Brookings-Wharton conference Standards, governance, bank regulation help to integrate emerging markets in global system

hat obstacles are there to the growth of emerg- Gothenburg surveyed international practice and con- Wing markets? “Round up the usual suspects,” cluded that creditor-oriented systems (the traditional advised Columbia University’s Frederic Mishkin at a U.K. practice) were effective, but so were debtor-ori- January 11–12 Brookings-Wharton conference that ented systems (the French focused on integrating emerging market countries in approach, for example, makes the global financial system. In response to Mishkin’s maintaining employment a call, presenters looked at the role of property rights, principal goal). What matters is bankruptcy law, standards and codes of best interna- enforcement and that all parties tional practice, security market development, corporate understand what will happen in governance, accounting standards, and bank regulation the bankruptcy proceeding. and supervision. Many also underscored how vital it is Ray Ball of the University of for emerging markets to be consistent in implementing Chicago discussed the closely the policies and the practices they choose to follow. related issue of corporate accounting, looking at how well Environment for enterprises various systems provide infor- A number of papers asked what steps are needed to mation on firms’ balance sheets bring the environment for enterprises in line with for the purpose of monitoring global standards. Reena Aggarwal from Georgetown and at how well they capture University talked about a paradoxical situation in changes—particularly losses— which emerging market economies thrive while their in the value of the firm. He Michael Pomerleano stock markets are in decline. She concluded that major drew an important difference between common enterprises in these emerging markets are increasingly law–based systems (the United Kingdom and the bypassing local stock markets to list themselves on United States), which are run mainly for shareholders, industrial country stock exchanges. But only the largest and those based on code law (continental Europe), in firms can do this, she said, so that the problems facing which other stakeholders have important rights. Both the remaining firms draw a great deal of attention. systems, he said, provide adequate monitoring, but Looking at corporate governance systems, Luis both fall short, in varying degrees, in terms of captur- Zingales of the noted that ing changes in the value of firms. Christian Leuz of the choice between a market-based “arm’s-length” the Wharton School agreed that accounting and dis- approach and a relationship-based approach depends closure systems are deeply embedded in a country’s crucially on the underlying contracting system. In institutional framework. Consequently, he observed, emerging markets, the arm’s-length model may not be traditional developing country systems, in which the optimal, he said, but it is likely to predominate in the concerned parties are limited to reasonably well long run, as it better accommodates international informed insiders, may in fact be the best option for investors. an environment with weak disclosure systems. Corporate governance reform may be important, Ball emphasized that complementary reforms are the ’s Michael Pomerleano commented, indispensable for developing better accounting sys- but the risk of future crises will not be substantially tems. Legal reforms, especially those that make man- reduced until public financial sector governance— agement liable to shareholders for misrepresenting the especially that of monetary authorities—is also condition of the firm, are essential for reliable account- reformed. Governance failures in this area have played ing systems, he said. It is a waste of resources to focus a key role in a number of recent crises, he said, citing on accounting standards where the supporting infra- the failure to take timely action to avoid the collapse structure is not in place, according to Ball. As an illus- of the Thai baht; the provision of emergency bank tration, he discussed China, which has adopted liquidity in Indonesia, much of which went to fund International Accounting Standards (IAS), but where capital flight; and the hiding of foreign reserve losses company accounts remain so poor that the credibility prior to currency crises in Mexico and Korea. of IAS itself is threatened. When firms get into trouble, whether in a crisis environment or not, bankruptcy procedures become Role of local banks important, and potential creditors need to know what While the conference addressed a wide range of topics, February 5, 2001 will happen. Clas Wihlborg from the University of many participants singled out the crucial importance 51

©International Monetary Fund. Not for Redistribution of the banking sector. As Mishkin emphasized, potential banking crises are a principal source of risk in emerging markets. Weak banks make it risky for the authorities to raise interest rates, thus limiting the tools available to defend against currency crises. This in itself can trigger a crisis that brings down the banks. Ian S. McDonald Improved banking regulation Editor-in-Chief and supervision are critical to Sara Kane maintaining a sound banking sys- Deputy Editor tem, and the World Bank’s Gerald Sheila Meehan Frederic Mishkin Gerald Caprio Senior Editor Caprio presented new cross-coun- Elisa Diehl Assistant Editor try research assessing the features of Sharon Metzger supervisory systems that contribute to strong banking The second day ended with a session led by IMF Senior Editorial Assistant systems. The study concluded, most notably, that there First Deputy Managing Director , who Lijun Li Editorial Assistant is a strong positive link between state ownership of discussed his views on exchange rate regimes and cri- Joann Wheeler banks and the likelihood of a crisis. It also found a very sis prevention. On the former, Fischer noted that the Staff Assistant robust link between the generosity of the deposit major emerging market crises of the past few years Philip Torsani Art Editor/Graphic Artist insurance system and bank fragility. While many of its had all involved the departure from a pegged exchange Jack Federici conclusions were in line with earlier research, the com- rate system, while similar countries with floating rate Graphic Artist prehensive databases (see www.worldbank.org/- systems had had problems without crises. He said that The IMF Survey (ISSN 0047- 083X) is published in English, research/interest/data.htm) that the paper draws from this had led observers to focus on the so-called corner French, and Spanish by the IMF provide a solid foundation for future research. solutions of a free float or a hard peg. Nevertheless, he 23 times a year, plus an annual Supplement on the IMF and an added, there is room for managed floats and other annual index. Opinions and View from the practitioners intermediate solutions, especially where countries are materials in the IMF Survey do not necessarily reflect official Each day’s discussion ended with a presentation from not open to international capital flows, and he views of the IMF. Any maps referred the audience to his recent discussion of used are for the convenience of a speaker active in emerging markets. The first day, readers, based on National PIMCO Emerging Market Fund’s Mohamed El-Erian exchange rate regimes at the meetings of the Geographic’s Atlas of the World, American Economic Association (see IMF Survey, Sixth Edition; the denomina- challenged the image of emerging markets as risky tions used and the boundaries and highly volatile. Noting that the volatility of January 22, page 26). shown do not imply any judg- ment by the IMF on the legal emerging markets’ security prices had declined over On crisis prevention, Fischer called attention to status of any territory or any the past year, he pointed to a range of reasons why this progress in five areas: more candid surveillance by the endorsement or acceptance of such boundaries. Material was so, mentioning improved macroeconomic policies IMF, especially with respect to countries’ vulnerabili- from the IMF Survey may be in the countries themselves, reduced participation by ties; introduction of the Financial Sector Assessment reprinted, with due credit given. Address editorial correspon- highly leveraged institutions, greater efforts at investor Program; work on developing and implementing dence to Current Publications relations by borrowing countries, and a rapid response standards and codes of good financial practice; Division, Room IS7-1100, IMF, Washington, DC 20431 by the IMF when recent crises in Argentina and increased transparency of the IMF itself; and intro- U.S.A. Tel.: (202) 623-8585; duction and reform of the IMF’s Contingent Credit or e-mail any comments to Turkey put the entire asset class at risk. [email protected]. The IMF An especially positive factor in the declining volatil- Lines, which he expected would soon begin to be used Survey is mailed first class in by member countries. Canada, Mexico, and the United ity, he said, was the more active role played by bor- States, and by airspeed else- rowers. This greater activism ranged from conference The overarching question, said Fischer, was how to where. Private firms and indi- viduals are charged $79.00 calls with investors to increased provision of data minimize the damage from vulnerabilities. Once a cri- annually. Apply for subscrip- (partly in response to IMF transparency initiatives) to sis occurs, there is a necessary choice between extend- tions to Publication Services, Box X2001, IMF, Washington, greater sophistication on the part of countries’ debt ing guarantees to the banking system or facing the DC 20431 U.S.A. Tel.: (202) managers in the timing of their market activity, collapse of the banking system. The IMF has sup- 623-7430; fax: (202) 623-7201; e-mail: [email protected]. including absorbing some of the volatility by actively ported a number of countries in recent crises when trading in their own securities. they took the first course. To those who worry about moral hazard created by guarantees, he said no coun- try would allow an unneccessarily large recession sim- Correction: In the January 8 issue of the IMF Survey the ply to serve as a warning to investors, nor should it do reference to the IMF’s Data Quality Reference Site (DQRS) was incorrectly identified on page 12. The IMF’s so. February 5, 2001 DQRS is available at http://dsbb.imf.org/dqrsindex.htm. Wayne Camard 52 IMF, External Relations Department

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