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STORY: IMF / FINANCIAL STABILITY
TRT: 2:50
SOURCE: IMF
RESTRICTIONS: NONE
LANGUAGE: ENGLISH / NATS
DATELINE: RECENT, WASHINGTON, DC
RECENT 2010, WASHINGTON DC
1. Wide shot, exterior of IMF
2. Med shot, Jeanne Gobat working at desk
3. SOUNDBITE (English) Jeanne Gobat, Monetary and Capital Markets, IMF:
“Financial institutions became vulnerable to the global financial crisis because they increasingly more relied on short-term wholesale funding markets. These risks were not detected by regulators or institutions. They generally reflect weaknesses in risk management practices and the market infrastructure and also regulatory gaps. And as the short-term wholesale funding markets dried up, banks and financial institutions had to turn to Central Banks and governments for funding.”
4. Cutaway, IMF
5. SOUNDBITE (English) Jeanne Gobat, Monetary and Capital Markets, IMF:
“These vulnerabilities can be avoided by strength in liquidity risk management practice. The first thing we need to do is improve and strengthen the liquidity buffers in banks as is currently proposed by the Basel 3. And that also addresses maturity mismatch. We need to strengthen the repo markets, the key funding market for banks. There we discuss ways to strengthen collateral valuation practices. Collateral is used as a source of funding in the repo market. And finally, we need to strengthen supervision. That includes also the supervision of banks’ offshore funding.”
6. Cutaway, IMF
7. SOUNDBITE (English) Jeanne Gobat, Monetary and Capital Markets, IMF:
“U.S. money market mutual funds contributed to systemic liquidity risks because they play a critical role in the short-term wholesale funding market. Banks, both U.S. banks and non-U.S. banks, rely on that market for funding. During the crisis, institutional investors in the U.S. money market mutual fund industry withdrew sources, withdrew funds from the money market funds and that triggered funding stresses. Now, one of the suggestions that we have put forward is that money market mutual funds should be valued regularly to reflect market risk. As such, investors would then recognize that they bear the risk. More proactively we’d also manage their funds. But we also suggest going beyond just money market mutual funds when looking at regulations to also account for all non-bank financial institutions that account for systemic liquidity risk.”
8. Wide shot, exterior IMF headquarters
The inability of financial institutions, including banks, to obtain short-term funding during the global financial crisis was the result of weaknesses in risk management practices by the institutions themselves, serious and unforeseen issues in how wholesale funding markets work, and regulatory gaps, according to a new IMF report.
Financial institutions increasingly relied on short-term wholesale rather than deposit-based funding to finance their activities, which caused system-wide liquidity shortages when wholesale markets dried up. The systemic liquidity shortage, essentially the simultaneous and widespread inability of institutions to find the cash they need to operate, was one of the key factors that threatened the health of the global financial system and triggered massive interventions by authorities to keep banks and other financial institutions afloat.
Financial institutions failed to take into account the sharp declines in collateral valuations that undermined their funding strategy in secured lending markets such as those for repurchase agreements (repos). Nor did they factor in the possibility of a sudden, large-scale disruption to money markets, when investors, uncertain about asset valuations, the ability of counterparties to live up to their obligations, and the availability of liquidity, withdrew and cut back credit lines, the IMF said in the special report released on September 29.
Banks, and non-banks, raise cash in repo markets by selling securities and promising to buy them back at an agreed price at a future date. If the borrower cannot repay, the securities serve as collateral that the creditor can sell. But during the global crisis the value of much of the collateral was questioned and creditors were reluctant to make loans.
Money market mutual funds, which invest with a goal of keeping their net asset value at $1 a share, essentially ceased buying asset-backed commercial paper that depended on mortgages and certificates of deposit. That also contributed to a worldwide shortage of dollars and affected many internationally active non-U.S. banks that fund their dollar-denominated assets in the U.S. wholesale market. To ease the global shortage, the U.S. Federal Reserve engaged in swaps with other central banks to pump out dollars in the world economy.
The IMF report on systemic liquidity problems is one of two special analyses that accompany the IMF’s Global Financial Stability Report, whose main chapter will be released October 5.
The IMF says that policymakers continue to struggle with how to address the systemic component of liquidity risk. The report says that policies to address systemic liquidity risk must deal both with institutions and the markets within which they interact.
