IMF says bank rules lag on safety while too-big-to-fail remains

September 25, 2012 06:24 AM

New financial regulations have yet to make markets safer and financial systems are still too complex, according to an International Monetary Fund report.

In some regions, financial reform measures are delaying a “reboot” to a safer economic system, the IMF said today in Washington. Risks remain that too-big-to-fail institutions will be further entrenched and that some bank-like activities will be pushed into the shadow banking system, the IMF report said.

“The data suggest that financial systems are still overly complex, banking assets are concentrated, with strong domestic interbank linkages, and the too-important-to-fail issues are unresolved,” the Washington-based lender said in the report.

The IMF report on financial reform comes as the U.S. is still implementing its 2010 Dodd-Frank law in response to the financial crisis. In addition, the European Union is attempting to create a single supervisor by handing the European Central Bank oversight powers over banks in the euro area.

The IMF said the financial system is not safer than before the crisis due to the greater interconnectedness and role of shadow banking. The IMF said it remains particularly concerned about too-big-to fail banks.

“Overall, risks in the financial system remain,” the IMF said as part of its Global Financial Stability Report. “Of particular concern are the larger size of financial institutions, the greater concentration and domestic interconnectedness of financial systems, and the continued importance of non-banks in overall intermediation.”

More Concentrated

The IMF said there is still the risk that “in some markets large institutions will become larger still, and more concentrated, and that these few global institutions will become even more influential -- thereby further entrenching the too- important-to-fail problem.”

Today’s IMF report is more critical of regulation than a study released Sept. 11 by IMF staff which found that new financial regulations will cause a “modest” increase in the interest rates banks charge on loans in developed countries as lenders reduce costs.

Through Dodd-Frank, the U.S. is implementing “resolution authority” that spells out how and when the government can seize and wind down struggling large banks and systemic non- banks before they catastrophically fail. Euro-area leaders are attempting to establish a central regulator and a resolution mechanism for bad banks backed by common funds from member states that could reduce concerns that customers will lose money when lenders fail.

Even Bigger

The financial crisis has resulted in even bigger and more interconnected banking groups and financial institutions, the IMF said.

“The officially inspired mergers, the nationalization of banks, and the extension of government underwritten guarantees that have been part of crisis management strategies all further instill the notion that some banks are too important to fail, potentially undermining the credibility of bail-ins,” the IMF said. “These interventions could result in more concentration, rather than less.”

The IMF said new capital rules from the Basel Committee on Banking Supervision should “enable institutions to better withstand distress” while possibly also resulting in unintended responses, such as pushing certain activities to the nonbank sector where those standards don’t apply.


The IMF cautioned that main elements of financial reform have not yet been implemented. As of September 4, 131 Dodd-Frank rules have been finalized while 132 requirements have not yet been proposed by regulators, according to a Davis Polk & Wardwell LLP progress report on the law.

“Some crucial elements of the reform are yet to be finalized, and many have not yet been implemented,” the IMF said in its report. “This leaves open the possibility of differences in their implementation or application, particularly as they trickle down from the international to the national level.”

European Union leaders in June called for a new banking supervisory system and underlined urgency in setting up the new system. In a speech yesterday, IMF Managing Director Christine Lagarde urged European policy makers to implement their plans to form a banking union.

‘Vicious Cycle’

“We have advocated this for some time,” Lagarde said. “We continue to believe it should be initiated as soon as possible -- to break the vicious cycle between banks and sovereigns.”

Also, the IMF said evaluating the impact of these reforms is “challenging because the reforms are in process, the crisis is still not over, and crisis management policies are ongoing in some regions.”

In a separate report, the IMF said there are “trade-offs” between the benefits of financial reform on growth and stability. In the report, the IMF studied the relationships of financial structures from 1998 to 2010.

“On the positive side, protective financial buffers within banks have been associated with better economic outcomes,” the IMF said in its report. “On the negative side, a domestic financial system that is dominated by some types of nontraditional bank intermediation has in some cases been associated with adverse economic outcomes.”

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