FSB Review of Risks and Vulnerabilities of the Global Financial System
The Financial Stability Board (FSB) met in Paris on 27 September to review risks and vulnerabilities affecting the global financial system, and progress on the regulatory reform agenda under co-ordination by the FSB.
Vulnerabilities in the Financial System
While considerable progress has been made in strengthening the resilience of the financial system worldwide, financial systems in advanced economies remain vulnerable to risks of fiscal strains in national and local governments, of renewed fragilities in bank funding markets and of weakening economic conditions. The potential for adverse feedback loops between weak economies, fragile banking systems, and fiscal strains remains significant. Further financial stability challenges arise from the continued reliance of some banks on support mechanisms, and from potential market pressures and risks of disorderly unwinding of large capital inflows to faster growing emerging markets.
The FSB emphasised the need to accelerate financial system repair by identifying and resolving weak banks in an orderly way, noting there are large benefits to a clear and systematic process, which avoids forbearance. Intensified supervisory scrutiny in targeted areas is needed as well to stem undesirable side effects of low interest rates and low market incentives for banks to adjust. Finally, authorities should continue to foster transparency through targeted consistent disclosures by financial institutions of risk factors that are most relevant to the market conditions at the time (e.g. sovereign risk during times of fiscal strains).
Progress on Regulatory Reforms
FSB members welcomed the agreement reached by the Basel Committee’s governing body on the new bank capital and liquidity standards. The new standards will markedly increase the resilience of the banking system, by reducing the likelihood and severity of future financial crises and creating a less procyclical banking system that is better able to support long-term economic growth.
The FSB, with the Basel Committee, have assessed the macroeconomic impact of the transition to the stronger capital and liquidity standards. The final report of the Macroeconomic Assessment Group, taking into account the calibration and phase-in arrangements agreed in September, will be published later this year.
Addressing systemically important financial institutions. The FSB reviewed the development of policy approaches for addressing the ‘too big to fail’ problems associated with systemically important financial institutions (SIFIs). It will make recommendations to G20 Leaders at the November Summit in Seoul covering the need for global SIFIs to have a higher loss absorption capacity; enabling the resolution of SIFIs without taxpayer solvency support; strengthening the intensity of SIFI supervision; and a peer review process to promote consistent national policies in this area.
Implementing central clearing and trade reporting of OTC derivatives
The FSB reviewed recommendations developed by an FSB Working Group to achieve the G20’s objectives to improve transparency, mitigate systemic risk and protect against market abuse in the over-the-counter (OTC) derivatives market. The draft recommendations promote consistent implementation across jurisdictions of measures to increase standardisation, central clearing and, where appropriate, exchange or electronic platform trading, and to have all OTC derivatives contracts reported to trade repositories. The report will be published at the time of the November G20 Summit in Seoul.
Reducing reliance on CRA ratings
The FSB reviewed principles being developed to reduce authorities’ and financial institutions’ reliance on credit rating agency (CRA) ratings. The goal of the principles is to reduce the cliff effects from CRA ratings that can amplify procyclicality and cause systemic disruption. The principles will call on authorities to reduce reliance on CRA ratings in rules and regulations, in order to reduce mechanistic market reliance on those ratings. The principles will be presented to G20 Finance Ministers and Central Bank Governors in October.
The FSB will establish outreach arrangements with non-member authorities, through the establishment of regional groups comprising member and non-member authorities. Members discussed the potential operational arrangements for these groups, including the information sharing and consultative roles that they could play. A detailed proposal on those arrangements will be further discussed at the October FSB Plenary meeting in Seoul. The regional groups’ first meetings will take place in 2011.