Financial Architecture

Task 1: Evolution of International Financial Architecture and Its Impact on Present Economic Crisis

Amid current economic turmoil, the international community embarked on a range of initiatives to strengthen the international financial architecture. As there is no agreed definition of what constitutes international financial architecture, it broadly means the framework and set of measures that can help prevent crises and mitigate its disastrous aftermaths in the more integrated international financial environment. Several aspects of the agenda for crisis prevention and crisis resolution deal with weaknesses in the international financial system that potentially contribute to the propensity and magnitude of global instability, hence requiring collective action at the international level. But there is widespread recognition that global financial stability also rests on robust national systems and hence requires enhanced measures at the country level as well.

Learning from the past:

G20 summit is held at a very vital time to arrest the dangerous waves of global financial crisis. In 1930's when the world dominant economy gathered under one roof to ponder upon the solution and rescue act of global crisis, it was bit too late. As the economic crunch-monster had already swallowed the substantial part of world economy. But good news is that this time around the world economic superstars has taken the stand at early stage of crisis. This timing is even more significant in a way that part 2 of financial crisis is always more awesome and difficult to repair. Because as in the 1930's, later stage of crisis hit the roots of political and social system which culminated to World War II.

After World War II, 730 delegates from 44 allied nations gathered to chalk out a solid, consistent and long-lasting monetary control system to prevent the recurrence of 1930's great depression. The setting up of rules, institution and procedures for an efficient international monetary system was the main agenda of the conference. The foundation of IMF, IBRD (now part of World Bank) and Bretton wood system was laid in the conference.

In 1947 GATT was another step towards the collaborated and allied effort to keep the world economy on track. But all these measure was not implemented in letter and spirit, hence the poverty is still on the rise and the gap between the richer nation and poorer nation is still widening.

Emergence and Refinement Of International Financial Architecture:

The ongoing effort to reform the international financial system - what we now narrate as the new international financial architecture (NIFA) - began shortly after the Mexican crisis of 1994-95, which was resolved with the aid of $50 billion in short term credits from the International Monetary Fund (IMF) and US Treasury. The architecture operations has gone through several phases, focused on different issues, as the official community has sought to apply the lessons learned from the many crises that followed the Mexican crisis - the Asian crisis of 1997, the Russian crisis of 1998, the Brazilian and Ecuadorian crises of 1999, the Turkish and Argentine crisis of 2001-02 and most recent the world wide crisis. The exercise of IFA can be described in short as “reform on the run”.

Descriptions and assessments of the architecture exercise usually distinguish between two targets - reducing the frequency of crises (crisis prevention) and reducing the costs of crises (crisis mitigation). The two efforts go side by side. Precautionary measures to strengthen and well-regulate financial systems in emerging-market countries can perhaps reduce the frequency of crises but may also reduce the severity of crises. The recent move toward more flexible exchange rates will likewise reduce the vulnerability of emerging-market countries to speculative attacks on their currencies. But it may also provide very few reasons to banks and firms to go for large amounts of foreign-currency debt and end up with devastating balance-sheet effects of large exchange-rate changes, the resulting damage to their creditworthiness, and hence seriously influencing the availability and willingness to extend domestic credits from banks.

The World Bank Group and IMF's role in this agenda is determined by its mandate of poverty reduction, its familiarity with and involvement in developing countries given its role as a global development institution, and its comparative strengths on social and structural issues:

First and foremost, the World Bank is helping countries assess the social and structural sources of vulnerability and address underlying policy and institutional weaknesses.

Second, the World Bank is contributing to efforts to strengthen economic and financial governance at the global level in its areas of comparative advantage, and to help bring developing country experience and perspectives to the discussions that are underway on reform.

Three important dimensions are underway with the IMF and WB pertaining to international financial architecture

(a) The Reports on the Observance of Standards and Codes (ROSC)

It's a framework to strengthen soundness and transparency of markets, institutions and policies. This is performed in collaboration with international institutions, social services bodies, public and private sector agencies. The aim is to enhance the reporting and hence checks on the fairness of market operations and government policies which is very important particularly for the certain country and generally for the whole world.

(b) The Financial Sector Assessment Program (FSAP)

The financial sector is the lynchpin of an economy so its health is so crucial for the overall system's stability and survival. In fact the current crisis is triggered by the factors directly and closely linked with financial institutions specially banks.

The bankers were greedy and irresponsible; that they made bad business decisions and sold bad products.

The system was inadequate and less-regulated.

Too much money was loaned insecurely.

This is why a watchful eye has to be kept on the operations of financial institutions. For this purpose 125 countries has signed up for this program which allow international analysts and experts to diagnose vulnerability and analyze development priorities of financial sector development. Although the out comes of these assessments have kept confidential but it serve as the summery assessment of country's compliance with the relevant standards and codes - the Reports on the Observance of Standards and Codes (ROSCs), which appear on the IMF's website and are therefore available to private-sector investors for use in judging country risk .

(c) The preparation of Public Debt Management (PDM)

This is very important area on which IFI's has to stress. There is massive flow of funds both in form of donation and loans, but these are misallocated and badly utilized. Hence the economic condition of receiving country remains almost the same and in most case further deteriorated. In fact these third world countries get stuck into the vicious circle of poverty. Therefore and advisory committee is formed to advise government of these countries in designing and implementing debt management strategy. This includes the investment of funds in the area which is in dire need as well as prudent and appropriate debt servicing.

Guidelines and a complementary Practitioner's Manual on the development of domestic markets for government debt. The World Bank also has strengthened partnerships with the relevant standard setting bodies and other institutions in the areas of corporate governance, accounting and auditing and insolvency regimes to forge a consensus and catalyze concerted actions. In addition, the World Bank is especially concerned with managing the social dimension of economic crises, and supporting social protection to help poor people manage the effect of economic shocks.

Several sets of actions are considered to be necessary to address the identified national policy, institutional and informational deficiencies. The main focus is to provide breathing space for regulatory and supervisory improvements (Köhler 2001). These improvements should focus on the implementation by local market and state institutions. Complying with ‘best practices' and committing to the standard & codes will indeed enhance the capacity to achieve the goal of increased transparency in the national system.


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