.

The OECD is working with governments to improve governance of remuneration, management of risk, board practices and the role of investors. All were factors that contributed to the crisis. Over 90 jurisdictions are actively working with the OECD to improve tax transparency and international exchange of information so that countries can fully enforce their tax laws to protect their tax base.

The FSB has also issued principles on compensation in banks so that it does not encourage excessive risk-taking. And the FSB, the Financial Action Task Force and the Global Forum on Transparency and Exchange of Information for Tax Purposes are all closely assessing jurisdictions’ adherence to international standards.

All this work is welcome and will strengthen important aspects of the financial system.  At the same time – now that the imminent danger has subsided – other, perhaps more fundamental questions – are surfacing and still need to be addressed. 

One that has come into focus with new proposals by the Obama Administration is the role of government in guaranteeing the activities of banks. Deposit insurance is a key element of the financial systems of most countries.  It provides assurances to depositors and prevents bank failures when there are unfounded rumours of bank weakness. This guarantee of stability is part of an implicit contract between society and financial institutions – in exchange for the vital role of banks in lending, mobilising capital and managing risk.  But should the guarantee extend to the activities of banks for their own profit?  And are there practical ways to distinguish banks’ activities for their own account?

Related to this is the question of “too big to fail”, and, in some cases, especially for small home jurisdictions, “too big to save”.  The higher capital requirements and leverage ratio cap that will be agreed by the end of this year will go some way to shrinking bank balance sheets.   But it is not clear that it will remove the problem of “moral hazard” that comes with size.  The biggest institutions believe that ultimately they will be saved by government if they get into trouble: as a result they can take more risk; and obtain capital more cheaply.  Governments are working on ways to make it easier to wind down institutions that get into trouble (bank resolution)  and the big banks have themselves been asked to produce “living wills” on how that can be done.  But many big banks have more than 2,500 legal entities. And resolution regimes differ widely across countries. Resolution of large institutions will be complicated. Hence, again, the question of “separation” of some bank activities is coming into focus.  Would it be easier to wind down the riskier parts of banks – if they could be isolated from the commercial lending that supports the real economy?

In this respect the OECD has been on the record for some time in favouring a non-operating holding company structure.  Its main aim is to separate core commercial banking functions—so important to the financing of households and SME’s—from certain investment banking functions. The structure proposed envisages separate legal subsidiaries where the capital of each is silo’d by law. This has certain advantages over Glass-Steagall style separation as it permits synergies in technology platforms, back office, and human resources. There are also economies of scale and scope that are worth protecting. But separate legal subsidiaries of a non-operating parent will mean that any smaller affiliate will have to pay the true cost of capital appropriate to its risk taking and the capital it has. If the entity still runs into insolvency in respect to its own capital backing it will certainly not be ‘too big to fail’. Indeed, the resolution process and living wills issues will be greatly simplified with separate balance sheets of subsidiaries.

Finally, as technical work on reform of the financial sector progresses, tensions related to implementation will emerge. Banks in different countries have different starting points for the amount and kinds of capital that they hold. Some will find it easier to meet the new capital rules by the 2012 deadline. Banks, and also structured investment vehicles, hedge funds and non-bank financial institutions, have different business models and will be affected in various ways by the new rules that are being developed. 

Ladies and gentlemen:

These differences across banks and across countries point to the importance of the third theme of the conference. Do we have the institutions of global governance – and sufficient collective political will – to follow through with stronger and harmonised financial rules? So far, governments seem willing to take strong measures, including at national level. To stay the course – through to effective implementation --will require a large investment. We need to build understanding of the issues. A lot is at stake – including the health of the real economy. We need to appreciate and acknowledge the interests of each system.  Governments will have to show flexibility. They will need to set priorities about what needs to be done now – and what can be phased-in over time. They will need to co-operate.

I am sure that this conference will contribute to these goals by building understanding and co-operation.

 

 

 

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