Tuesday, November 18, 2008

Shaukat Aziz: The IMF must come to the fore in countries’ time of need

As Pakistan finalises a $7.6 billion bailout from the IMF, the country’s former prime minister says leadership and wisdom is required to help the globalized financial markets survive the financial crisis.

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The foundations of the global financial system have been shaken and we are going through a very challenging period, facing a crisis of confidence with reduced liquidity, capital and debt availability. The world has globalized and inter-linkages, dependencies and connectivity have increased exponentially.

When the crisis arrived, many argued that decoupling would occur and there would be no contagion. Nothing is farther from the truth: no country or market is an island. All stakeholders will be hit. As the dynamics of each market are different, the extent of the impact will vary but no one can completely escape this tidal wave.

We must examine why we arrived at such a situation and what lessons we can learn. Can we prevent such events from reoccurring? A few years ago, things were healthy: rising asset values, strong global growth, buzzing markets abundant capital flows and plentiful liquidity. Globalization, deregulation and liberalization were actively promoted to accelerate growth and prosperity. A market system is the right way but this requires a change in mindset by all stakeholders. Policymakers, regulators, financial institutions, companies and individuals must all adjust. Yesterday's approach will not get us where we want to go.

The power of free enterprise cannot be underestimated. Globalization, deregulation and free enterprise come with a requirement for change and new challenges. Structural reforms have paid huge dividends. This must continue if we are to leverage our true potential. Reform is continuous and must not fall victim to the current crisis. We have also been affected by fragmented regulatory regimes. Regulators do a good job in a controlled environment, but with deregulation and globalization, they must change. Complex new products are not always understood by those who market them nor by regulators. New risk management challenges and lack of understanding resulted in huge losses and erosion of confidence.

Financial institutions were driven by a euphoria which encouraged uncontrolled growth, imprudent risks, and a breakdown of controls. Senior management must be accountable for failure of risk management in addition to imprudent compensation policies. Bonus payments should be spread over the life of the transaction and the originators of risk products must carry the risk until maturity. Once ownership exists for the life of the transaction, behaviour will be more responsible. Risk was also offloaded via derivatives offered by insurers and others. No one questioned the total aggregate exposure of institutions and counterparties for each type of contingent liability. If anybody did, there was no real analysis of the potential risks if contingent liabilities became real. Stress testing for different scenarios is essential for prudent risk management and requires senior management overview.

The role of the rating agencies needs closer examination and oversight. It is clear that institutions cannot abdicate their risk evaluation and approvals to the agencies. Primary responsibility lies within each institution. Rating reports are valuable but not the only indicator considered by decision makers.

Apart from failure of risk management by financial institutions, we need to address the fragmented regulatory environment. Regulators at local, regional and national level must create seamless regulatory regimes. Multilateral and national institutions must develop a paradigm where regulators look across institutions by type of risk and coordinate their activities. An effective model needs to evolve to meet these challenges. The IMF can and should play a proactive role. Frankly, it has been on the sidelines of the current crisis. It must come to the fore and drive global coordination and increase its resources to countries in need of support. Furthermore, countries need to increase capacity so that policymakers and regulators are equipped with the skills to understand complex products and ask the right questions in constant touch with market behaviour and developments.

Governments must build capacity to be ahead of the curve and realise that markets require constant, proactive and pre-emptive attention. This will allow them to prevent or minimize crises. They need frequent interaction with key participants to avoid surprises and feel the pulse of the markets. This should not be done only in a crisis but in good times. When things are going well arrogance creeps in. Greed and arrogance lead to irrational decisions which shake the very foundations of markets, reduce income and jobs and result in market meltdowns. The current situation for emerging markets and the world is serious and will require a longer-term solution. Credit is not freely available, access to capital markets has diminished and the system is suffering from gridlock and lack of confidence. We must work through this crisis by learning from mistakes and adjusting and adapting to the new paradigm. Deregulation however, does not mean abdication. The authorities must protect public interest and help avoid systemic risks. The financial services industry has many smart people intermediating risks, meeting needs and designing complex products. But more than smarts is needed: it requires leadership and wisdom to meet the challenges which confront us.

Shaukat Aziz was Prime Minister of Pakistan from 2004 to 2007. Before that he was the country’s finance minister. He was previously an investment banker at Citigroup, holding a number of senior executive positions

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Shaukat Aziz: The IMF must come to the fore in countries’ time of need

As Pakistan finalises a $7.6 billion bailout from the IMF, the country’s former prime minister says leadership and wisdom is required to help the globalized financial markets survive the financial crisis.

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