Fortifying financial systems against crises
| Author | Sean Craig |
| Position | IMF Monetary and Financial Systems Department |
| Pages | 306-307 |
Page 306
Despite growing global payments imbalances, high credit growth, and recurring concerns about possible asset price bubbles, the world's financial systems have displayed remarkable stability in recent years.What can be done to preserve this stability and help avoid further crises? In early September, a high-level conference at the IMF examined the challenges facing central banks and supervisors and debated measures that could help strengthen crisis prevention efforts.
Assessing the risk of financial crisis is an inherently difficult task, Roger Ferguson Jr. (Vice Chair, U.S. Federal Reserve) observed in his opening address. A policy challenge is how to cope with this uncertainty. The approach adopted by the Federal Reserve, he said, is to seek to limit the impact of any crisis that might occur rather than be overly preoccupied with predicting and preventing it. Finding the right balance between the roles of regulation and market discipline in crisis prevention is also a major challenge. Excessively tight regulation can stifle market discipline, which, he cautioned,may not be conducive to financial stability.
Malcolm Knight (General Manager, Bank for International Settlements) saw the challenges of growing global imbalances and unprecedentedly low real interest rates being further compounded by rapid changes in finance. The intensifying search for yield, together with increasingly sophisticated financial systems, allows market participants to tap a wider variety of funding sources, but this, in turn, has contributed to rapid credit growth and rising asset prices. In earlier cyclical upturns, he added, monetary tightening would have helped dampen credit growth, but in the current cycle, central banks have delayed tightening because of continued low inflation.
Paradoxically, the success of monetary policy in containing inflation expectations may be contributing to credit growth and rising asset prices.
Complicating the policymakers' task is a limited understanding of the link between credit growth and financial crises. Charles Goodhart (Professor, London School of Economics) said that his recent research suggests that credit growth is more likely to trigger a crisis when accompanied by rising asset prices.
In many emerging market countries, rapid credit growth can increase the likelihood of crises by...
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