Running The Bank Of Central Banks - interview with Andrew Crockett, Bank for International Settlements - Interview

International Economy, The, May, 2001 by Klaus C. Engelen

Concerning the first--conjunctural issues--it is useful to look separately at the United States, Europe, and Japan. The feeling was that the U.S. financial system was well capitalized and capable of handling a cyclical downturn. Therefore the slowdown in the United States--while it would undoubtedly throw up some additional bad loans and would impact the banks profits--would not significantly compromise their ability to continue to extend finance to good credits. So it was not felt that a slowdown in the United States would lead to a credit crunch--not unless the situation became much worse than currently foreseen.

As for Japan, I think that we concluded that there was not likely to be a significant failure in the banking system, partly because the capital position had gotten somewhat better, and partly it was concluded that the Japanese government one way or another would prevent a destabilizing failure by an institution. Whether the financial sector in Japan will contribute much to recovery is another matter. Quite clearly, more needs to be done in the area of structural reform, in further strengthening banks' capital, and reactivating financial intermediation.

As far as the European financial sector was concerned, exposure in the telecom sector had been raised in the September meeting of the Forum. As a result of that, a working party had been established under Michael Foot of the British FSA. The conclusion from that study was that although there were indeed significant exposures to the telecom industries, those were bearable, and did not pose a threat for financial stability. Of course, the economic situation in Europe still appears more robust than in Japan or in the United States.

TIE: Where did the Forum sense the major threat to the system?

AC: One of the functions of the Forum is to ask the question: will financial vulnerabilities compound the economic cycle in the real economy, making the cycle worse or causing a crisis? The general answer to that question at the Washington meeting was that the financial system is strong enough not to be an additional source of weakness. But there are some exceptions to that general statement. Japan is obviously a concern, as are some emerging markets.

Looking at the longer-term structural changes, there were two or three major issues at the Washington meeting that bear watching: for example, the issue of whether the new risk-shifting instruments are adequately understood and robust enough to stand up in times of pressure. By that, I mean credit derivatives and other securitized instruments that are sold by the originator to financial institutions in different market segments. By and large, risk-shifting instruments are good because they allow risks to be passed on to institutions that are more able or willing to bear them. If properly used, they should strengthen the financial system. However, there are some nagging doubts. One is: will these instruments stand up legally and administratively if they are really put to the test in times of stress? For example, will insurance companies that have underwritten some of the risks really be willing to pay up immediately, or will they try to test the legal robustness? In the capital markets the standard rule is pay first, argue later, whereas with insurance contracts, it sometimes can seem to be the other way around. If the insurance industry is underwriting risks in the capital markets, that could cause a problem.