Bank Credit Procedures Are Key

• Author: Claire Liuksila
• Position: Editor, Finance & Development
• Pages: 3-4

Page 3

The past decade has witnessed a string of banking crises, some of them associated with sharp swings in asset prices, severe bouts of exchange market volatility, shifts in the macroeconomic environment, and problems in key emerging markets. To prevent such crises in the future, much effort has gone into improving financial system regulation and supervision. Yet, according to Gerald Corrigan, former Chairman of the U.S. Federal Reserve Bank of New York and of the Basle Committee on Banking Supervision, strengthening regulatory and supervisory capability is only part of the solution. The essential requirement is the development of a culture of credit, including improvements in banks' credit procedures and the institutional environment in which credit transactions take place.

A group of IMF staff recently had the opportunity to exchange views on banking system soundness and supervision informally with Corrigan at a seminar chaired by IMF First Deputy Managing Director Stanley Fischer. The IMF holds such seminars from time to time to provide staff with an opportunity to go "one-on-one" with leading experts on the key policy issues that arise in the IMF's work with member countries.

Although banking crises might be triggered by a variety of circumstances, their common denominator, according to Corrigan, is poor quality assets, which are often difficult for even the best supervisory systems to detect. The problem often begins right at the loan applica-Page 4tion stage, when banks compile information about prospective borrowers. In industrial countries, much of the information declared by the borrower can be verified by credit bureaus, tax returns, and securities market prospectuses, and the borrower's obligation to be truthful is backed by legal sanctions. This may not be the case in developing countries, where the mechanisms to verify information about borrowers are generally lacking. Moreover, the fact that some companies belong to industrial groups that are principal shareholders of the banks that lend to them makes the information problem in some developing countries even more acute.

The next stage-loan approval-is also important. The policies and procedures surrounding the credit review process must be flexible and adapt over time to changing circumstances. In the banking systems of many emerging economies, such flexible and adaptable policies and procedures are still in the early stages of development. Incomplete information about...