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IMF emboldens financial reformers with damning report

The banking industry is still too concentrated and dependent on volatile wholesale funding, warns the IMF.

The IMF’s Global Financial Stability report serves as a shot across the bows of that vanishing group: proponents of laissez-faire regulation and bankers critical of the seeming pro-cyclicality of regulation.

In the IMF’s words: 

“Financial system are still overly complex, banking assets are highly concentrated, with strong domestic inter-linkages, and the too-important-to-fail issues are unresolved. Moreover, as some activities become more costly, some banks will get out of those businesses, but others with enough scale economies will stay in — making these activities even more concentrated.”

With Basel III, UK’s Vickers report, the Dodd-Frank Act, and market pressures for reform, the IMF alarm over the fact financial systems still appear “highly concentrated” and overly dependent on volatile wholesale funding is a damning indictment of the current regulatory momentum.

The IMF then goes on to cheekily pose the following questions – as if it’s 2008 again:

“[A] discussion should address the question of whether imposing higher costs can be expected to lower systemic risks. If not, the questions become: will restraints on activities be more effective, and what might their cross-border implications be?.”

IMF calls have been emboldened by data released by the US Federal Reserve in April that show that five banks – JPMorgan, Bank of America, Citi, Wells Fargo and Goldman Sachs – held $8.5 trillion in assets at the end of 2011, equal to 56% of the US economy.

The institutions combined are now around twice as large as a decade ago, relative to the US economy, sparking concern over the concentration of banking risk and rising fiscal liabilities – a fact that triggers consternation from banking reform critics, who fear the monstrous size of banks has sparked regulatory capture.

The IMF report then calls for speedier efforts to flesh out recovery and resolution planning for failed banks. However, it then adds fuel to the fire by suggesting its research proves that a reduced dependence on overseas bank funding is a bigger driver in buttressing financial stability in Australia, Canada, India and Malaysia – which are weathering the crisis well – rather than prudential supervision, though it does not look at the culture of conservative lending practices in these economies.

In summary, this IMF report will embolden the bank reformist agenda and, after years of preaching the virtues of aggressive financial liberalization in emerging markets, will no doubt trigger policymakers’ caution.

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