'Global finance reform has to be fundamental'

Though the recent financial crisis has shown the huge risks in globalisation of finance, there is no evidence of a fundamental review of the ideological base of the global economy and global finance, said Y V Reddy, former governor of the Reserve Bank of India.

“In other words, the new global financial architecture (GFA) is new only in operational terms but not in strategic terms,” he said.

While delivering the fourth IG Patel Lecture – instituted by the London School of Economics in honour of its late director – Reddy said the recent crisis had brought into focus the gross inadequacies of the GFA, of the institutional and policy arrangements aimed at enhancing benefits and minimising risks of globalised finance.

Reddy spoke of how the international monetary system and exchange rate arrangements generated macroeconomic imbalances, were a source of financial instability and went on without correctives. The surveillance of systemic risk was inadequate and financial markets have been globalised and financial institutions have been operating cross-border without adequate global coordination of regulations.

Surveillance by the International Monetary Fund, a GFA pillar, was not even-handed. It didn’t spotlight some of the weaknesses in major advanced economies. When the crisis occurred, its lendable resources were inadequate to meet the requirements of a number of developing economies, many of which had been impacted and not because of their own weaknesses.

As a result of the global crisis, some of the proposals originally mooted after the Asian crisis in 1997 were being revisited more seriously than before. Now, there is better appreciation of the problem as being global in nature — though in reality, the problem was in advanced economies but being transmitted to many developing countries, said Reddy.

New GFA
On a new GFA, Reddy said there was greater effort now to address systemic issues in surveillance. Only last month, the IMF made it mandatory for 25 jurisdictions with systemically important financial sectors to undergo financial stability assessments every five years. Selection of countries for the assessment is based on the size and connectedness of their financial sectors. The lendable resources, too, have been enhanced. The IMF was also making efforts to erase the stigma associated with approaching it.

“The link between the financial and real sectors has not been explored adequately. There is still an assumption that real activity will have to necessarily adjust to financial markets. Also, the trade-offs between growth, stability and regulation have not been sufficiently explored in the design of improvements to the GFA,’’ he said, adding that the design seemed to aim at addressing the stability issues of advanced economies rather than structural and developmental issues of developing economies. The missing element in regulation is the interconnected and cross-border financial processes, particularly in the activities of international banks.

Reddy said the functioning of a revived IMF and a rediscovered G-20 will determine how new the new GFA will be.