Reforms to Global Financial Architecture
Mortlock, Geof, The Reserve Bank of New Zealand Bulletin
In recent years, and particularly since the Asian crisis of 1997/98, much international attention has been directed at proposals to reform aspects of the international financial system -- the so-called "global financial architecture". This article outlines the concerns underlying the international financial reform proposals and summarises their key objectives and elements.
The last three years or so has been a period of reconsideration of several elements in the international financial system. The review process was initiated in the context of the Asian crisis of 1997/98 and other episodes of financial and economic instability, in an attempt to identify measures to reduce the risk of future instability and promote a more effective means of resolving financial difficulties when they do arise. Many of the reforms identified are still under way and in some cases are likely to take several years to implement.
Given the potential importance of reforms to the international financial system, and the implications for national economies, including that of New Zealand, it is useful to promote greater public understanding of the issues involved. This article seeks to do that by explaining the context in which the issues have arisen and summarising the main elements of the reform proposals.
As we observe later in this article, there is much of value to be extracted from the proposals. But, at the same time, the collection of measures does not yet live up to the label that the international community attaches to it and that we have reported in the title of this article.
Section two of the article sets out the principal concerns that have given rise to the proposed reforms of the global financial system. Section three discusses the policy objectives underlying reforms and the policy responses being pursued to meet these objectives. It then summarises the key elements in the main policy initiatives. Section four discusses in general terms some of the implications for New Zealand arising from the international financial reforms. And section five draws together some concluding thoughts.
2 The concerns underlying international financial reforms
Interest in reforming elements of the international financial system were triggered by a number of concerns, particularly those arising from the financial and economic instability experienced in parts of Asia and Russia in 1997/98. The main concerns are summarised below:
Financial liberalisation and cross-border capital flows
One of the principal concerns relates to the process of financial sector and capital account liberalisation and the risks that can arise after a period of rapid liberalisation. In particular, there has been a growing awareness that rapid liberalisation, and the associated expansion of credit and increase in the mobility of cross-border capital, can give rise to significant risks unless liberalisation is preceded or accompanied by measures to promote more effective risk management.
One of these risks is the potential for large capital inflows to be poorly invested, resulting in a misallocation of resources, which in turn can reduce the growth capacity of an economy and distort asset prices. For example, in a number of countries, rapid financial and capital account liberalisation, unsupported by sufficient strengthening of the management of risks, resulted in a sharp increase in commercial property and equity-related investment. As a consequence, commercial property and equity prices rose to levels that subsequently proved to be unsustainable. The eventual correction in these prices contributed to a sharp deterioration in the asset quality and financial performance of the financial and corporate sectors. In some cases, the deterioration was so severe that large numbers of banks and other corporate entities became insolvent, leading to widespread financial instability. …