Sumario: 14 April 2008, New York - Statement by Joaquín Almunia , European Commissioner for Economic and Monetary Affairs; Special high-level meeting of the Economic and Social Council with the Bretton Wood institutions, the World Trade Organisation and UNCTAD; "Building and sustaining solid financial markets: Challenges for international cooperation"
President Mérorès, Distinguished participants, Ladies and Gentlemen,
It is an honour to address this meeting and present to you the European Commission's assessment of the ongoing turmoil in the international financial system. I come from Washington where I participated to the G7 meeting and the Spring Meetings of the IMF, and I can anticipate that the European assessment and proposal fit very well with those of the major players in the global economy.
Smooth functioning financial markets underpin prosperity and progress the world over, and global financial stability is a global responsibility, so I will start by highlighting the importance of international coordination in fashioning a global policy response to the financial turbulence.
What is the origin of the problems we are facing?
Until the middle of last year, the international financial system was prospering. It was characterised by ample liquidity, rapid innovation and investor search for yield. Underpinning this development was leverage - the process whereby the market can create its own liquidity by reinvesting initial borrowings several times over.
The result was an expansion and deepening of financial activity across the globe. But it was accompanied by an unprecedented accumulation of credit risk within the system. As risk spreads narrowed and asset prices became inflated, there were increasing signs that investors were under-pricing risk. Predictions of a potentially disruptive correction in global asset prices became more widespread until in mid-2007, the correction began.
After many years of unconstrained leverage, the global financial system is now firmly in the grip of a de-leveraging process. Just as the process of leveraging brought bumper profits, the process of de-leveraging is now bringing corresponding losses.
Europe has responded to financial-system weakness revealed by the turmoil
This painful process will only end when investor confidence has been restored. The loss of investor confidence in the financial system reflects uncertainty about the ultimate size and location of losses. And this can be linked to several factors, notably:
1 concerns about information asymmetries due to a lack of market transparency;
2 doubts about the adequacy of risk management systems and risk measurement instruments within financial institutions
3 possible gaps in our prudential framework; and
4 more general concerns about the functioning of so-called non-organised markets.
In each of these areas, the role of credit rating agencies and the adequacy of their ratings have come under particular scrutiny.
It is essential that investor uncertainty about credit losses be removed. In the short term, investor confidence can only be restored by full disclosure of all losses by financial institutions and adequate recapitalisation. European Ministers of Finance earlier this month and the G7 and IMF Meetings just last week-end called for rapid and robust disclosure of risk by financial institutions. In the medium term, the weaknesses in the financial system - which has allowed such uncertainty to emerge
- must be addressed at a fundamental level.
But we should not forget that investor uncertainty relates to very basic characteristics of a modern financial system. Financial innovation has brought major benefits to the global economy. It has fostered a more efficient allocation of resources and boosted economic growth potential.
And not only for advanced economies. Major benefits have accrued for emerging countries via the development of their capital markets which has helped meet financing needs and fostered economic growth, which is now supporting their resilience in the face of the ongoing crisis.
The EU's response to the financial turmoil intends to achieve an appropriate balance between restoring investor confidence and retaining adequate incentives for entrepreneurship and innovation in the financial system.
A roadmap of actions was adopted by EU Finance Ministers in October 2007 which identifies four key objectives:
1 improving financial transparency in the market, notably with respect to banks' exposures to securitisation and off-balance sheet items;
2 an upgrading of valuation standards, particularly in respect of illiquid assets; in this context, the main focus will be on consistent application of international accounting standards, not only in respect of banks but also in respect of other financial intermediaries;
3 strengthening the EU's prudential framework for the banking sector, notably in relation to managing liquidity risk, concentration risk, and off-balance sheet exposures
4 investigating structural market issues, such as the role played by credit rating agencies, and the incentives created by the so-called "originate and distribute" model of credit-risk management.
The European roadmap favours self regulation and industry-led initiatives, as we believe that the primary responsibility for managing risk in the financial system lies with the private sector. On the other hand, regulatory action is needed whenever appropriate, and in particular if the industry fails to deliver substantive responses.
The latest ECOFIN progress report shows that implementation is underway and the roadmap should be fully implemented by the end of 2008.
Global financial turmoil requires global financial response
The response to financial-sector problems in one country will have inevitable spillover effects on the financial sectors in other countries. Therefore a coordinated response to the turmoil at European and international level will be essential.
So far, there has been remarkable international consensus on the underlying causes of the financial turmoil and on the broad policy response. The final report of the Financial Stability Forum has been presented in Washington last week-end and its main policy recommendations are entirely consistent with the EU roadmap.
The FSF report recommendations ware endorsed by the G7 participants and the IMF Committee, and a clear timeline for action added, including actions to be taken in the short-term (100 days) and in the medium to short-term (by the end of 2008). This shows the urgency to move ahead and for the financial industry to deliver substantial improvements on their market practices.
Such a high degree of international consensus is a very encouraging start. But, we now have to move on implementing these policy responses.
It is clear that each country has the right to tailor its policy response to the specific situation of its financial sector and to its own legal and institutional setting. On the other hand, it would be a mistake to believe that one can just "go it alone" without due regard to the international dimension.
This approach would be a mistake for several reasons:
1 First, it would ignore the reality of globalised financial markets where differences in market regulation and oversight can create competitive distortions and opportunities for undesirable regulatory arbitrage;
2 Second, it would be a missed opportunity for policymakers in different parts of the world to learn from each other's experiences of the financial turmoil. The dynamics of the current turmoil have undermined many of the pre-conceived notions about how financial markets work and respond to stress. Clearly, we are all on a steep learning curve and we should learn together.
3 Finally, a lack of international co-ordination in responding to the financial turmoil would send a negative signal to the markets. In the course of the turmoil, we have seen that markets respond most favourably when authorities act in concert.
To conclude,
Policymakers around the world must work together to upgrade the functioning of the global financial system. International policy co-ordination is always a challenge. But, the "structural break" in our thinking about financial markets due to the current turmoil offers us the opportunity to forge a new common approach. We should not let this opportunity slip by.
Over time, emerging economies will play an ever more important role in safeguarding financial stability alongside traditional players in the world economy. They should therefore be included in this international collaborative approach. For this successful reform of the international financial architecture and Bretton Woods institutions, as well as of other key international fora, is of the essence.
I have shown above how policy makers in Europe and the world over are providing recommendation and taking actions to respond to the current financial market turmoil. However, it is important that the underlying causes of the existing problems be tackled. In particular, the rapid accumulation of global imbalances and the risk of their disorderly unwinding, should continue to be on the top of the political agenda.
Additionally, we should not forget that the scarcity of primary resources, also due to inadequate energy and food policies of some countries, is putting enormous pressure on commodity prices. These global price increases contribute to inflationary pressures and pose challenges for the conduct of monetary policy and increases the risk of further slowdown of growth. But they are especially worrying because of their impact on developing countries and on the most vulnerable people in these
countries. This threatens the worldwide achievements in poverty reductions so far and we should not let this happen.
Thank you.
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