Current challenges in the global financial markets

The Financial Stability Forum (FSF) met in Rome on 28-29 March. Members discussed the current challenges in financial markets, the steps that are being taken to address them and policy options going forward.

Financial system risks and responses

The financial system faces a number of significant near-term challenges. With many securitisation markets effectively closed, assets are accumulating on bank balance sheets. Together with valuation losses on mortgages and other assets, this is straining capital positions and contributing to tightening credit conditions. Hoarding of liquidity and counterparty concerns are leading to a shortening of the maturity of banks’ funding profiles and causing severe strains in interbank and other lending markets.

While the necessary deleveraging has been ongoing since last summer, the process is being complicated by the lack of transparency and valuation difficulties for some credit instruments. Financial institutions should continue enhancing their disclosures of risk exposures and refining valuation judgements concerning structured credit activities and poorly performing assets on and off the balance sheet. Banks, securities firms and financial guarantors have made progress in replenishing capital levels and should continue to do so where necessary. The raising of capital and the repairing of credit markets will facilitate balance-sheet management by financial institutions and help to counteract the potential cycle of financial market and economic weakness.

National authorities have taken a variety of exceptional steps to facilitate adjustment and to dampen the impact on the real economy. Authorities in the main financial centres are in continuous contact and closely monitoring developments. Supervisors are working with firms so that risks in current market circumstances are effectively identified and appropriately managed. Central banks have provided liquidity to address market pressures, both individually and in concert, and will continue to do so as long as needed. Authorities will also act cooperatively and swiftly to investigate and penalise market abuse or manipulation.

Strengthening market and institutional resilience

The FSF discussed the report to be delivered to G7 Finance Ministers and Central Bank Governors in April that identifies the key weaknesses underlying the turmoil and recommends actions to enhance market and institutional resilience going forward. The report has been prepared by a working group comprising senior officials from major financial centres and from the international financial institutions and the chairs of international supervisory and regulatory bodies. It sets out specific policy recommendations in the following areas: prudential oversight of capital, liquidity and risk management; transparency, disclosure and valuation practices; the role and uses of credit ratings; the authorities’ responsiveness to risks and their arrangements to deal with stress in the financial system. These recommendations are concrete and operational and, if approved, the FSF will report on their prompt implementation.

Hedge fund industry

In its 2007 report on highly leveraged institutions the FSF called on the hedge fund industry to review and enhance sound practice benchmarks. In response, best practice standards have been developed by the UK-based Hedge Fund Working Group, and are to be released shortly by a similar US-based group. Both groups have established boards which will keep the standards up to date and monitor the take-up of the standards by hedge funds. The FSF would welcome regular reports on the adoption of the standards by the hedge fund industry and how well these standards are meeting the objectives of increasing transparency and improving risk management practices.

Sovereign wealth funds

The FSF discussed work underway at the IMF and OECD with regard to sovereign wealth funds (SWFs). The IMF in close partnership with the SWFs is coordinating work to identify a set of voluntary best practice guidelines, focusing on the governance, institutional arrangements and transparency of SWFs. The OECD is developing guidance for recipient countries’ policies toward investments from SWFs. Members welcomed these efforts and the participation of the SWFs in the development of these guidelines.

(This is press release of BIS)

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