1 Financial Market Development: Sequencing Of Reforms To Ensure Stability Presented By V....

1

Financial Market Development: Financial Market Development:

Sequencing Of Reforms To Ensure StabilitySequencing Of Reforms To Ensure Stability

Presented ByPresented By

V. SundararajanV. Sundararajan

FiFifth Annual Financial Markets And Development Conference Onfth Annual Financial Markets And Development Conference On

The Future Of Domestic Capital Markets In Developing CountriesThe Future Of Domestic Capital Markets In Developing Countries

April 14–16, 2003, Watergate Hotel, Washington, D.C.April 14–16, 2003, Watergate Hotel, Washington, D.C.

Organized By The Brookings Institution, The International Monetary Fund, and The World BankOrganized By The Brookings Institution, The International Monetary Fund, and The World Bank

2

Introduction & Central Theses

The Hierarchy of Markets

Financial Market Development

Risk Mitigation

Sequencing

OutlineOutline

3

Central ThesesCentral Theses

Institutional InfrastructureInstitutional Infrastructure for Macroeconomic Control

Financial ReformsFinancial Reforms Sequenced According to the Hierarchy and Complementarity of Markets

A StrongA Strong Domestic Domestic Investor Base: Investor Base: Foreign Capital Can Complement But Not Substitute for Domestic Investors

An Integrated Approach An Integrated Approach to External & Domestic Financial Liberalization

Market Development-Cum-Stability Requires...Market Development-Cum-Stability Requires...

4

Institutional InfrastructureInstitutional Infrastructure

Instruments & Markets

Prudential Regulation & Supervision

Market Infrastructure

Policy Transparency

Payment Settlement Arrangements

Information, Accounting & Disclosure

5

Asset-Backed Securities & Derivatives

Corporate Bonds & Equities

Government Bond Market

Treasury Bill Market & Foreign Exchange Markets

Money Market

The Hierarchy of MarketsThe Hierarchy of Markets

6

The Hierarchy of MarketsThe Hierarchy of Markets

Money Markets:Money Markets: The Foundation of All Capital Markets & Interest Rate Setting

Government Bond Market:Government Bond Market: Backbone of All Securities Markets & Yield Curve

Money & Government Bond Money & Government Bond Markets : Markets : Highly Interdependent

FX Market:FX Market: “Entry Market” for Foreign Investors

Markets are Hierarchical and InterdependentMarkets are Hierarchical and Interdependent

7

Money MarketMoney Market

Central Bank Liquidity ManagementCentral Bank Liquidity Management

Banks Liquidity ManagementBanks Liquidity Management

Interest Rate Setting & Interest Rate Setting & TransmissionTransmission

Foundation of Financial MarketsFoundation of Financial Markets

8

Money Market Money Market DevelopmentDevelopment

Central Bank Role

Soundness of Financial Institutions

Repurchase Agreements

Prudential Criteria for Market Participation

Payment Settlement Arrangements

Critical FactorsCritical Factors

9

FX Market DevelopmentFX Market Development

Central Bank RoleCentral Bank Role

Soundness of Market ParticipantsSoundness of Market Participants

Degree of CompetitionDegree of Competition

Dissemination of InformationDissemination of Information

Impediments to Price DiscoveryImpediments to Price Discovery


10

Govt Bond Market Govt Bond Market DevelopmentDevelopment

CommitmentCommitment to Market-Based Financing to Market-Based Financing

Bond Design:Bond Design: Standardize, Concentrate in Standardize, Concentrate in Benchmark Securities, Issue RegularlyBenchmark Securities, Issue Regularly

Regulatory Incentives:Regulatory Incentives: Remove Remove Obstacles to Competition, Tax DistortionsObstacles to Competition, Tax Distortions

Timing: Timing: Short-Term First, Long Term LaterShort-Term First, Long Term Later

Market Intermediaries: Market Intermediaries: Use Primary Use Primary Dealers & Develop Institutional InvestorsDealers & Develop Institutional Investors


11

Corporate Bond & Equity Corporate Bond & Equity Market DevelopmentMarket Development

Regulatory & Legal FrameworkRegulatory & Legal Framework

Corporate Governance & DisclosureCorporate Governance & Disclosure

Financial Information & PricesFinancial Information & Prices

Design of Market InfrastructureDesign of Market Infrastructure

Clearing & Settlement SystemsClearing & Settlement Systems

12

Institutional InvestorsInstitutional Investors

Enhance Transparency, Market Discipline, Corporate Governance & Shareholder Rights

Provide a Framework for Long-Term Capital Accumulation

Act as a Stable Source of Demand for Securities

Intensify Competition Among Intermediaries

Are Critical Because They...Are Critical Because They...

13

Risks Grow As Markets Risks Grow As Markets DevelopDevelop

Complexity & Dimensions of Risks Rise as New Markets & Instruments Are Added

Financial Risks Macro Risks

Risk Mitigation Policies Should be Comprehensive

14

Risk MitigationRisk Mitigation

Risks in Each Market Need to Be Risks in Each Market Need to Be Effectively Managed Before More Risks Effectively Managed Before More Risks Are Injected into the Financial SystemAre Injected into the Financial System

Key PrincipleKey Principle

15

Pillars of Risk MitigationPillars of Risk Mitigation

Prudential Supervision & Market Conduct

Bank Restructuring & Recapitalization

Design of Market Risk Controls in Settlement System Choice of Market Infrastructure

16

Pillars of Risk MitigationPillars of Risk Mitigation

Design of Central Bank & Debt Management Operations

Intervention Procedures

Macroprudential Surveillance

Adjustment of Macro-Policies to Limit Risks & Volatility From Financial Reforms

17

Money MarketMoney Market

Credit Risk:Credit Risk: Financial Disclosure, Credit Risk Analysis & Pricing, Frameworks for Repos & Collateral

Liquidity Risk:Liquidity Risk: Maturity Mismatch Limits, Liquid Assets, Back-Up Credit Lines, Liquidity Management

Central Bank Operating Risk: CB Operating Procedures, Risk Controls, Loss Sharing Arrangements in Payment System

Risks & Risk Mitigation MeasuresRisks & Risk Mitigation Measures

18

Foreign Exchange MarketForeign Exchange Market

Exchange Rate Risk:Exchange Rate Risk: Exposure Limits, Net Exposure Limits, Net Open Position Limits, Capital Requirements, Open Position Limits, Capital Requirements, Hedging InstrumentsHedging Instruments

Credit Risk:Credit Risk: Credit Risk Analysis & Pricing, Underwriting Standards

Liquidity Risk:Liquidity Risk: Maturity Mismatch Limits, Transparent Trading & Market Conduct

Central Bank Operating Risk: Intervention Policies, Macro-Policy Consistency, Guarantees


19

Government Bond MarketGovernment Bond Market

Settlement Risk:Settlement Risk: Dematerialize Securities, Dematerialize Securities, Automate Settlement, Monitor Members Automate Settlement, Monitor Members

Liquidity Risk:Liquidity Risk: Reduce Fragmentation, Develop Benchmark Securities, Use Primary Dealers

Interest Rate & Rollover Interest Rate & Rollover Risks: Prudential Requirements for Risk Management

Market & Credit Risks: Standardize Contracts, Improve Credit Risk Pricing, Use Rating Agencies, Transparency on Large Positions


20

Equity MarketEquity Market

Counterparty & Settlement Risk:Counterparty & Settlement Risk: Capital Requirements, Supervision, Membership Restrictions, Central Counterparty, Early Warning System

Market & Liquidity Risk:Market & Liquidity Risk: Accounting & Auditing Standards, market Transparency, Valuation Requirements, Exposure & Concentration Limits


21

Capital Account LiberalizationCapital Account Liberalization

Capital Account Liberalization & Domestic Financial Reforms Should be Integrated

Capital Account Opening Amplifies Existing Risks & Creates More of Them

The Hierarchy of Markets & Risks Provide Key Benchmarks & Principles

Key IssuesKey Issues

22

SequencingSequencing

First Priorities Are Monetary Policy Instruments & Money & FX Markets

Policies Must Be Comprehensive & Address Interdependencies & Linkages Among Markets

Market Development Measures Must Be Accompanied By Prudential & Supervisory Measures to Contain Risks

Selected Key PrinciplesSelected Key Principles

23


Initial Financial Structure of Firms Affects Pace of Reforms

Reforms Requiring Long Lead Times For Capacity Building Should Start Early

Liberalization of Capital Flows Should Be Sequenced to Reinforce Domestic Financial Reforms

Transparency & Data Disclosure Practices Should Support Capital Account Opening

Selected Key Principles (Continued)Selected Key Principles (Continued)

24

Hierarchy of Markets Hierarchy of Markets

Type of Type of MeasuresMeasures

Money & Exchange Market & Related Central Bank Reforms

Government Bond Market & Public Debt Management

Corporate Debt & Equity Markets

Derivatives & Asset-Backed Securities

MMarket Developmentarket DevelopmentEntry

Trading & settlement

Information, governance

Risk MitigationPrudential supervision

Risk controls

Macroprudential surveillance

Stylized Sequencing IStylized Sequencing I

25

Hierarchy of Markets Hierarchy of Markets Type of Type of MeasuresMeasures

Money & Exchange Market & Related Central Bank Reforms

Government Bond Market & Public Debt Management

Corporate Debt & Equity Markets

Derivatives & Asset-Backed Securities

Financial System Financial System InfrastructureInfrastructureAccounting & disclosure

Insolvency regime

Information, governance

Capital Account LiberalizationFDI

Portfolio equity

Long term debt

Short-term debt

Stylized Sequencing IIStylized Sequencing II

26


Sequencing Implies a Critical Mass of Reforms at Each Stage of Market Development

No Unique Sequencing or Pace—Depends on Country Specific Institutional Circumstances & Initial Conditions

Comprehensive Approach to Identifying Risks to Monetary Control & Financial Stability

Macroprudential Surveillance is Key Complement to Prudential Surveillance

1 Financial Market Development: Sequencing Of Reforms To Ensure Stability Presented By V....

Documents

Transcript of 1 Financial Market Development: Sequencing Of Reforms To Ensure Stability Presented By V....