International Financial Architecture and the Resolution of Financial Crises

Governor of the Bank of Canada. This is a slightly revised version of a speech given to the National Capital Branch of the Canadian Institute of International Affairs on 14 May 2002.THE PREAMBLE TO THE BANK OF CANADA ACT calls on the Bank to promote the economic and financial welfare of Canada. In this context, the Bank aims to foster good economic performance through monetary stability - that is to say, through low, stable, and predictable inflation. But no market economy can function properly unless it is also supported by an efficient and stable financial system. Sound financial institutions, a robust infrastructure, and well-functioning financial markets are necessary to facilitate transactions and to properly channel savings into investments.This is certainly true for Canada's domestic economy. But in today's interconnected world, it is equally true for the global economy. Recent experience has shown that world events can have serious repercussions on national financial markets, including ours, and indeed on our entire economy. The Mexican crisis of 1994-5 and the Asian and Russian crises of 1997-8 are cases in point. In both instances, Canada was sideswiped. And although the recent acute economic and social problems in Argentina have not resulted in widespread contagion, they have, nevertheless, had implications for Canadian banks operating in, or holding claims on, Argentina.So, Canadians have more than a passing interest in a healthy global financial environment. As the world becomes more and more integrated, sound macroeconomic policies and sound financial systems across all countries are becoming increasingly important.The episodes of financial stress that the world has experienced in recent years have revealed weaknesses in the foundation of the international financial architecture. To reduce the incidence and the impact of global financial disturbances, those problems have to be addressed, and that foundation has to be fortified.In the aftermath of the crises of the late 1990s, the international community acted to identify and to begin to deal with financial vulnerabilities.Canadians have been actively involved in this work. And the Bank of Canada has played its part. The Bank participates in several international forums where issues of financial stability are debated. And it works closely with others to strengthen the international financial architecture by developing frameworks for the prevention, management, and resolution of crises.While significant progress has been made, more needs to be done. But before discussing what needs to be done, a brief review of the lessons we have learned, or ought to have learned, from recent financial disturbances is in order.CRISIS PREVENTION - LESSONS AND PROGRESSWhat are some of the factors that led to the serious problems experienced by Mexico, a number of Southeast Asian countries, Russia, and, more recently, Argentina?In various combinations, there were large current account and fiscal deficits, heavy reliance on short-term borrowing, weak banking systems, poor risk management, overvalued exchange rates, and a lack of transparency in fiscal, monetary, and financial policies. Moreover, the presumption that the international community would come to the rescue if things turned sour appeared to offer some form of protection to borrowers and lenders in emerging markets. This presumption distorted market signals and encouraged over-borrowing and over-lending.So what has been done, and what can be done, to minimize the risks of future crises?A Sound Macroeconomic Policy FrameworkIt is now broadly recognized that sound and credible macroeconomic policies are the first line of defence against financial crises. As we know from our own experience in Canada, this means a fiscal policy focused on keeping public sector deficits and debts on a sustainable track and a monetary policy focused on keeping inflation low and stable. …

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