Financial sector flying too close to the sun
WASHINGTON, DC: Monetary policy needs to stay accommodative to achieve the economic growth desired, but a side effect is the danger of reckless risk taking, which is particularly acute in the non-bank sector, managing director of the International Monetary Fund (IMF), Christine Lagarde, said.
Noting that there are present and future threats to growth, Lagarde said there are similar threats to financial stability.
"While the real economy might suffer from too little investment, the financial sector might be flying too close to the sun," she said, explaining that there was too little economic risk taking and too much financial risk taking.
The IMF head, citing an example of the risks posed by the non-bank sector, said mutual funds now account for 27 per cent of global high-yield debt, twice as much as in 2007.
At the same time, she said risks are more concentrated since the top 10 global asset management firms now control a whopping US$19 trillion, larger than the United States', the world's largest economy.
"History teaches us a clear lesson - the bigger the boom, the bigger the bust. A sudden shift in sentiment could easily cascade across the entire globe," Lagarde told a plenary at the annual meetings of the IMF and World Bank Group on Friday.
She said this fed into the longer-term issue that affects financial stability and the increasing interconnectedness of the world economy. "As you know, financial flows can zap and zoom across the world at lightning speed," said the IMF chief.
Lagarde said the degree of financial integration has jumped tenfold since the IMF was founded in 1944, noting that in the two decades before the crisis started in 2008, international bank lending, as a share of world gross domestic product, rose by 250 per cent.
"This interconnectedness offers great benefits," allowing more people to access global financial networks. But it also comes with a dark side: It makes financial crises more likely to occur, and more virulent when they do occur," she said, citing the events of 2008. Lagarde served as France's finance minister between 2007 and 2011.
Quoting Rabindranath Tagore, polymath and recipient of the 1913 Nobel Prize in Literature: "You can't cross the sea merely by standing and staring at the water," Lagarde said: "That means we need the right tools and policies. If financial markets are more challenging, then policies must be more powerful, and regulators and supervisors must be better equipped. The bottom line? We must complete the financial sector reform agenda, and we must continue to update it as financial minds are creative and fertile in seeking out new loopholes."
She said much progress has been made, especially on banking regulation, but there was still a need to overcome the too-important-to-fail problem.
"We need better rules for non-banks, better monitoring of shadow banks, and better safety and transparency over derivatives. We need to strengthen macroprudential safeguards," Lagarde said.
"And let's be candid - we need to see a change in culture and behavior; we need to move away from the myopic mentality that led to the crisis, the tendency to prize profit over prudence, self-interest over service, excess over ethics."
Lagarde said the IMF has a key role to play in coping with this new world of interconnections.
"A world of large capital flows means that we need a large global safety net. Regional arrangements, including the new BRICs (Brazil, Russia, India, China, and South Africa) contingency reserve arrangement, certainly have an important role to play," said the managing director.
"But the IMF, as the only truly global institution focused on financial stability, must have adequate instruments and resources," she said, later noting that "we must strive to be even more representative of our dynamic global membership by completing the 2010 governance reforms being held in abeyance by the United States Congress".
Citing lessons learned over 70 years, Lagarde said a strong global economy requires a strong IMF.