IMF draws lessons from financial crisis

Almost three years since the onset of the global financial crisis, the International Monetary Fund (IMF) gives its answer to what lessons central banks can draw from this catastrophe that has dragged many major economies into the worst recession in decades.

"The crisis brought the financial system to the verge of systemic collapse and raised the prospect of depression and deflation. Central banks helped defuse these threats, including through exceptional measures," the IMF said in a report released on Tuesday.

The crisis, triggered by a liquidity shortfall in the U.S. banking system, has resulted in the collapse of large financial institutions, the bailout of banks by governments and downturns in stock markets around the world. It is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.

Central banks from most major economies have done a great deal to fight the crisis by adopting both conventional and unconventional measures. Taking the U.S. for example, the Federal Reserve, the country's central bank, cut the leading interest rate to a historical low level and designed unprecedented facilities to inject liquidity to the financial system and soothe the credit crunch.

The report, titled Central Banking Lessons from the Crisis, said that the crisis seems to provide three important lessons for policy frameworks.

First, the IMF believed that financial stability should be addressed mainly using macroprudential policies, which seek to ensure financial stability by mitigating the build-up of systemic risk.

Macroprudential tools include capital requirements and buffers, forward-looking loss provisioning, liquidity ratios, and prudent collateral valuation.

"All potentially systemic institutions and markets should be within the macroprudential regulatory perimeter. Central banks should play a key role, whether or not they serve as the main regulator," said the report.

Second, the IMF insisted that price stability should remain the primary objective of monetary policy.

"Central banks have maintained the price stability credibility they gained before the crisis and this public good must be preserved," it noted. "The monitoring and analysis of financial system developments and risks can be better integrated into the formulation and implementation of monetary policy."

Third, the agency believed that it is necessary for central banks to make changes to their liquidity operations and broad crisis management frameworks, including to address moral hazard.

"Changes to enhance the flexibility of central bank operational frameworks will improve the resilience of the system. Institutions and markets that are potential recipients of liquidity support in times of stress should be monitored and regulated," said the report.

[Source: Xinhua, Washington, 20Jul10]

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