Monday, July 23, 2007

Q3.7| International Standards and Codes

Question 3.7

5.3 Developing International Standards and Codes
Prior to the East Asian crisis, there had been no systematic effort by international
agencies such as the IMF and the World Bank, or the other international financial agencies with responsibilities for monitoring the global financial sector, to establish standards and codes of good practice in regard to the financial
sector. The East Asian crisis highlighted the fact that there was no standard
set of benchmarks against which different countries’ financial sectors could be
assessed. In the absence of these benchmarks, it was argued, it would be difficult
either to give useful advice to countries, or to help prevent crises arising from the financial sector. For each country’s financial sector differed considerably, in its institutional structure, its degree of interconnectedness with global financial markets and in the calibre of policies applied by the financial authorities
and by financial institutions themselves, in regulating, supervising and managing the sector and its institutions.

Following the East Asian crisis, a large volume of work was conducted to create
standards and codes by which all countries might be benchmarked. The main
organisations involved were the IMF, the World Bank and other international
agencies such as the Bank for International Settlements, a long established central bankers’ organisation located in Basel. As this process has evolved, the IMF and the World Bank have come to assess whether countries are observing internationally recognised standards and codes in twelve separate areas. Following these assessments, the IMF and the World Bank also offer technical assistance to implement necessary reforms.

5.3.1 The Standards and Codes Framework
Since 1997, standards and codes have developed to advance:
• (1) transparency
• (2) the financial sector as a whole
• (3) market integrity.
Within those groups, the IMF and the World Bank (in cooperation with other standard setting authorities) have focused their work on twelve specific areas:
• data quality
• monetary and financial policy transparency
• fiscal transparency
• Transparency standards
Why transparency? It is a basic principle of financial economics that markets work best if full information is widely available. That is especially important for information about government economic policy and macroeconomic information
about the economy as a whole. The 1997 financial crises in Asia gave a wake-up call to bodies such as the IMF, for its staff discovered that, even for an industrialised country as advanced as South Korea, accurate data on such key variables as foreign exchange reserves had not been readily available.

Following that wake-up call, internationally recognised standards and codes covering government policy-making and operations were among the first to be developed. The IMF played a key role as standard setter in this area and three important sets of codes and standards on transparency have been developed.

Firstly, to improve the quality and timeliness of data, the IMF has been encouraging
its members to subscribe to the Special Data Dissemination Standard (SDDS) or participate in the General Data Dissemination System (GDDS). The SDDS is designed to guide countries that have, or are seeking, access to international capital markets. In subscribing to the SDDS, countries commit themselves to publish data according to a standard format, and to explain their data disseminationpractices. The GDDS is open for all member countries and covers socio-demographic, macro-economic and financial data. In agreeing to participatein the GDDS, countries commit themselves to publish their statistical practices, as well as plans for improving them. The GDDS is typically used by developing countries that do not have access to international capital markets.

Second, through a collaborative effort with its member countries, the IMF published a Code of Good Practices in Fiscal Transparency. The code outlines a series of standards for the collection and dissemination of fiscal data and information. The ultimate objective of the code is to encourage a well-informed public debate about the design and results of fiscal policy, thereby making governments more accountable.

Third, the IMF has also – and again with cooperation from its various member
countries – developed and published a Code of Good Practices on Transparency
in Monetary and Financial Policies. This code identifies desirable data transparency
practices for central banks and other financial agencies. One driving force
for promoting transparency in relation to monetary policy is the belief, supported
by macroeconomic theory, that a central bank’s efforts to control
inflation and achieve other objectives of macroeconomic stabilisation policy can
be most successful if the central bank can influence people’s expectations about
inflation and interest rates. Transparency can contribute to that, although in
major financial centres central bankers have reason to include some ambiguity
in their overall assessment of the economy and pronouncements about future
policy.

2. Financial sector standards
International financial sector standards have been established to assist both
national authorities and the international financial agencies, to prevent financial
crises from emerging. Unlike the GDDS, SDDS and the Codes of Good Practice in Fiscal Policy and in Transparency in Monetary and Financial Policies, the IMF and the World Bank are not the standard-setters themselves, in regard to many of these financial sector standards. Instead, the IMF and the World Bank cooperate with other agencies, including the Basel Committee on Banking Supervision, the International Organisation of Securities Commissions, the International Association of Insurance Supervisors, and the Committee on Payment and Settlement Systems, all of which have established standards in their respective spheres of authority.

In one partial respect, however, the IMF and the World Bank have positioned themselves as partial standard-setters in regard to financial sector standards.
This occurred in late 2002, when the IMF and the World Bank added recommendations
developed by the Financial Action Task Force to combat money laundering and the financing of terrorism to the list of areas they assessed.

3. Market integrity standards
Progress has also been made on standards covering corporate governance, insolvency, accounting and auditing. Although the IMF is involved, the World Bank takes the lead in this area, in cooperation with the Organisation for Economic Cooperation and Development (OECD), the International Accounting Standards Board and the International Federation of Accountants. The development of efficient legal systems for dealing with bankruptcy of firms, banks and other borrowers is seen as an important foundation for financial market integrity. The World Bank has developed Principles and Guidelines for Insolvency and Creditor Rights Regimes and actively promotes the development of sound bankruptcy systems. How does it contribute to the strength of the financial sector? Here is how the World Bank team summarised the case in their June 2004 Report on Observance of Standards and Codes (ROSC) for Chile:
Predictable mechanisms for debt enforcement and insolvency proceedings contribute to the development of a modern market economy. Such predictability also fosters confidence that fuels investment, credit, lending and commerce and contributes to a constructive credit-delivery competition. An effective insolvency and creditor rights system plays an important role in creating and
maintaining the confidence of both domestic and foreign investors. The general public perception as to the predictability and effectiveness of said insolvency and creditor rights systems not only contributes to the capital flows to Chile but also to the cost decrease of credits. World Bank (2004:3)


5.3.2 Assessing compliance with standards and codes
A country’s observance of internationally recognised standards and codes is examined by IMF and World Bank staff and summarised in what are known as Reports on the Observance of Standards and Codes (ROSCs). ROSCs covering the financial sector and monetary and financial policy transparency are usually prepared within the framework of the Financial Sector Assessment Program (FSAP), which you studied in the previous section.

The assessments are not designed to rank countries, or to seek to embarrass them. Instead, the assessments try to reflect the country’s particular circumstances,
including its stage of development and institutional capacity. Accordingly, no ratings or pass-fail grades are issued. Those practices are not simply due to diplomatic tact and the IMF and World Bank’s principle of seeking to achieve agreement and partnership with member countries’ governments. The avoidance of criticism or ratings is also prompted by knowledge of the damage that a clear ‘fail’ rating could do to a country’s ability to borrow and to the stability of a financial system that, by definition, is already fragile. By the end of March 2003, almost half of the IMF’s 184 member countries had completed one or more ROSC modules.

Countries themselves are responsible for implementing the recommendations contained in a ROSC or FSAP. Many developing countries, however, request technical assistance from the IMF and other international bodies in doing so. Finally, in order to keep ROSCs current, IMF and World Bank staff provide follow-up assessments. These range from brief factual updates to more detailed re-appraisals, where warranted.

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