General Manager's statement

Statement by Mr Jaime Caruana, General Manager of the BIS, at the BIS press conference on the occasion of the Bank's Annual General Meeting, Basel, 28 June 2010.

A warm welcome to you all. I am accompanied by Stephen Cecchetti, the BIS Economic Adviser and Head of the Monetary and Economic Department. Before Steve and I take your questions, I would like to make a short statement.

This year's BIS Annual Report focuses on the legacy of the financial crisis. The exceptional measures taken worldwide over the past two years succeeded in preventing a financial system meltdown and in bringing to an end the great contraction in global economic activity.

But policy challenges today are no less daunting than they were a year ago. The room for manoeuvre for macroeconomic policies has narrowed. Most advanced economies are reaching the limits of fiscal expansion. The essential task of reducing leverage and repairing balance sheets is not finished. Extraordinary measures seek to help an orderly adjustment, but we must recognise that some of them are delaying the necessary changes.

Steering economic policy in such circumstances requires a delicate balance. A well-articulated medium-term perspective is needed to guide all policies - including those aimed at supporting a still-fragile recovery and keeping the financial system operating. Policymakers also have to foster adjustment in the financial sector and the development of a less credit-dependent growth model.

The specific policy measures that are needed will vary according to the different circumstances in each country. The scale of fiscal problems and the strength of local banking systems differ across countries. There is therefore no single policy prescription for all.

Let me underline three broad policy challenges.

First, a convincing start needs to be made to reducing fiscal deficits in the advanced economies. In many countries, growth can no longer be sustained by fiscal expansion and front-loaded fiscal consolidation is required. Recent announcements of fiscal consolidation plans and targets by a number of countries are therefore welcomed. The alternative of having to cope with the financial and macroeconomic disruption from a sudden loss of market confidence would be far worse.

Over the past year, growth in many emerging market economies has recovered strongly. This has helped to improve global demand conditions. But inflation and capital inflow pressures in many of these economies are now raising difficult policy dilemmas. A more flexible exchange rate could help relieve inflation pressure in some countries, as well as promote more balanced global growth.

The second challenge is that authorities must foster the necessary strengthening of balance sheets in the financial sector. This is the precondition for restoring financial stability and scaling back public sector involvement in financial intermediation. Banks have raised new equity capital, but some are still not well positioned to absorb the losses and risks that may lie ahead. In addition, some banks have yet to make transparent the scale of losses already on their balance sheets, and remain too dependent on very short-term borrowing. 

Exceptional government and central bank support was needed to quell the enormous uncertainty and market disruption during the crisis. But keeping support measures in place over a long period creates moral hazard. The public sector must actively promote adjustment to a more stable financial sector.

Third, we need to finalise international agreements on the reform of financial regulation. A coherent global financial stability framework is a precondition for a safer, more resilient financial system. It is therefore very encouraging that the Financial Stability Board has made considerable progress on its reform agenda.

Action is required on several fronts. We need more and better capital and liquidity buffers to make banks substantially more resilient. We must also reduce the moral hazard associated with the too-big-to-fail issue. And the systemic dimension of financial risk needs to become tightly woven into the new regulatory and supervisory fabric.

The Basel Committee is well advanced in its preparation of regulatory reforms addressing the core elements of bank soundness - capital, liquidity and leverage. The Committee's reforms are being prepared in consultation with the industry, and the measures are undergoing rigorous quantitative testing, including a macroeconomic impact study.

A sustained global recovery requires a stable and resilient financial system. The long-term benefits of lowering the probability and cost of financial crisis are substantial, and the reforms will quickly generate significant benefits from enhanced resilience. The new regulations need to be phased-in in a way that is compatible with the ongoing recovery. According to preliminary estimates, the net impact on global output during the phasing-in of the new regulatory regime is likely to be small and transitory.

Finally, the role of macroeconomic stabilisation policies - that is, monetary and fiscal policy - in ensuring financial stability must be recognised. Unsustainably high fiscal deficits can quickly destabilise financial markets. And long periods of extremely low policy rates give rise to financial stability risks. This means that, in order to play their financial stability roles effectively, central banks need realistic financial stability objectives and effective tools that are consistent with their monetary policy responsibilities.

Let me conclude. In today's fragile economic and financial environment, rebuilding confidence is an enormous challenge. We cannot wait for stronger global growth to facilitate policy adjustment. Credible actions for meaningful fiscal adjustment and for restructuring the financial system would boost confidence. Finalising international agreements on regulatory reform on schedule will reduce uncertainty and also send a positive signal, not only to markets, but also to the public at large.

Recently announced policy measures represent significant steps in the right direction: fiscal consolidation in some countries, the publication of stress test results for European banks, and the support of the G20 for the regulatory reform agenda are all important steps forward.