David Henderson: 01-01-08: Larry Summers’ Judgment

Article from Forbes here.

Davd Henderson questions Larry Summers’ Judgment. David worked with Summers during the Reagan Administration. I have reproduced a paragraph below.

You might want to read all of the commentary. It’s interesting.

Obama mentioned Summers’ intellect, as did many of the reporters who wrote about his appointment. Indeed, one of the words people use most often in talking about Summers is “brilliant.” As someone who worked with Summers under his mentor, Martin Feldstein, when Feldstein headed President Reagan’s Council of Economic Advisers (CEA), I can attest to his sharp mind. What concerns me more, though, is his understanding of the economy and of economic policy. One can be brilliant and still make bad forecasts and huge mistakes in judgment. And that matters when you’re coordinating a president’s economic policy.

David R. Henderson is a research fellow with the Hoover Institution, an associate professor of economics at the Naval Postgraduate School, and the editor ofThe Concise Encyclopedia of Economics.

Fed of New York: 11-30-08 Geithner Leaves Fed

Article here.

Possible short list for Geithner position as reported by the Wall Street Journal

1. Kevin Warsh – Fed Governor
2. Bill Dudley – Directs Fed’s Market Desk
3. Peter Fisher – Former Treasury Official, now at BlackRock
4. Stanley Fischer – Directs Israel’s Central Bank
5. Roger Ferguson – CEO of TIAA-CREF, Former Deputy Fed Chairman

Central Banking: 11-30-08 Basel Committee

Release here.

The Basel Committee on Banking Supervision today announced a comprehensive strategy to address the fundamental weaknesses revealed by the financial market crisis related to the regulation, supervision and risk management of internationally-active banks.

Nout Wellink, Chairman of the Basel Committee said that “the Basel Committee’s work programme is well advanced and provides practical responses to the financial stability concerns raised by policy makers related to the banking sector.”

Mr Wellink added that “the primary objective of the Committee’s strategy is to strengthen capital buffers and help contain leverage in the banking system arising from both on- and off-balance sheet activities.” It will also promote stronger risk management and governance practices to limit risk concentrations at banks. “Ultimately, our goal is to help ensure that the banking sector serves its traditional role as a shock absorber to the financial system, rather than an amplifier of risk between the financial sector and the real economy,” Mr Wellink said.

The key building blocks of the Committee’s strategy are the following:

* strengthening the risk capture of the Basel II framework (in particular for trading book and off-balance sheet exposures);

* enhancing the quality of Tier 1 capital;

* building additional shock absorbers into the capital framework that can be drawn upon during periods of stress and dampen procyclicality;

* evaluating the need to supplement risk-based measures with simple gross measures of exposure in both prudential and risk management frameworks to help contain leverage in the banking system;

* strengthening supervisory frameworks to assess funding liquidity at cross-border banks;

* leveraging Basel II to strengthen risk management and governance practices at banks;

* strengthening counterparty credit risk capital, risk management and disclosure at banks; and

* promoting globally coordinated supervisory follow-up exercises to ensure implementation of supervisory and industry sound principles.

Mr Wellink further noted that the Basel Committee expects to issue proposals on a number of these topics for public consultation in early 2009, focusing on the April 2008 recommendations of the Financial Stability Forum. The other topics will be addressed over the course of 2009.

Mr Wellink emphasised that the Committee’s efforts will be “carried out as part of a considered process that balances the objective of maintaining a vibrant, competitive banking sector in good times against the need to enhance the sector’s resilience in future periods of financial and economic stress”.

About the Basel Committee:

The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. It seeks to promote and strengthen supervisory and risk management practices globally. The Committee’s members come from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, United Kingdom and United States.

Central Banking: 11-30-08 Eddie Yue, Hong Kong Monetary Authority

Release here.

Ladies and gentlemen,

I would like to thank the organisers for inviting me to speak at this forum, which is being held in Hong Kong for the first time.

In the past several months, we have witnessed the unfolding of a global financial crisis. The sub-prime problem in the US and the ensuing credit crunch in the industrialised economies have spread and brought about a weakening of confidence in the solvency of the financial system. Concerns about credit risk exposures among financial market participants mounted following the failure of Lehman Brothers. Interbank money markets in many economies came under extreme pressure or seized up entirely. Extraordinary and concerted efforts by governments and central banks to restore confidence, inject liquidity and recapitalise the banking system appear to have paid off to the extent of preventing the collapse of the banking and financial system although credit and money markets remain stressed. As the turmoil deepened, people have also focussed attention on the wider impact of the crisis on the real economy, leading to a grimmer outlook for global economic performance.

Against the backdrop of this global financial crisis, Islamic finance is inevitably affected and subject to challenging conditions reflected by a steep slowdown in activities such as sukuk issuance and declines in equity value managed by Islamic funds. New sukuk brought to the market in the first three quarters amounted to some US$13 billion, down 40% from the same period last year.[Footnote 1 - Source: Bloomberg.]

But the pullback in new sukuk issuance and the widening of sukuk yield spreads are generally in line with what has been happening in the conventional market. This broadly suggests that the global sukuk market slowdown has more to do with the general market conditions and a general reluctance to issue US dollar instruments. Observers say that while there are still those who wish to issue sukuk, investors would prefer to stay on the sidelines in the current volatile market environment. It is true that the industry is experiencing a temporary setback, but this also reflects how closely integrated Islamic finance is with the global financial system, which is not at all bad news for the industry because when global markets stabilise and take a turn for the better – as they must in the long run – Islamic finance will ride on that curve and excel.

While we are in the midst of a global financial turmoil and there are many challenges lying ahead of us, I’m delighted to find this impressive gathering of regulators, shariah scholars, business leaders and practitioners who commit themselves to the future development of the financial market. Your presence here is ample evidence that there remains plenty of opportunities even in circumstances like these and that a forward-looking view is more important than ever. Today, I’m particularly honoured to join you in the discussion of a topic that has been recognised as a source of sustainability and growth – Islamic finance. There are two main issues that I would like to talk about today.

First, despite the current financial turmoil, we continue to see the long term potential in Islamic finance. There are two good reasons for this. One is that the Islamic finance industry is in many ways fortunate to be at an early stage of development during this turmoil. Despite the effects of a temporary shortage of liquidity, which has been a worldwide phenomenon, the degree of damage has been far lower than that to the much wider network of international finance, primarily because of the more restricted spread of Islamic financial instruments across regions and the generally lower level of leverage allowed in Islamic financial transactions. Although Islamic finance has grown by leaps and bounds in recent years, assets held by Islamic financial institutions and insurance operators known as takaful providers are estimated to be US$1 trillion, accounting for only about 1% of the financial assets in the overall banking and insurance sectors.[Footnote 2 - 2 Sources: Islamic Financial Services Board; IFSL Research]

The industry’s remarkable annual growth rate of 15% to 20% has to be viewed in perspective: after all it began from a small base. This suggests that there is still ample room for growth on the supply side in the provision of Islamic financial products.

On the demand side, the potential of Islamic finance is often linked to the 1.4 billion-strong Muslim population worldwide, and some people appear to believe that this obviates the need for further development of Islamic finance. But population is not the only factor: economic development in Islamic regions also has to be taken into account. The IMF has estimated that there are some US$800 billion worth of investment projects under way or in the pipeline in countries of the Gulf Cooperation Council (GCC) over the next five years, with major projects in the oil and gas sectors, infrastructure and real estate. According to a UK research report, the annual investment rate in the range of US$200 billion to US$300 billion in the GCC is about half the annual rate of India and one-tenth that of China.[Footnote 3: 3 Source: Chatham House report on “The Gulf as a Global Financial Centre”]

As some of the deals may be of a scale that requires financial risks to be spread internationally, global banks are already geared up to tap this market through the formation of Islamic bank subsidiaries and Islamic banking windows. With the increased participation of global and regional players, project financing opportunities will increasingly attract interest from investors worldwide and that project finance will need to be delivered in forms that comply with the principles of Islamic finance. This in turn will fuel the demand for Islamic finance. There is clearly very significant long-term potential across most of the region.

The second issue is our continuous commitment to developing Islamic finance in Hong Kong. The Chief Executive of the Hong Kong Special Administrative Region acknowledged in his Policy Address in 2007 that Islamic finance offers huge potential for development. To further consolidate Hong Kong’s position as a global financial centre, Hong Kong should actively leverage on this new trend by developing an Islamic financial platform. Our priority is to push ahead with the development of an Islamic bond market. There should be no doubt about our determination to establish a platform for Islamic finance in Hong Kong.

In a recent speech, the Secretary for Financial Services and the Treasury also mentioned that having reviewed Hong Kong’s legal, taxation and regulatory regimes, there is no fundamental obstacle to accommodating a sukuk market in our existing system. Technical modifications to the taxation regime to provide a level playing field for Islamic finance transactions are being pursued as a priority.

With our commitment and status as an international financial centre, we believe that Hong Kong is well positioned to develop Islamic finance. We should play to our key strengths and capabilities and I would like to highlight two very important aspects on which Hong Kong intends to capitalise.

The first aspect relates to the core strengths of Hong Kong in providing a stable and free economy. Hong Kong has been ranked the freest economy in the world for 14 consecutive years by the Heritage Foundation. We have no foreign exchange controls and do not impose tax on offshore income, capital gains, dividends, estate or sales. There is free movement of capital, talent and goods. It is a combination of many factors including political stability, a strong legal and regulatory regime, and a pro-business market environment which makes Hong Kong a popular city for international business in Asia. Given these core values, there are no barriers to entry and no obstacles to mobility for financial and human capital from local and overseas financial institutions planning to engage in Islamic or conventional finance in Hong Kong.

The second aspect is the unique role Hong Kong plays in the economic development of China. In the past three decades when the Mainland was achieving economic liberalisation, Hong Kong has capitalised on its strong cultural and geographic links to become the gateway connecting the Mainland market to the world. Our close and increasing economic cooperation with the Mainland undoubtedly makes Hong Kong the natural choice for anyone wishing to tap into China’s high savings rate and huge growth potential.

Hong Kong is the premier capital formation centre for the Mainland and hence a global investment platform for enterprises from around the world wishing to gain exposure to China’s growth. This is demonstrated by the fact that we have the largest, deepest, and most open Chinese capital markets outside of the Mainland: half of our stock market capitalisation comprises Mainland related companies. At the end of August, our stock market was the sixth largest in the world and the second largest in Asia in terms of market capitalisation. It ranked first in the world in securitised derivatives turnover, and first in Asia for stock options turnover and exchange-traded funds turnover. It also ranked fifth in the world in total equity raised through IPOs.[Footnote 4 Source: World Federation of Exchanges]

In the other direction, many Mainland companies have set up regional headquarters or offices in Hong Kong as part of their strategies to step up their international presence. Continuously high growth in recent years has resulted in a vast accumulation of wealth on the Mainland and the authorities there are progressively liberalising the requirements for Mainland financial institutions to invest overseas. As a result, Hong Kong has benefited from the outward investment flows given our geographic, cultural and linguistic affinities with the Mainland and our ability to provide a broad access to numerous Asia-Pacific and global markets. The potential demand for wealth management thus presents capital-market intermediaries in Hong Kong with huge opportunities.

We are also the first jurisdiction outside of the Mainland with the ability to conduct renminbi banking business and deal in renminbi-denominated financial products. The establishment of a renminbi bond market in Hong Kong last year marked a key milestone in the development of renminbi business here. It has helped entrench Hong Kong as a testing ground and pilot market for China’s continuing financial reform and liberalisation.

There is clearly immense scope for us to leverage on our key strengths as a close business partner, a capital formation centre and a financial intermediary for the Mainland economy in the development of Islamic finance. There are opportunities for us to extend our reach to potential Islamic investors and financiers in the Middle East and Asia. The addition of Islamic finance as a new asset class in our financial system will add value to Hong Kong as a thriving financial centre and a leading financial services hub in Asia.

As a major financial centre, Hong Kong – with its flexible and innovative market participants and its responsive government – has always stood ready to adapt to and embrace new ideas. Even if the current financial environment appears unfavourable to the development of Islamic finance in the short term, this is, at worst, a temporary setback as future prospects remain promising. We at least do not intend to be put off by temporary difficulties from our goal of making Hong Kong an Islamic financial hub. Indeed we believe that this is a good time to do the groundwork of installing the necessary legal, taxation and market infrastructure.

To name just a few developments in the past 12 months: a new Dow Jones Islamic Market Index was launched to track China-related equities listed on the Hong Kong Stock Exchange; Islamic mutual funds were introduced by a local bank and an asset management company featuring China-related equity investments through the stock market platform in Hong Kong; and an exchangeable sukuk linked to the shares of a Mainland company listed in Hong Kong was issued in March, enabling investors to gain exposure to China’s growth story. The response so far has been highly encouraging: for example, the sukuk was 10 times oversubscribed.

Likewise, positive progress is achieved in the development of Islamic banking in Hong Kong. Following the first Islamic banking window introduced three months ago, I’m glad to witness yet another market player who is set to launch its Islamic banking window in Hong Kong at this auspicious occasion today. The increasing number of banks taking part in Islamic banking activities will add further momentum to the development of an Islamic capital market in Hong Kong by providing an important tool for funding and liquidity management.

The Hong Kong Monetary Authority will continue to give full support to the HKSAR government in its initiative to develop Islamic finance in Hong Kong by acting as a market enabler and infrastructure provider. The HKMA has taken important steps and devoted considerable resources to promote the industry in Hong Kong. We are now focusing our efforts on four major areas: first, building Hong Kong’s international profile and forging closer ties with market participants in the Middle East; secondly, promoting market infrastructure and establishing policies conducive to the development of Islamic finance; thirdly, promoting talent and knowledge of Islamic financial principles among market professionals in Hong Kong; and fourthly, encouraging the development and launch of Islamic finance products in Hong Kong.

Concluding remarks

Ladies and gentlemen, the potential for the growth of Islamic finance is clear. The foundations for its development here in Hong Kong have already been laid. It is essential for all of us to look beyond the current global financial turbulence and treat the development of Islamic finance as an investment in the future. With this in mind, I would like to encourage all of you, whether you are regulators, financial institutions or investors, to look critically at the opportunities that lie before us. Islamic finance is a new asset class that has the potential to bring new economic growth to Hong Kong and the region given our wealth of knowledge in financial intermediation, our experience, and our agility in adopting innovative products. So let us work together towards building a stronger and stronger link and increasing cooperation with other global players to identify and capitalise on new opportunities. Today’s holding of the Islamic Finance Forum in Hong Kong is a significant step on a journey that is just beginning. I look forward to travelling this road with all of you.

Thank you.

Article: 12-01-08 Summers Internal Pollution Memo

Article here.

Comment: I have reproduced the first two paragraphs below. The bottom line. The articles discusses the Internal Memo which Larry wrote while at the World Bank in 1992 on pollution and that an optimal strategy was “to export” pollution or “dirty industries” to Less Developed Countries. Larry provided three reasons. I reproduced the reasons below as well.

The statements are valid. However, the issue is not exclusively “economics” and I know that Larry understand that decisions are not made simply with the use of economic analysis; there are moral issues involved as well, as the article rightly proclaims. Read the article for the arguments against Summers’ position.

Obama’s successful bid for the US presidency was greeted by international celebrations everywhere across the globe. The international delight that accompanied Obama’s success was not confined to the western world and their compatriots in the poor countries. On election night, the refugees and IDPs of the beleaguered Darfur clung to their transistor radios and remained awake until 4am when they finally celebrated his outstanding victory speech. For years and years gone by, the USA imposed itself as an unwanted global leader. This time, thanks to Obama, the world has chosen the USA to act as its leader.

There is no doubt that Obama’s first commitment goes to his US constituency. Nonetheless, in his victory speech, Obama signaled a recognition of his international constituency and emphasized that the destiny of the entire world is indeed intertwined. President Elect Obama has certainly started off very well. But the appointment of Lawrence Summers to head his National Economic Council does not tally well with his implied commitment to an international constituency and particularly its less fortunate members, primarily the refugees and IDPs (Internally Displaced Persons) residing in the poorest countries of the world. Some years ago (1992), Summers, who was then Chief Economist of the notorious World Bank, advised or rather instructed, the movement of “dirty industries” to the Third World. Below, in its entirety, is my own critique at the time under the title “Obscene Economics”. The work was published in the Irish Reporter (1992) and as a part of a booklet issued by the Institute for African Alternatives (IFA;1994). First of all though, I must concede that people learn from their mistakes and change. I do hope that Mr Summers does just that.

Summer’s three reasons to export pollution.

(1)The measurement of the costs of health-impairing pollution depends on the forgone earnings from increased morbidity and mortality. From this point of view a given amount of health impairing pollution should be done in the country with the lowest cost, which will be the country with the lowest wages. I think the economic logic [perhaps the WB’s] behind dumping a load of toxic waste in the lowest-wage country is impeccable and we should face to that.

(2)The costs of pollution are likely to be non-linear as the initial increments of pollution probably have very low cost. I’ve always thought that under-populated countries in Africa are vastly under-polluted; their air quality is probably vastly inefficiently low “sic” compared to Los Angeles or Mexico City. Only the lamentable facts that so much pollution is generated by non-tradable industries (transport, electrical generation) and that the unit transport costs of solid waste are so high prevent world-welfare-enhancing [better read western-welfare-enhancing] trade in air pollution and waste.

(3)The demand for a clean environment for aesthetic reasons is likely to have very high income-elasticity. The concern over an agent that causes a one-in-a-million change in the odds of prostate cancer is obviously going to be much higher in a country where people survive to get prostate cancer than in a country where under-5 mortality is 200 per thousand. Also much of the concern over industrial atmospheric discharge is about visibility-impairing particulate. These discharges may have very little direct health impact. Clearly trade in goods that embody aesthetic pollution concerns could be welfare-enhancing. While production is mobile the consumption of pretty air is a non-tradable.

The author is Head of Bureau for Training and Strategic Planning of JEM. He can be reached at: Abdullahi@eltom.nuim.ie

Central Banking: 11-30-08 Njuguna Ndung’u, Central Bank of Kenya

Release here.

Consultative Group Meeting, Nairobi, 24 November 2008.

I am pleased to be here this morning at the opening of the FIRST Initiative Consultative Group meeting. My thanks go to the Governing Council and the Program Manager for the kind invitation. Allow me also to thank FIRST Initiative for choosing to host both the Governing and Consultative Group meetings in Nairobi famed as “the Green City in the Sun”. I would also wish to welcome you all to Nairobi and hope that you will extend your stay to enjoy the varied and scenic delights that Kenya offers.

Ladies and Gentlemen: This is indeed a “watershed” meeting that comes after the completion of the first four year mandate of FIRST Initiative. I am informed that FIRST Initiative began its operations in 2002 with a five year mandate that was successfully completed in 2007. The mandate was to provide Technical Assistance to support growth and poverty reduction in low and middle income countries by promoting a financial sector that was stable, deep and diversified. This is indeed a noble objective and it is therefore gratifying to note that FIRST will now enter a second phase of operations to run to the end of 2012.

Role and significance of FIRST in development

FIRST mission to deliver flexible, top-quality technical assistance related to financial sector is welcomed in the region where the role of the financial sector is recognized as an engine for development. Most of you in this room can remember vividly the days of financial repression when government legal restrictions prevented financial intermediaries in the economy from functioning at their full capacity. The regulations generally included interest rate ceilings, compulsory credit allocation, and high reserve requirements. The development philosophy has shifted away from direction and control. Governments of developing countries have now realized the great potential of the financial sector in fostering development. The formation of FIRST as an institution was to help developing countries tap the potential support to the development of the financial sector.

The fact that FIRST initiatives always come in after Financial Sector Assessment Program (FSAP) and other assessment have been undertaken by the IMF and the World Bank signals to governments of developing countries that our partners not only perform a “health check” of our financial system but they also offer “health solutions” after a prognosis has been identified.

Many of the projects financed by FIRST initiative have helped countries tighten their adherence to international standards and codes for the financial sector. In doing so, I belief in the assertions that FIRST has helped developing countries achieve part of their development goals of building an efficient, inclusive and transparent financial system. The fact that FIRST works closely with the recipient institutions to prioritize technical assistance activities that are consistent with the recipient country plans is a great plus. It re-defines development partnership of donors and recipient countries.

I note with great pleasure FIRST model of doing business. It encourages recipient governments to identify their financial sector problems, prioritizes them, and then supports viable solutions. It also pools the efforts of several development agencies, leveraging their expertise and reducing duplication. Often, FIRST takes on targeted projects and once completed, FIRST disseminates the results to boost their impact and catalyze long-term support from both development partners and recipient governments.

In Kenya the Vision 2030 has identified that the problems of high interest rate spreads and limited access. The focus then is how to reduce these spreads, raise access and deepen the financial sector. The level of solutions require policy reforms that alleviate market, institutional and political barriers to competition. The Vision 2030 has identified areas in which policy reforms can have a major impact in reducing such barriers and thus increasing the effectiveness and competitiveness of financial intermediation.

Here in Kenya, I would like to acknowledge an initiative such as FinAccess initiated and partly funded by FIRST which has given us the survey information which has become an integral part of financial market processes and analyses. The results have helped us understand some of the issues in the financial sector and have provided us a better understanding on how to develop the sector. There is an increasing body of evidence to support the view that financial sector development contributes to both economic growth and poverty reduction by affording people greater access to finance.

Going forward

Going forward, I have noted with satisfaction that FIRST will seek to strengthen the causal links between its technical assistance and the contributions of deep, orderly financial systems to economic growth, poverty reduction, and social equity. FIRST will do this by increasing its emphasis on achieving market development outcomes, and filling gaps in domestic financial markets. It will also continue to give priority to supporting governments in lower-income countries in developing action plans geared toward these outcomes.

Such a move is welcomed in the region where there has been a very strong upward trend in diversification of economic activities among rural households over the decade. One robust finding of the rural panel analysis is the importance of access to credit as a correlate of escaping from poverty. In Kenya for example, most (70 percent of) Kenyans do not have access to any form of credit. For those who do access loans, there is significant disparity in average amounts – with non-poor households borrowing 42 percent above the average amount, and poor households 77 percent below; the advantage for urban households is even larger, whereas female headed are way below average (World Bank 2008). The question is whether we have adequate financial vehicles for each of these diverse house-holds.

Financial stability and development are a crucial prerequisite and a facilitator of reforms in other sectors, including private sector development, infrastructure, housing, and social policies. Financial sector development is vitally linked to growth and poverty reduction. Well-functioning financial systems channel funds to productive uses essential for a country’s transformation.

Financial services

In Kenya, we have identified that a well-functioning financial system is critical to accelerating economic growth. That is, a vibrant and globally competitive financial sector will drive high levels of savings and finance Kenya’s investment need.

According to the Financial Access Survey 2007, by FSD Kenya, the banking sector serves only 19 per cent of Kenya’s bankable population with 8 per cent being served by other financial services providers such as MFIs and SACCOs. 38 per cent are totally excluded and 35 per cent rely on informal financial services providers. The evidence is also that access to financial services outside the main cities still remains limited. The introduction of MFI’s, the SACCO’s and CRBs will produce the best financial infrastructure to reach all segments of the economy and information flow to help them function properly.

For Kenya to achieve its aspirations of Vision 2030, the levels of investment will require a continuous increase in the level of national savings to sustain economic growth. In this regard, financial sector reform measures will be implemented and more savings products developed to support the requisite national savings.

To do so I intend to suggest areas where support of FIRST initiative will be most welcomed in Kenya’s case, but also applies to most countries in SSA:

• Enhance the role of the Government in the financial sector to provide a legal, regulatory, and supervisory framework that promotes soundness and competition in the sector. More support for the review, amendment and drafting of financial sector laws and regulations that govern all the regulators with the objective of strengthening their effectiveness.

• Reduce the existing deficiencies in the clearing and settlement mechanisms in national payment systems. The modernization of the national payment system has included, among other things, the introduction of Real Time Gross Settlement (RTGS) and the Kenya Electronic Payments and Settlement System (KEPSS) to all participants. But now require enhancement to ensure overall adoption.

• Increasing access to credit. The major impediments to growth in developing countries especially in SSA is the insufficient access to credit for large segments of the population and enterprises, especially micro, small and medium sized ones. Areas which FIRST can support include: improvements in the operation of the government registries including: assistance to the Companies Register to enable the Registry clear the backlog in filing and allow for speedy and accurate information sharing of corporate information and data; improvements in the land registration system through digitizing land records; establishment of a legal and regulatory framework for the operation of a credit reference bureau that would facilitate the much needed information flow among the credit granting institutions.

• Improve the financial legal environment. The legal system in the region currently faces major challenges in supporting effective financial intermediation. Furthermore, the drafting, implementation and application of the legislative and regulatory reforms, require strong capacity in the judiciary and in the legislative and executive offices charged with legislative drafting and law revision.

• Clear and effective laws backed by a strong and credible judiciary are an essential element in creating an environment that is conducive to business and financial activity. Enforcement of contracts in the financial sector is a major signaling mechanism that helps the financial sector development and innovation intermediation.

• Develop a financial sector that reflect the economic structures of the country and avoid temptations of one size fits all. Most SSA are characterized by formal and informal finance. The process of formalization requires understanding of the economic structures.

Conclusion

In conclusion, I realize that the issues for discussion during this meeting are vital to the financial sector at this crucial time when the world is seeking solutions to the global financial crisis; the Central Bank of Kenya and the Ministry of Finance are interested and also party to the issues being discussed here. The financial sector reform agenda is now even more urgent in the wake of the ongoing global financial crisis. I am informed that you spent a good part of yesterday discussing the crisis and I am sure that you came up with useful proposals that you will be sharing. It is inevitable that there will be fundamental changes to the global financial architecture and institutions that govern it. This will pose a greater challenge to developing countries that are already resource constrained and yet need to quickly embrace these changes. Again, partners such as FIRST Initiative will be called upon to quickly deploy technical assistance to client countries.

Targeted technical assistance in the financial sector will support governments’ effort to deepen a market based economy which contributes to a sustainable fiscal position and improved allocation of resources. Broad-based financial and legal sector reforms will directly contribute to improving equity and reducing poverty through expanding access to financial services. Poverty is sustained by exclusion in the market. The poor benefit from financial services by providing a safe haven for their savings. The route to savings together with investment opportunities that promise returns is the road to enhance poverty reduction. These objectives will be achieved through provision of technical expertise and building capacity to implement our countries’ financial sector and legal sector reforms whenever required.

I therefore look forward to the output of today’s discussions that should enable FIRST to meet and exceed the monumental expectations from client countries in its second phase of operations.

On that note, it is my honour and pleasure to declare the FIRST Consultative Group Meeting officially open and to wish you fruitful deliberations.

Thank you.

Central Banking: 11-30-08 Zeti Akhtar Aziz, Central Bank of Malaysia

Release here.

It is my pleasure to be here today at this official launch of “HSBC Amanah Malaysia Berhad” (HSBC Amanah). This launch is significant in a number of respects. It reflects the continued expansion of Islamic finance in Malaysia , taking place at a time of great uncertainty in the global financial system. The launch of HSBC Amanah, as an Islamic subsidiary of an international financial group, is also significant as it will contribute towards enhancing further the international dimension of Islamic finance in Malaysia, thus strengthening our international financial and economic linkages with other parts of the world.

The Islamic subsidiary represents the transformation of the Islamic banking window operations into a dedicated entity that allows for greater strategic direction and drive of performance for the Islamic banking business. The advancement of the Islamic subsidiary institutions structure has the potential to further complement the goals of the group by providing an alternative model to spur the expansion of the banking business. It will pave the way for providing strong support in terms of capital, resources and operational infrastructure to elevate performance. In doing so, it will also contribute towards enriching further the diversity of players and strengthening the institutional infrastructure of the Malaysian Islamic banking system.

The continued growth of Islamic finance in Malaysia

The international economic and financial environment is expected to remain very challenging with several major economies now in recession and continued uncertainties prevailing in the international financial system. In spite of this, the Asian economies are still growing, albeit at a more modest pace. The dominance of domestic demand and increasing regional economic integration have enhanced the prospects for Asia to sustain a modest pace of growth.

In this challenging international financial environment, it is encouraging that Islamic finance has continued to demonstrate its evolution and strong growth. Islamic finance has now become a new vehicle contributing to increasing the financial linkages not only within Asia but also with the rest of the world thereby facilitating cross-border allocation of capital globally. Indeed, a number of international financial centres have recognised Islamic finance as an integral part of their financial system in order to complete the suite of financial products and services being offered, and therefore are actively developing this segment. The Islamic finance industry has not only continued to grow but it has also been able to present a higher level of dynamism.

The key indicators of the Islamic banking sector continue to record a progressive pace of development. The Islamic banking assets have expanded by 23% to RM234.9 billion compared with a year ago. The Islamic banking industry now accounts for 16.7% of total assets in the industry. Similar trends can be observed in the growth of deposits that have reached RM180.4 billion, an increase of 27.7% during this period while, total financing has also increased by 24.5% to RM143.4 billion. This growth has also accompanied by an increase in the number of full-fledged Islamic banking branches. From January to September this year, 93 new branches were opened thereby enhancing the outreach of Islamic financial products and services.

Another area that has seen significant growth is in the Sukuk market. The Malaysian sukuk market has expanded significantly with an average annual growth rate of 22 per cent since 2001. Despite the current market conditions that have affected the volume of new bonds and Sukuk issuance, the Islamic capital market has continued to structure innovative Islamic financial instruments. By the first half of 2008, the composition of the more innovative Sukuk Musharakah had increased to 84% as compared to 58% of the total sukuk issuance in 2007.

In addition, several new Islamic financial products have been introduced including residential mortgage backed securities, Commodity Murabahah deposit products, commodity based financing, credit card based on ujrah , as well as, structured products based on Musharakah, Mudarabah and Ijarah.

Malaysia has acquired a unique market space for driving Shariah-based innovation by combining the depth of knowledge with the drive for innovation. The Islamic financial services industry in Malaysia possesses a conducive environment for innovative advancement that is supported by a regulatory framework that ensures not only the stability of the system but also promotes the active and vibrant functioning of the system.

These developments and continued evolution of Islamic finance have demonstrated the ability to not only meet the rapidly changing requirements of the global economy, but also to remain competitive in a challenging environment . Following the greater international interest in Islamic finance, it has gained an increasingly prominent role in the international financial system. This is reflected by the active involvement from governments, corporate sectors and global investors from both Islamic and non-Islamic countries.

Potential role of foreign Islamic subsidiaries

The policy for the establishment of foreign Islamic subsidiaries in our Islamic financial system is also part of the initiative to enhance the outreach of Islamic finance and to strengthen our international linkages. It reflects part of the further liberalisation of the Islamic financial services industry in Malaysia. Foreign Islamic subsidiaries have the potential to promote innovative product development and enhanced international integration of the Islamic financial system.

Firstly, by leveraging on the global networks available, foreign Islamic subsidiaries are well positioned to engage in innovative product development in a more cost effective manner. Malaysia provides an enabling platform such structuring of Islamic financial products and instruments. The recent establishment of the International Shariah Research Academy (ISRA) as a premier research entity has further enhanced the infrastructure to facilitate this innovative process. ISRA focuses on applied research in Shariah and Islamic finance, and provides the avenue for greater engagement between industry players and scholars. In addition, the tax neutrality treatment, has paved the way for the introduction of innovative products such as Ijarah Munthahiah Bithamleek (leasing ending with ownership) and Musharakah Mutanaqisah (diminishing partnership) in home financing, and currency option using the concept of Hamish Jiddiyah (security deposit) and Tawarruq (monetisation).

Secondly , foreign Islamic subsidiaries have an important role in enhancing the international linkages of the Islamic finance industry regionally and internationally. Reinforced by a well developed legal, regulatory and Shariah framework and with three decades of experience, our Islamic financial system offers a unique platform as a meeting place between those that require funds and those with surplus funds. Malaysia has the full complement of the financial infrastructure, products and institutions. This is reinforced by the adoption of international regulatory best practices and liberal foreign exchange administration rules. This environment has encouraged the issuance of ringgit denominated sukuk by multilateral institutions and foreign multinational corporations in our market. It has also increased participation of investors in our Islamic financial markets. In a number of the sukuk issuances, the foreign subscribers (other than from Asian region) represent more than two thirds of total subscribers. Given the investment opportunities in the East Asian region, there are significant potential business activities, especially in the Asia-Pacific region. To optimize the business potential, Islamic financial institutions need to develop their niche strengths and leverage on Malaysia’s resources to extend the operations to both the regional and global market.

As a foreign Islamic banking subsidiary, the potential to provide greater market access in the domestic economy and improve the overall financial inclusion is also important. This includes the offering of new financial products to the different domestic economic segments.

Concluding remarks

On this occasion of the official launch of HSBC Amanah Malaysia Berhad, let me take this opportunity to congratulate HSBC Bank Malaysia Berhad on the initiative to establish its own of the Islamic banking subsidiary and for its commitment to contribute to the success of Islamic finance. By allocating dedicated resources in the Islamic subsidiary in Malaysia, HSBC Bank will enhance its potential to contribute to the advancement of Islamic banking business going forward.

I wish HSBC Amanah Malaysia Berhad every success in its endeavours.

Central Banking: 11-30-08 Heng Swee Keat, Monetary Authority of Singapore

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Research Comment: For those interested in Islamic finance and banking, you should read. Also, the topic of Islamic finance is potentially an interesting subject for a master’s or doctoral thesis.

Good morning, ladies and gentlemen.

I am honoured to speak at this opening plenary, following the keynote remarks by His Excellency, Governor Rasheed Al-Mara.

I am also delighted to be in Bahrain, recognised globally as one of the leading centres for Islamic Finance. Besides having a core of active Islamic financial institutions, Bahrain also plays host to a number of organisations central to the development of Islamic Finance, including AAOIFI, the LMC, IIFM and the IIRA, and of course, this WIBC.[Footnote 1 - Source: CBB website, http://www.cbb.gov.bh. AAOIFI - Accounting and Auditing Organisation for Islamic Financial Institutions; LMC - Liquidity Management Centre; IIFM - International Islamic Financial Market; IIRA - Islamic International Rating Agency; WIBC – World Islamic Banking Congress.]

The Central Bank of Bahrain ["CBB"], a highly regarded regulator, has played a key role in spearheading the development of Islamic Finance. The CBB has scored many “firsts”, including the first central bank sukuk in 2012 and being the first country to develop and implement regulations specific to the Islamic banking industry. The CBB has also established the Waqf Fund to finance research, education and training in Islamic Finance. There is much that the MAS can learn from the CBB.

The current global crisis – some root causes

The theme of this session – having an effective regulatory framework – is of great relevance given the on-going financial crisis. The current financial crisis is unprecedented in terms of its scale, complexity, and speed of transmission. While the series of coordinated actions by financial authorities and Governments have helped to stabilise the markets somewhat, sentiments remain fragile, and many of the underlying problems remain. Many reasons have been offered about the root causes of the current crisis. Let me just highlight a few of these.

The first is the unprecedented levels of leverage taken on by global financial institutions coupled with very loose lending standards in the credit markets. Consumers in the US were also highly leveraged. The high leverage enabled asset values and consumption to be raised to unsustainable levels. When sentiments finally turned, there was massive deleveraging.

The second is that complexity magnifies risks. The proliferation of complex securities and derivatives had not diversified risk amongst different counterparties as was originally intended, but instead increased aggregate systemic risk throughout the financial system. Not only banks and investment banks were affected but a whole range of players including credit insurers, hedge funds and investors in asset-backed commercial paper have also suffered major losses.

The third is the inadequate assessment of risks and compression of yields. Many of the assessments were based on complex modeling and did not give sufficient regard to the tail risks in these financial products including the illiquidity risk. In some instances, there may not have been sufficient diversity of views of the risks and pricing of structured credit, with a heavy reliance on rating agencies.

Against these key causes, we must include the backdrop of unsustainable macro-economic imbalances that were building up in the global economy, and policy responses which effectively allowed yields to fall to very low levels. The aggressive search for returns also led to severe compression of yields which distorted investor behaviour and long-term valuations.

The interaction of high leverage, excessive complexity and compression of yields meant that when sentiments turned, the magnitude of price falls across asset classes have been sharp, and the dynamics of the deleveraging process unpredictable. Financial institutions and markets have also become so highly interconnected that an event in one area sets off a chain of events that magnify and exacerbate the initial shocks.

The shocks in the financial markets have now been transmitted to the real economy in the developed countries. Through both the financial as well as the trade and investment channels, these shocks are also propagated to emerging economies. The negative feedback loop between the deterioration in the real economy and sell-offs in financial assets have added to the uncertainty. It will take some time before the crisis runs its course.

Policy agenda

Our immediate focus must be to limit the damage of the financial crisis on the real economy, and stop the downward spiral created by the negative feedback loop. Policy measures must include not just fiscal and monetary policy stimulus, but also an acceleration of structural changes to correct the underlying imbalances, to put the global economy on a sounder footing for renewed growth.

There has also been much discussion about regulatory reform. Reform is certainly necessary, but we must avoid swinging the regulatory pendulum to the other extreme. While the present system has major flaws, it is not fundamentally broken. Fixing these flaws demands thoughtful and pragmatic changes at the global level. Piecemeal quick fixes, which may be logical and perhaps even headline grabbing, may end up creating unforeseen and unintended consequences. It would be a mistake, for instance, to swing towards overly prescriptive rules, or to severely restrict all forms of securitisation and financial innovation. As financial markets are at different stages of development in various countries, we must also avoid a “one-size-fits-all” approach. Certainly, we will need greater international cooperation, and the work of bodies such as the IMF, FSF, BCBS, IOSCO, IAIS,[Footnote 3 - IMF – International Monetary Fund; FSF – Financial Stability Forum; BCBS – Basel Committee on Banking Supervision; IOSCO - International Organisation of Securities Commissions; IAIS - International Association of Insurance Supervisors.] and initiatives sponsored by groupings such as the G20 will be important in this reform effort.

An effective regulatory framework for Islamic finance

The current global crisis has posed a series of extreme stress tests on financial systems and our regulatory approaches, and offers many important pointers for the development of Islamic Finance. Allow me to highlight a few.

First, one of the most significant lessons about the crisis is also the most basic, that is, finance needs to return to its basic function of allocating scarce capital to the most productive uses, with the capital earning an appropriate risk-adjusted return.

In this regard, the underlying Shariah precept in Islamic Finance of not using capital for speculation, but to build productive capacity and generate sustainable economic growth, takes on great relevance. By adhering to this basic precept, I am confident that Islamic Finance will assume a more prominent role in the coming years.

Second, whatever the forms of intermediation, we must remain focused on the types and nature of risks, and how these risks are distributed among the players. Before this crisis, the main focus was on risks posed by hedge funds. As it turns out, a large part of the risks were sitting in the core banking system, in the form of off-balance sheet items held in SIVs. Mortgage lenders which originated subprime mortgages were outside the regulatory ambit. The main lesson here is that we have to examine risks holistically, across the value chain of activities and across different asset classes and markets, and not be blinkered in pre-judging where risks sit. For tail risks in particular, the dark corner where we shine the light may not necessarily be the place where those risks reside.

Many of the risks inherent in Islamic Finance are similar to those of conventional finance, including credit risks, market risks, market conduct risks, operational and reputational risks. However, the exposure to those risks could differ between conventional and Islamic finance. For instance, Islamic banks are generally exposed to substantially more liquidity risk than their conventional counterparts, as the range of liquid instruments and hedging instruments are more limited. Islamic banks tend also to be more exposed to the property and infrastructure sectors, in part because these are the prevalent asset classes in the Gulf and also in part because Islamic finance has to be based on physical assets. Given the “large and lumpy” nature of such transactions and the tendency for asset bubbles to build up quickly, it is a risk that merits special attention.

In addition, there are also risks unique to Islamic Finance such as Shariah-compliance risk. If products are later found to be non-Shariah compliant, the institutions not only face reputational damage, but also costly unwinding of such structures, with possible losses to investors. The third point is that to achieve a good outcome, an effective regulatory approach needs to embrace a tripartite approach. Regulators, financial institutions and investors all have a role to play.

Allow me to share briefly the approach that MAS takes. As a regulator, MAS looks at both the micro-prudential aspects, looking at the safety and soundness of individual financial institutions, as well as macro-prudential aspects, looking to see if system-wide risks have been built up in the aggregate.

In doing this, we adopt a risk-based approach towards supervision and regulation, in order to promote sustainable development of the sector. For example, we set appropriate limits and capital charges to address the credit, market and other risks. The standards of governance and risk management are set at levels commensurate with the activities and the risks being taken. Sometimes we are accused of being overly conservative, but this prudence has served us well.

In all instances, we seek to find the right balance between “principles-based” and “rules-based” regulation; to avoid being over-prescriptive in rule-making or being over-reliant on market discipline alone to curb excessive risk-taking. Similarly, market conduct measures focus on upholding principles of fairness and transparency, for instance, through requirements on disclosure to investors and a fair-dealing sales process.

The second leg of the tripartite approach is to put the primary responsibility for sound risk management and oversight of each institution on the board and senior management, which must set the right tone and culture. The third leg is to promote greater awareness among BIS investors of their financial needs, encourage financial planning and promote deeper understanding of the risks and returns of different products, through educational programmes such as MoneySENSE [Footnote 4 - 4 MoneySENSE is a national financial education program in Singapore covering three tiers of financial literacy – basic money management; financial planning; and investment know-how. Details on MoneySENSE are available at www.moneysense.gov.sg

The fourth pointer from the current crisis is the importance of preventing regulatory arbitrage, and ensuring a level playing field. With regards to Islamic Finance, in particular, MAS seeks to ensure a level playing field between the conventional and Islamic financial players. Where the economic substance and risks are similar, the same regulatory treatment is accorded, regardless of whether the product is a “conventional” or “Islamic” product. For example, Singapore-based banks treat murabaha-based5 asset financing as a credit risk exposure to the customer for the purpose of maintaining regulatory capital. As Islamic Finance grows, our regulatory framework must continue to evolve to maintain regulatory consistency in managing the underlying substance of the risks.

International collaboration

The fifth and very crucial point that emerges from the current crisis is the importance of international collaboration. As Islamic Finance grows, cross border transactions will multiply. We must therefore take an international perspective in preventing and resolving problems right at the outset. Allow me to suggest three areas where regulators can work closely.

The first area is that legal, regulatory and supervisory frameworks that are developed should be based on internationally recognised principles and standards. The work done by international standard-setting bodies such as the IFSB, IDB, AAOIFI and IIFM [Footnote 6 - 6 IFSB - Islamic Financial Services Board; IDB – Islamic Development Bank; AAOIFI - Accounting and Auditing Organisation for Islamic Financial Institutions; IIFM - International Islamic Financial Market.] is instructive in this regard. For example, “The Ten Year Framework and Strategies” co-issued by the IFSB and IDB is a thoughtful blueprint. AAOIFI has also produced standards in areas such as accounting, auditing, ethics, Shariah compliance and governance. Today, the applications of Shariah precepts differ somewhat in certain areas. It will eventually be desirable to have some standardisation to enhance consistency and to remove one source of regulatory risk.

However, our goal should be to achieve a gradual harmonisation of standards and approaches to regulation, rather than immediate convergence. Even in conventional finance, regulatory approaches and standards differ across different jurisdictions. A flexible, risk-based approach will also allow continued innovation to take place, while ensuring the resultant risks are appropriately managed.

Second, we need to develop a wider range of tools to detect and mitigate risks. In conventional finance, work is underway in reviewing shortcomings in capital adequacy and liquidity management in the Basel II framework, as well as the provision of clearing and settlement infrastructure for derivatives. For Islamic Finance, we need to continue to develop instruments that help to mitigate risks. Bahrain’s initiative in developing the Liquidity Management Centre [Footnote 7 The Bahrain Monetary Agency was the primary sponsor in establishing the Liquidity Management Centre] is an excellent example of such an effort.

In this regard, I am pleased to announce that the Monetary Authority of Singapore is now in the final stages of setting up a sukuk issuance facility. I had announced, at this May’s Islamic Murabaha-based asset financing refers to mark-up asset financing, commonly used in home financing and car financing. In such a transaction, banks generally purchase the asset to be financed, and then sells it to the customer at a mark-up, to be paid on a deferred basis.

Financial Services Board Summit, Singapore’s plan to set up a facility to provide Shariah-compliant regulatory assets to these financial institutions as part of our efforts to promote the growth of Islamic Finance in Singapore.

The sukuk structure is based broadly on the Al-Ijarah structure, or the sale-and-leaseback of an underlying property. Sukuk issued by the facility will be given equal regulatory treatment as Singapore Government Securities, or SGS, and returns will be tied to the risk-free yield of SGS of equivalent tenor. The facility is open to all financial institutions that plan to or are currently carrying on Shariah-compliant financial services in Singapore. We are issuing on a reverse enquiry basis, which means we can size and time the issuance according to the needs of the financial institutions. A number of financial institutions have already expressed interest and we expect the first issue to take place at the start of next year. We invite eligible and interested financial institutions to approach MAS as we work towards a formal launch.

Last but not least, efforts to further international collaboration will need to be supported by a solid platform for co-operation and information sharing amongst regulators. Formal agreements between regulators on the scope of cooperation and information sharing will be helpful in this regard. Singapore, as a full member of the IFSB, and a signatory to MOUs with various GCC countries, is keen to explore further avenues for cooperation and collaboration.

Underpinning all these, of course, is the need to continue to broaden and deepen knowledge and expertise on Islamic Finance among regulators and industry players. An investors’ education platform to promote risk awareness of Shariah compliant products will also serve to reinforce market discipline by raising awareness of the characteristics and risks of Shariah products, as well as boosting demand for such products.

Conclusion – opportunities for Islamic finance

I would like to end on an optimistic note by reiterating the opportunities available in Islamic Finance. While we must expect the global economy and financial activities to slow in the coming months, the long-term structural improvements in Asia and the GCC will continue. Between Asia and the GCC, for instance, total trade grew by 17% annually since 2000 to exceed US$328 billion in 2006 [Footnote 8 - 8 Based on IMF and CEIC statistics.] Total cross-border capital flows between Asia and the GCC are also predicted to increase from US$15 billion at end 2006 to US$300 billion by 2020. [9 Source: http://archive.gulfnews.com/articles/08/05/25/10216034.html. Even if only half of these projections are realised, growth is still sizeable. It is thus crucial that we remain focused on enabling long term growth and development even as we tackle the current crisis.

There are many productive areas for the private sector to work in close partnership. I look forward to working closely with our colleagues in the Middle East to further promote cooperation in financial services and Islamic Finance, which will serve as key pillars for promoting long-term, sustained economic development and cooperation in our two dynamic regions.

On that note, I would like to thank you all for your kind attention this morning, and I wish everyone a fruitful conference.

Central Banking: 11-30-08 Justin Lin, World Bank

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Mr. Chairman, Excellencies, Distinguished Delegates, Ladies and Gentlemen:

It gives me great pleasure to have the opportunity to speak at this important meeting. The world is in the midst of a historic economic crisis whereby, in the next year, developing countries could account for all of GDP growth worldwide. Having stronger voice and representation from developing countries is increasingly important in such a world. Six months ago, President Zoellick asked me to be the World Bank’s Chief Economist, making me the first person from a developing country to hold this post since the World Bank was created over 60 years ago. Now in asking me to lead the Bank delegation to this key meeting, he wanted to have someone from the developing world represent the institution, its analysis, and its ideas.

This is more than symbolic. Financing for development is no longer about the old paradigm of aid dependency or charity, or about the North teaching the South. It is about an investment in a stable and inclusive future. That requires including new voices at the table, boosting South-South partnerships, and accepting that the North must learn to learn from the South.

Mr. Chairman, we have distributed a fuller written statement on behalf of the World Bank Group. In my remarks here, I will focus on a few key messages.

It is almost seven years since the international community met in Monterrey, Mexico, and agreed on a mutual accountability framework for development cooperation, whereby developing and developed countries resolved to work together to promote economic growth and foster the achievement of the Millennium Development Goals (MDGs). At international meetings earlier this year, which marks the halfway point to the 2015 target year for the achievement of the MDGs, we noted the substantial progress that has been made under this framework of cooperation as well as the need to intensify our efforts to address the tough challenges that remain.

Today, as the world economy is buffeted by the worst financial crisis seen in decades, a crisis that entails grave implications for developing countries and threatens to undo the hard-won gains in growth and development of the past years, the world needs international economic cooperation even more. Our meeting in Doha provides a timely opportunity to reaffirm and strengthen our commitment to the framework for cooperation and mutual accountability agreed in Monterrey.

Over the past year, developing countries have faced the triple jeopardy of food, fuel, and financial crises. As a result, many developing countries today are entering a danger zone. Growth in developing countries that averaged 7.8 percent in 2006-07 is now projected to slow to 4.5 percent in 2009. The economies of high-income countries, many of which have already entered into a recession, are now expected to contract by 0.1 percent in 2009, with global growth down to 1 percent. There is much uncertainty and even these scenarios could be optimistic. Some developing countries will be hit much harder than the average, experiencing growth that is negative in per capita or even absolute terms.

While the channels of transmission may differ, virtually no developing country, be it an emerging market country or a poor country in Africa, has escaped the impact of the widening crisis.

Coming on the heels of the food and fuel price shocks, the global financial crisis could significantly set back the fight against poverty and progress toward the MDGs. Sharply tighter credit conditions and weaker growth are likely to cut into financing available to invest in infrastructure and meet education, health, and gender goals. The poor will be hit hardest. Current estimates suggest that a one percentage point decline in developing country growth rates pushes an additional 20 million people into poverty. Already, more than 100 million people have been driven into poverty as a result of the rise in food and fuel prices.

In an increasingly globalized world, where crises can spread quickly across the globe, the response must be global, coordinated, and fast. Policy challenges need to be addressed at the country level, but it is more critical than ever that the international community acts in a coordinated and supportive way to make each country’s task easier.

Lessons from earlier crises point to the importance of safeguarding investment in long-term growth and development. As developing country budgets adjust to a new fiscal reality, careful management of resources will be necessary to safeguard investment in infrastructure and human development, while ensuring that the poor and vulnerable are protected through well-designed social safety nets.

Developing countries must also take steps, appropriate to their circumstances, to strengthen their financial systems, to place them on a sounder footing and avoid disruption in access to credit, especially to small and medium enterprises that are crucial to job creation.

It is critical that aid flows to developing countries be maintained, and past commitments honored and supplemented. At some $100 billion per annum, official development assistance volumes are modest in comparison to the trillions of dollars being spent on addressing the financial crisis in developed countries. We must also press ahead to implement the Accra Agenda for Action to improve aid effectiveness.

In the face of a prospective decline in private capital flows to developing countries in the aftermath of the financial crisis, we must intensify our efforts to catalyze and leverage private capital in support of development, including through innovative public-private partnerships. On current projections, net private capital flows to developing countries could drop from about $1 trillion in 2007 to roughly half that level in 2009.

It is also imperative to resist protectionism and avoid turning inward in times of financial uncertainty. We welcome the commitment expressed by G-20 leaders at their November 15 summit to strive to reach agreement this year on modalities that lead to a successful conclusion to the WTO’s Doha Development Agenda with an ambitious and balanced outcome. Progress on that front would provide a much-needed boost to confidence in the current difficult environment. It will support the recovery of global trade, which on current projections could fall in 2009 for the first time since 1982, and the reinvigoration of economic growth. Coordinated action is also needed to maintain the flow of trade financing.

The current global financial crisis poses major challenges, but it also creates opportunities. A vigorous response to the crisis can set the stage for a new multilateralism that supports sustainable and inclusive globalization. There is a mismatch between 20th century global institutions and 21st century global challenges. The G7 framework is no longer sufficient. The new approach should not be a fixed or unitary system, but a flexible and inclusive network that includes the rising economic powers such as the BRICs but also representatives of the poorer countries, links up various international institutions (IMF, FSF, WBG, WTO, UN), and works on issues beyond trade and finance to include development, climate change, and fragile states.

The old North-South paradigm no longer fits today’s world, and must give way to a broader framework for cooperation and learning, including South-South and South-North.

The World Bank Group stands ready to play its part. Working with partners, the Bank can help in what must be a multi-faceted response to the current crisis, drawing on its full range of financial, analytical, advisory, and coordinating resources—to protect the poor and vulnerable from immediate and long-term harm, assist the financial and private sectors in responding to the crisis, support countries in managing the fiscal challenges, and avoid cuts and delays in investments upon which economic recovery and long-term development will depend.

The World Bank has moved quickly to help countries deal with the food and fuel price shocks, through a $1.2 billion Global Food Crisis Response Program that in under accelerated implementation and an Energy for the Poor initiative that is at an advanced stage of preparation.

The World Bank Group will substantially increase its financial support to developing countries in response to the financial crisis and underpin that with stepped-up technical and advisory services.

The International Bank for Reconstruction and Development (IBRD) could make new commitments of up to $100 billion over the next three years. This year, IBRD lending could almost triple to more than $35 billion compared to $13.5 billion last year.

Following its record 15th replenishment, the International Development Association (IDA) has authority to commit $42 billion for the next 3 years, which can be frontloaded to meet the needs of low-income countries, including many in Africa.

The International Finance Corporation (IFC) is launching four new facilities for bank recapitalization, infrastructure financing, trade facilitation, and refocused advisory services. Combined with financing mobilized from others, these new facilities could provide more than $30 billion over the next three years.

The Multilateral Investment Guarantee Agency (MIGA) can also provide much needed risk mitigation for flows of private finance to developing countries.

The reform of the Bretton Woods Institutions constitutes part of the agenda for a new multilateralism. A modernized World Bank Group must represent the international economic realities of the 21st century and recognize the role and responsibility of growing stakeholders. Voice and Participation is an issue for resolution by World Bank shareholders. Last month, shareholders endorsed an initial package of reforms. As a second step, shareholders agreed that the Bank should undertake a comprehensive work program to move toward a more equitable distribution of voting power between developed and developing countries. The Zedillo Commission, created by President Zoellick to look at World Bank Group governance more broadly, will report back next year.

In conclusion, Mr. Chairman, our meeting comes at a critical time. The international community must work together to overcome the financial crisis and prevent it from triggering a development and human crisis. It also must seize the opportunity to lay the foundation for a new economic multilateralism that is responsive to today’s realities and challenges. The World Bank Group is fully committed to work with partners in this effort.

Central Banking: 11-30-08 José Manuel González-Páramo, ECB

Release here.

November 21, 2008

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1. Introduction

Ladies and Gentlemen,

It is a great pleasure for me to participate in the Annual Alumni Conference of the IE Business School and share with you some considerations about the impact of uncertainty on international financial markets and the responses by central banks, particularly by the ECB, and by governments from all over the world.

One of the most relevant features of the current turmoil has been the role of uncertainty both within the financial sector and toward the financial sector. Indeed, the events over the last fifteen months have shown that, despite regulatory advances and technological progress in the financial sector, a number of weaknesses in key areas related to transparency, such as valuation practices and disclosure standards, are at the root of the financial market turmoil and have had major repercussions for the smooth functioning of key markets and institutions.

In my intervention today I will briefly recall the dynamics of the financial market turmoil. I will then highlight the role of uncertainty during the turmoil and the way central banks and other authorities have responded to the challenges posed by the developments in the financial system. Finally, I will make some concluding remarks.

2. The financial market turmoil

As we all know, in August 2007 the global financial system entered a period of considerable turbulence that started with a liquidity squeeze triggered by rising delinquencies in the US sub-prime mortgages, and led to significant disruptions in various segments of the financial markets.

More than one year later, the global financial system is still undergoing a correction process, and money and credit markets are suffering from lack of confidence on the precise impact of the turmoil on the robustness of financial institutions and their ability to weather the current shocks.

More generally, most segments of the global financial system continue to function under stress. While much progress has been made in the efforts to identify and value the exposures to complex securities that have been in the epicentre of the turbulence in the markets, uncertainty still remains about the losses that will ultimately be suffered by investors and financial institutions across the globe.

Many financial institutions are under very high pressure to clean their portfolios and to strengthen their capital base, reinforcing the rapid de-leveraging process already underway. In addition, in the months following the takeover of Bear Stearns and the collapse of Lehman Brothers, the financial market turmoil intensified again and underwent a more damaging and disruptive phase in which large financial institutions failed or had to be rescued by either their private counterparties or public authorities, while the viability of the investment banking industry as a whole and of “the originate to distribute business” business model was put into question.

At the same time, a number of international financial markets – particularly the markets for equities in developed and emerging economies, currencies as well as commodities and other industrial raw materials – have experienced a significant increase in volatility. Of particular concern for central banks has been the re-emergence of significant tensions in global money markets, where market liquidity has come under severe strain and term interest rates remain at elevated levels.

Before talking about what central banks and other public authorities have done to address the challenges posed by the financial market turmoil, let me take a step back and elaborate on the role of uncertainty in the current turmoil.

3. The role of uncertainty

One of the most relevant features of the current turmoil has been the enormous increase in general uncertainty related to the financial sector and the heightened degree of what economists call “asymmetric information” in credit markets (for instance, the fact that borrowers have more or better information than lenders about the potential returns and risks associated with the project for which they demand financing).

In the current context, uncertainty mainly relates to imperfect information in relation to credit valuations. Uncertainty generally increased during the summer of 2007, because market participants realised that the current practices used for valuations – often based almost solely on ratings – were no longer valid. With liquidity strains characterising certain market segments, it became impossible for financial firms to properly value a range of financial assets and off-balance sheet exposures using the existing standards on valuation and accounting.

As a result of widespread uncertainty about credit valuations, market participants found it difficult to model the expected occurrence of defaults, which led to wider credit spreads. Another typical effect of increased uncertainty was the flight-to-quality phenomenon in favour of government bonds as well as cash and bank deposits.

In addition, lack of transparency throughout the securitisation process (the process by which credit claims are engineered into complex structured products) made it difficult for market participants to identify where the risks were accumulating in the financial system and to assess the possible losses from these exposures. Not surprisingly, efforts by public authorities at the international, European and national level (notably, the Financial Stability Forum report) to identify measures aiming at restoring confidence and enhancing the resilience of the financial system, have stressed the need to address weaknesses in valuation practices and to enhance market transparency.

During the current turmoil, uncertainty about the size and location of losses created by the opaque transfer of credit risk brought about by complex securitisation mechanisms has aggravated the adverse selection problem typical of credit markets, rendering it increasingly difficult for market players to distinguish between solvent and insolvent borrowers (an application of the so-called “market for lemons” problem). Such uncertainty has heightened counterparty credit risk concerns, inducing banks to demand high risk premia of their creditors, while discouraging them from lending to each other.

Thus, increased uncertainty has led to the protracted “freezing” of the interbank lending market. This has translated into funding liquidity problems for individual banks, i.e. difficulties in funding their business activities. As the degree of funding liquidity of banks, especially large banking groups, depends on the liquidity of the credit and securities markets they rely on for their external financing, funding liquidity and market liquidity are in practice interrelated. Indeed, some economists have developed models in which market and funding liquidity reinforce each other, leading to the emergence of “liquidity spirals” that may account for some of the declines in the liquidity of markets and individual institutions observed from the start of the crisis.

Protracted market illiquidity can also have potential negative repercussions for the banking sector and the economy as a whole. In fact, under normal market conditions, market illiquidity is typically short-lived, particularly since it creates profit opportunities for traders who, by providing extra funding liquidity, support the price discovery process and restore the smooth functioning of the market. In contrast, during a severe turbulence the disruption of the mechanisms channelling liquidity – be it through assets prices or the balance sheet of financial institutions – may also deeply and lastingly weaken the balance sheets of financial institutions and undermine their solvency, ultimately creating systemic risks for financial stability.

4. Policy responses from the Eurosystem and other central banks

The general increase in uncertainty has affected the work of central banks via its impact on monetary policy formulation, implementation and transmission.

Let me give you three examples of how uncertainty affects the conduct and implementation of monetary policy in the euro area.

• The intensification and broadening of the financial market turmoil has led to an extraordinarily high degree of uncertainty surrounding the outlook for economic growth and medium terms price stability in the euro area, which poses challenges for the formulation of monetary policy.

• As a result of increased uncertainty and the changing environment, the ECB cannot longer rely on some of the liquidity management tools and procedures that had previously served it well in order to implement in the money market the monetary policy stance decided by the Governing Council.

• Besides, increased counterparty credit risk and developments in the financial system have impaired the functioning of the money market, which represents the first step of the monetary policy transmission mechanism.

Along these lines, let me explain how central banks have responded to the challenges arising from market turmoil using a combination of operational measures and increased international co-operation

Main challenges to central banks

In general, public policy responses to the financial market turmoil and the ensuing problems for the banking systems have focused on addressing three key sources of concern: market liquidity, funding and solvency.

As earlier mentioned, these three dimensions of the turmoil are not entirely disjointed. Indeed, the current turmoil has brought to the fore the enhanced interaction between market liquidity and funding liquidity of individual institutions, partly reflecting the trend among large global banks towards greater reliance on wholesale market sources for funding as opposed to retail deposits. In addition, the experience of some financial institutions in recent months has shown that protracted illiquidity may weaken the balance sheets of institutions and in extreme cases put their solvency at risk.

Against this background, central bank interventions have aimed to address funding liquidity shortages by supporting market liquidity. In doing so, they have contributed to preventing insolvencies. Of course, this does not mean that central banks have targeted individual counterparty solvency concerns, which is of course a task which falls within the reach and responsibilities of governments rather than central banks.

Policy responses from central banks

The responses have varied across central banks depending on the conditions of domestic money and credit markets as well as on their specific institutional frameworks. However, in general, the responses from central banks have mostly consisted of the following categories of interventions:

• Active liquidity management: central banks have acted to keep short-term money market rates in line with their policy rates (or targets) through more active reserve management, thereby flexibly responding to shifts in the demand for reserves.

• Enhanced liquidity provision: central banks have sought to ease pressures in broader funding markets through a combination of measures, such as an increased supply of longer-term funds, the expansion of collateral accepted in lending operations, and the widening of the range of counterparties that may have access to collateralised lending. In some cases, central banks have also extended lending to non-depository banks and to financial institutions other than banks.

• Support to market trading activity: some central banks established securities lending facilities to improve the functioning of interbank repo markets.

In addition, several central banks – including the ECB – have also adjusted their monetary policy stance to take into account the impact of the financial market turbulences on inflation and real activity.

In particular, in response to changes in the outlook price stability in the euro area, the ECB announced on 8 October a 50 basis point reduction (to 3.75%) in its key policy rate – the interest rate on the main refinancing operation – in a move coordinated with five other major central banks. A further reduction by 50 basis points (to 3.25%) was decided on 6 November against the background of a further alleviation of risks to price stability at policy-relevant horizons at a time when weakening demand and the intensification and broadening of the market turmoil implies the materialising of some downward risks for economic growth.

Responses of the Eurosystem

Having briefly mentioned the adjustment to the euro area monetary policy stance, let me now discuss how the Eurosystem has responded through operational measures to the challenges stemming from the financial market turmoil.

• Increased cooperation: central banks have increased their co-operative efforts both through enhanced communication and collective market monitoring, and through co-ordinated actions to provide both overnight and longer-term funds.

• Emergency liquidity assistance: in a fortunately limited number of episodes, central banks have assisted their domestic governments in providing emergency liquidity assistance to institutions under stress.

As a starting point, it is worth recalling three key features of the Eurosystem’s operational framework that have played a role in shaping the response to the turmoil in the euro area. The Eurosystem: (1) grants access to central bank liquidity to a very large range of counterparties; (2) accepts a rather wide spectrum of private and public collateral in all classes of lending operations; and (3) conducts open market operations on a relatively large scale.

These features of the operational framework have allowed the Eurosystem to resort to a more pro-active liquidity management in order to achieve two objectives:

1. to keep the very short-term money market rates in line with the chosen policy rate, thereby delivering the desired monetary policy stance, and

2. to ensure the smooth functioning of the market, thereby contributing to preserving financial stability.

In particular, since the outbreak of the turmoil in August 2007 the Eurosystem has adjusted the distribution of euro liquidity supplied over the course of the maintenance period by frontloading the supply of liquidity at the beginning of the period and reducing it later in the maintenance period. Furthermore, it significantly increased the amount of refinancing provided via longer-term refinancing operations with a view to smoothening conditions in the term money market. In order to keep the total amount of outstanding refinancing unchanged, the net amount of liquidity provided via shorter term refinancing operations has been reduced accordingly.

Following the rescue of Bear Stearns last March the financial market turmoil entered a new, more intense phase that further deteriorated with the collapse of Lehman Brothers in mid September. In response to the renewed tensions, the Eurosystem stepped up its efforts to support the appropriate functioning of the euro money markets and to alleviate both the euro and the USD funding needs of euro area banks by:

1. further enhancing the policy of frontloading liquidity at its weekly main refinancing operations,

2. significantly increasing the average duration of its refinancing operations, and

3. also by expanding coordinated provision of USD liquidity within the context of the Term Auction Facility, as will be discussed in the next sub-section.

In order to contribute to easing liquidity tensions in the euro money markets, the Eurosystem took on 8 October the exceptional decision to: (a) temporarily change the tender procedure in its weekly main refinancing operations to fixed rate tender with full allotment so as to provided uncapped access to euro liquidity (of course, against adequate collateral), while (b) reducing the corridor of standing facilities (from 200 basis points to 100 basis points) around the interest rate on the main refinancing operation.

More recently, in the context of the latest initiatives undertaken by the EU authorities to restore confidence and the appropriate functioning of our financial systems, on 15 October the ECB approved a new set of temporary measures designed to further enhance the provision of long-term euro liquidity until the end of the year and over the next quarter and to expand the list of collateral accepted in the Eurosystem monetary policy operations until the end of next year.

In particular, as part of the measures designed to enhance the provision of long-term euro liquidity, the fixed-rate tender procedure with full allotment has also been temporarily extended to longer-term refinancing operations, implying that euro area counterparties can now borrow as much euro liquidity as they wish (against eligible collateral) also at some key term maturities, against an expanded set of eligible assets accepted as collateral.

The new set of temporary measures aim to further enhance the access to euro liquidity to solvent banks, while also contributing to restore confidence among market participants in the current environment in which money markets remain under stress and the traditional channels of liquidity transmission are impaired.

Increased international cooperation

In addition to domestic operational responses, central banks have further strengthened their cooperation throughout the turmoil. They have enhanced their cooperation first by means of enhanced information sharing and collective monitoring of market developments and later on through coordinated steps to provide liquidity.

The main example of such coordinated actions among central banks is the US dollar Term Auction Facility, which started in December of last year and in which the ECB agreed with BIS for the US Federal Reserve to grant loans in dollars to euro area banks. These USD liquidity providing operations have increased over time in terms of size and number of participants (and now involve thirteen central banks, from both developed and emerging economies, in addition to the ECB).

As far as the Eurosystem is concerned, the scope of this facility has significantly increased over time in terms of maturities covered and volumes involved. On 15 October the Governing Council took a further step with the decision – announced together with Bank of England and the Swiss National Bank – to conduct operations at various maturities at fixed interest rates and with full allotment. As a result of this decision, euro area counterparties will be able to borrow as much USD liquidity as they wish, also at some term maturities, against eligible euro-denominated collateral, with the supply of USD guaranteed by an unlimited temporary reciprocal currency arrangement between the Federal Reserve and the ECB that will remain in place for as long as needed.

On 15 October the Eurosystem also entered into an agreement with the Swiss National Bank in order to facilitate the provision of liquidity denominated in Swiss Francs to euro banks. At the same time, in the past few weeks the Eurosystem has signed agreements with the central banks of several European countries in order to improve the provision of euro liquidity to their banking sectors.

Increased financial intermediation

Before discussing the latest coordinated initiatives, I would like to point out that, as a result of its enhanced liquidity interventions in euro and other currencies (notably, in USD) during the turmoil, the Eurosystem has significantly increased its involvement in financial intermediation in the euro area. We are now effectively intermediating liquidity flows among banks in order to mitigate the dysfunctions of money markets.

Of course, this is not the ideal long-term solution in a market-oriented economy like the euro area and it also potentially implies increased financial risks for the Eurosystem (which are nevertheless taken care of through adequate risk control measures). However, as long as money markets remain dysfunctional, the Eurosystem will continue to provide liquidity as needed in order to ease tensions in the impaired money markets, with a view to ensuring that access to liquidity of solvent banks is not disrupted, thereby contributing to safeguarding financial stability. At the same time, we very much look forward to the reactivation of inter-bank lending and to banks resuming their traditional intermediation activity.

5. Recent coordinated initiatives

Let me briefly refer to the recent coordinated initiatives of international and European governments and central banks.

During the early phases most of the current turmoil government interventions focused on addressing problems at single institutions, mainly through rescues and the provision of guarantees covering the liabilities of individual institutions under stress. More recently, increasing awareness that the current turmoil has the potential to jeopardise systemic financial stability has prompted governments to announce more general and comprehensive schemes (mostly based on capital injections in exchange for equity and on the provision of state guarantees) that are designed to support their entire financial systems rather than individual institutions.

The more recent initiatives have not only been comprehensive but also “coordinated”, reflecting the increasingly consensual view that the “global” nature of the financial tensions requires a common understanding among governments of the roots of the tensions and concerted actions to address them. The framework for such concerted actions is defined by the common principles in key areas (ensuring appropriate liquidity, facilitating the funding of banks through various means, providing additional capital resources to financial institutions, recapitalisation of distressed banks, ensuring appropriate implementation of accounting rules, and enhancing cooperation among European countries), laid in the recent public commitments by the G7, Ecofin and governments of the euro area.

In this respect, three important commitments are: (1) the Plan of action of the G-7 finance ministers and central bank governors of 10 October, (2) the ECOFIN Council conclusions of 7 October and (3) the Declaration on a concerted European action plan of the euro area countries on 12 October. These documents list common principles in key areas (ensuring appropriate liquidity, facilitating the funding of banks through various means, providing additional capital resources to financial institutions, recapitalisation of distressed banks, ensuring appropriate implementation of accounting rules, and enhancing cooperation among European countries), while leaving national governments free to design the operational aspects of such interventions according to the specific characteristics of their domestic financial industries.

In particular, these public commitments establish some core principles on how to address liquidity, funding and solvency problems that should contribute to define a common and more effective approach to overcoming the present turmoil. This common approach has started materialising through the announcements by various euro area governments of co-ordinated action plans that comply with the general principles agreed in euro area and international fora.

The importance of cooperation mechanisms and information sharing was also underlined by the European Council on 15 and 16 October with the creation of a “financial stability cell” aiming to improve crisis management in the EU and the decision to establish regular meetings of national regulators.

The importance of broad international cooperation to address the challenges faced by the world economy has been renovated in the Statement released after the G-20 Summit on Financial Markets and the World Economy of 16 November. The Statement indicates principles for the reform of the international financial systems and the improvement of the global financial architecture as well as policy responses to the global slowdown in economic activity.

Strengthening market transparency, improving disclosure and accountability are indicated among the core principles for reform of financial markets, with the Statement also including a specific action plan listing both immediate and medium-term actions in these areas.

In general, the principles for reform indicated by the G-20 are in many respects consistent with those previously stated in the public commitments of other international fora. Nevertheless, as has been stressed by commentators, their restatement by the G-20, a group of countries including both the major developed economies and the largest emerging economies, is a confirmation of both the global nature of the financial crisis and the equally global determination to overcome it.

Indeed, all of the public commitments so far together with the plans already adopted by many countries clearly show the strong determination of the international community to preserve the stability of our financial and economic sectors and improve the functioning of the international financial systems.

Of course, it is too early to tell the effect of the latest initiatives by public authorities, but there are some positive signs. The coordinated measures taken in recent weeks by governments and central banks worldwide seem to have had a favourable impact on financial markets as the premia on banks’ CDS contracts have fallen sharply, money market rates have fallen very significantly, spreads have narrowed and volumes traded on money markets seem to have increased somewhat while some (still smaller than usual in aggregate) term money market transactions have taken place. Despite these improvements, the situation remains far from normal.

6. Final remarks

Uncertainty is at the root of the financial market turmoil that we are currently experiencing. Such uncertainty translated into a severe under-appreciation of the risks associated with certain classes of financial instruments and institutions. More recently, with the intensification and broadening of the market turmoil, uncertainty has further increased and developed into a pervasive phenomenon affecting a wide range of markets, assets and financial sectors.

Systemic uncertainty may potentially undermine the foundations of our financial systems, which are in turn essential for the orderly functioning of our economies. This is why many of the policy recommendations from a wide range of fora and organisations aim at addressing the causes of uncertainty by implementing steps leading to a sound transparency framework based on improved disclosure, high-quality accounting standards and solid valuation practices.

In the meantime, public authorities are taking a number of systematic and comprehensive measures designed to address the ongoing financial turmoil. These measures, in combination with the enhanced liquidity provisions by central banks, should restore confidence and contribute to re-establishing an environment in which governments, regulators and supervisors can implement the urgent reforms that are needed in order to anchor the global financial system to sound foundations.

It is of essence that private institutions live up to their responsibilities. In particular, by doing their part to restore orderly conditions in the money markets and by resuming in earnest their intermediation function, the private banking community should help to ensure that the liquidity measures taken by central banks and the initiatives taken by governments in terms of bank recapitalization and debt guarantees lead to the desired results.

Many thanks for your attention.