A Brazilian Perspective on Reform of the International Financial Architecture

Transcription

1 A Brazilian Perspective on Reform of the International Financial Architecture Report commissioned by DFID By Ricardo Gottschalk* Institute of Development Studies University of Sussex Brighton, BN1 9RE Tel: Fax: JULY 2001 * This report was prepared as part of the DFID funded study Reform of the International Financial Architecture: Views, priorities and concerns of governments and the private sector in the Western Hemisphere and Eastern Europe. I am thankful to Sophie Messner, from DFID, and Stephany Griffith-Jones for helpful comments and suggestions on an earlier draft.

2 Table of Contents List of Acronyms 3 Executive Summary 5 Introduction 11 Part I. Views, priorities and concerns of the government, private sector and others on reform of the IFA Progress So Far The New Agenda 12 a. Codes and Standards 12 b. The New Basle Capital Accord 15 c. New proposals for improving the CCL 16 d. PSI Further Issues of Concern 18 a. The provision of development finance by MDBs and distribution of capital flows across countries 18 b. Illegal money in international transactions 19 c. Participation of developing countries in the building-up of a new IFA 19 Part II. Assessment of Codes and Standards in Brazil Brief Macroeconomic Context Standards in Macroeconomic Policies and Data Transparency 22 a. Monetary and fiscal policy transparency 22 b. Data transparency Financial Regulation and Supervision 26 a. Banking supervision 26 b. The strength of the financial sector 27 c. The role of Federal Banks in directed credit provision 31 d. Promoting the capital markets in Brazil Areas for Technical Assistance 38 Conclusions 40 References 42 2

3 List of Acronyms ABRASCA Associacao Brasileira de Companhias Abertas (the Brazilian Association of Public Companies) ADRs American Depository Receipts ANBID Associacao Nacional dos Bancos de Investimento (the National Association of Investment Banks) ANDIMA Associacao Nacional das Instituicoes do Mercado Aberto (the National Association of Open Market Institutions) BACEN Banco Central do Brasil BASA Banco da Amazonia BB Banco do Brasil BIS Bank for International Settlements BM&F Bolsa de Mercadorias & Futuros BNB Banco do Nordeste BNDES Banco Nacional de Desenvolvimento Economico e Social BOP Balance of Payments BOVESPA Bolsa de Valores de Sao Paulo CAC Collective Action Clauses C&S Codes and Standards CCL Contingent Credit Line (IMF) CEF Caixa Economica Federal CLF Committed Loan Facility (World Bank) COPOM Comite de Politica Monetaria do BACEN (Central Bank s Monetary Policy Committee) CPSS Committee on Payment and Settlement Systems CVM Comissao de Valores Mobiliarios (the Brazilian Securities Comission) ECGD UK s Export Credit Agency (ECA) ECLAC Economic Commission for Latin America and the Caribbean (UN) FAPESP Fundacao de Amparo a Pesquisa do Estado de Sao Paulo (State Government Research Funding Agency) FDI Foreign Direct Investment FSA Financial Services Authority FSAP Financial Sector Assessment Programme FSF Financial Stability Forum FTAA Free Trade Area of the Americas GDDS General Data Dissemination Standard (IMF) IBGC Instituto Brasileiro de Governanca Corporativa (Brazilian Institute of Corporate Governance) IAS International Accounting Standards IASC International Accounting Standards Committee IFA International Financial Architecture IFIs International Financial Institutions IOF Imposto sobre Operacoes Financeiras (Tax of exchange transactions) IOSCO International Organisation of Securities Commissions IRB Internal Ratings Based Approach (New Basle proposal) MDBs Multilateral Development Banks MERCOSUR Mercado Comun del Sur (Common Market of the South) OFC Offshore Financial Centres 3

4 PPA PROEX PSI ROSCs SAL SDDS SMEs SPB SRF US FASB US GAAP Plano Plurianual (Multiyear Plan) Programa de Financiamento as Exportacoes (BB) Private Sector Involvement Reports on the Observance of Standards and Codes Structural Adjustment Loans (World Bank) Special Data Dissemination Standards (IMF) Small and Medium-sized Enterprises Sistema de Pagamentos Brasileiro Supplemental Reserve Facility US Financial Accounting Standards Board US Generally Accepted Accounting Principles 4

5 Executive Summary 1) This report presents the views, priorities and concerns of government representatives (at the highest levels), the private sector based in Brazil and others on the reform of the international financial architecture (IFA). The report also assesses the state of art of different codes and standards in Brazil, and the areas Brazilians believe external technical assistance is particularly welcome. 2) Senior officials have expressed a clear desire for a new financial architecture. They recognise that important progress has been made so far. In their view, since the currency and financial crises of the late 1990s, there has been greater reliance on long-term capital flows as a source of external finance, new instruments have been created to prevent and better manage crises, the IMF is seen now as taking a much more pro-active attitude towards crisis-threatened and crisis-affected countries, and a more effective private sector involvement (PSI) in crisis management has taken place. For Brazilians, these facts and initiatives characterise a first phase of important changes in the IFA after the crises of the late 1990s. 3) Brazilian senior officials see now the beginning of a second phase, which has an agenda that includes important issues and initiatives: implementing and improving Codes and Standards (C&S) of international best practice in developing countries, the new Basle Capital Accord, new proposals for improving the CCL, and developing a framework for PSI in crisis prevention and management. 4) Brazilian officials see efforts to adopt C&S as very important. They also welcome the fact that C&S can be seen as a soft law, to which countries can adhere voluntarily rather than by force. Voluntary standards allow governments and companies to adopt those that best suit their circumstances and give them a sense of ownership. Private sector representatives equally stress the importance of C&S, and welcome efforts in Brazil to implement them, and note that the country is acting on various fronts simultaneously, with the result that the degree of transparency has increased dramatically in the recent past. 5) However, Brazilian officials raised a number of issues and concerns. First, they believe that there are too many C&S 66 so far this being especially true for poor countries. Moreover, C&S are too uniform, which is inappropriate for countries with different needs, given their different stages of development and circumstances. Second, there is a need to distinguish between implementing C&S and the practice of assessing implementation. Implementing C&S is in itself a very resource-absorbing and time-consuming activity, which involves adopting new practices, procedures and processes. For these reasons they see assessment mechanisms such as ROSCs and FSAP as somewhat premature. Third, Brazilians expressed concern about not only the timing, but also with how assessment is pursued. Specifically, they find unfair that what is usually measured is how much the country still has to improve to meet international benchmarks rather than the amount of progress that has been made in implementing or improving C&S. 6) As regards the new Basle Capital Accord, Brazilians welcome the fact that the current proposal aims to introduce more flexible rules in determining the ratio of 5

6 capital to risk-weighted assets. However, they expressed concern about the idea of allowing banks to use their own internal risk assessment systems to determine the levels of capital adequacy. For them, this proposal entails a number of problems. First, it would increase pro-cyclicality in bank lending. Second, overall lending to developing countries could be reduced, as a reflection of a tendency towards risk aversion. Third, whilst in normal times the internal ratings based (IRB) models may be effective, in situations of market instability, they become counterproductive. 7) According to a senior Central Bank official, the IRB approach would only fit for the larger international banks of developed countries. In Brazil, very few banks four or five would be able to apply sophisticated models. This could lead to banking concentration. Therefore, Brazilian authorities are encouraging their banks to prepare for the IRB approach. This may require technical assistance. A further problem is that the current proposal does not suggest any measure to protect small borrowers, which might suffer from higher borrowing costs caused by stricter requirements being imposed on banks. 8) As noted earlier, Brazilian authorities very much welcome the creation of new mechanisms, such as the SRF and the CCL, for crisis prevention and management. However, although they welcome the recent changes incorporated into the CCL, they believe further improvements can be made. For example, they propose greater automaticity, which could mean a dispensation from an evaluation process undertaken for the purpose of granting a CCL, using instead information from routine assessments applied to all countries, such as the IMF Article IV Consultation. Brazilians believe that it is very important that such step be taken, as preventing crises is always better than having to manage them. 9) But should a crisis occur, they stress the need to envisage ways to facilitate a PSI in crisis management, so that private finance can complement official finance. This, they believe, would make a crisis less painful and more manageable, and would bring to the process an important burden-sharing element. However, the Brazilian position is that no strict rules should be set as how PSI should be, given that countries face different financing situations and prospects of market access in the future. 10) Having expressed their views on what they see as the new agenda of the IFA, Brazilians pointed to a number of issues they are currently focusing on. These include the development finance role of MDBs and the need of a greater role of developing countries in the discussions of a new IFA. 11) Brazilian officials observed that since the crises of the late 1990s, private capital flows to the emerging economies are on the whole rather scarce. The new Basle Capital Accord if implemented will reinforce rather than reverse this declining trend. In this context, Brazilians view that the MDBs, and in particular the World Bank, should create new products for middle-income countries. In addition to supporting their balance of payments and growth needs, and helping reduce the costs of external borrowing (by giving more leverage power to negotiate better loan conditions with private creditors), these new products would help countries 6

7 tackle their urgent development needs, which cannot be met by private finance alone due to market failures and externalities. 12) As regards participation of developing countries in the building-up of a new IFA, Brazilians believe that although having improved slightly, participation in the discussions and decision-making process of a new IFA is still very asymmetrical. Greater participation by developing countries is needed, among other reasons because the larger emerging economies have a bearing on the stability of the international financial system, and were the ones that suffered most from the recent crises. 13) The second part of the report, which assesses where Brazil stands in terms of implementing C&S, highlights two major areas: 1) macroeconomic policy and data transparency (covering specifically monetary and fiscal policy transparency, and data dissemination) and 2) financial regulation and supervision (covering banking, as well issues concerning the capital markets, including corporate governance). 14) In the monetary area, the private sector welcomes steps by the central government towards greater transparency in how the monetary policy is being currently conducted. They mention as positive aspects of this policy the adoption of the inflation targeting framework, the disclosure (monthly) of the minutes of the Central Bank s Monetary Policy Committee (COPOM) meetings, the production of inflation reports (quarterly), and the working papers and seminars that are being released and promoted. They believe these policies reduce the degree of uncertainty as regards the behaviour of the Central Bank, and help the markets know better what constraints are affecting the decision-making process. 15) In the fiscal area, the following initiatives have been pointed out by government officials, the private sector and others as key to the current fiscal adjustment and to the transparency and predictability of the fiscal accounts: the Fiscal Responsibility Law and the government recognition of the so-called contingent liabilities. The Fiscal Responsibility Law is a code of conduct for the public administration at all levels, aimed at improving fiscal management, accountability and transparency, thereby preventing risks that can affect the equilibrium of the public accounts. The recognition of contingent liabilities, in turn, gives greater predictability to the fiscal accounts. Another welcomed step towards greater fiscal transparency and predictability has been the government s initiative to develop a multi-year fiscal framework the Multiyear Plan (PPA). 16) As regards data transparency, it is a widely shared opinion that the country has undergone big changes in the recent past. Today the composition of external reserves is published very month, and their levels, every day. The most recent step towards greater data transparency has been the country s adherence to the Special Data Dissemination Standard (SDDS). Brazil, together with 40 other countries, is deemed by the IMF as having met the SDDS specifications for the coverage, periodicity and timeliness of data. 17) Moving on to the area of banking supervision, areas judged as particularly strong are the legal structure and power enforcement. In addition to these, other areas in 7

8 which the country is also strong include assessing operational risks of banks, and onsite supervision. Areas in which supervision is less strong include supervisors capacity to evaluate credit policy of banks and supervise risks, the offsite monitoring system and accountancy procedures, for which technical assistance might be helpful. 18) To tackle some of the problems mentioned above, a number of initiatives have been taken. These include the implementation of a new loan classification system and the central risk information system, both aimed at improving assessment of bank credit policies and risk. Moreover, the government has proposed regulations for ensuring that bank accounting procedures conform to international standards, and also regulations for liquidity risks; furthermore, it has required a consolidating reporting by banks. Another major initiative, which relates specifically to the functioning and stability of the financial system, has been the development of a new payments system. 19) More generally, it is broadly agreed that overall Brazil s financial system is strong on the whole well capitalised, with relatively low ratios of non-performing loans and high provision levels. The average level of capital adequacy met by banks in Brazil was 14.5% by November 2000, a level much higher than what is recommended by the current Basle Accord. However, this level is not uniform across different categories of banks. 20) In the view of a Brazilian academic, the current strength of the banking system reflects a defensive strategy by banks of holding a portfolio of assets composed mainly of government bonds with little of consumer or other credit. His concern is that the current trend of strong consumer credit expansion may create turbulence in the system. Among a group of nine private foreign and domestic banks, total credit expanded over 34% in the year Although government officials recognise that growth of credit has been high, they seem relatively unconcerned, given that it starts from a low basis. 21) Interestingly, the recent credit expansion has not been translated into more credit to the SMEs or to the poor, and there is no evidence that the pattern of freely allocated credit will change in the future. Until now, federal public banks have tended to fulfil more the role of providing development finance, and targeted more vulnerable sectors and customers. 22) However, to the extent that the public banks start meeting the Basle and other new loan loss provisioning requirements, they may stop lending to the poor. This is seen as a cause of serious concern in view of the huge developmental needs and levels of poverty incidence the country still exhibits, despite its status of an emerging economy. This could be a field for technical assistance to help establish clearly possible impact of different measures. 23) More generally, long-term financing provided by domestic banks has been historically limited, and the public banks have been able to meet this financing gap only modestly. In face of that and given that the current trend of the country s financial system is to aggravate this problem, much of the focus today in Brazil is on the development of the country s capital markets. 8

9 24) Brazilians agree that national companies need the support of strong and deep capital markets in order to be able to grow and compete internationally. However, in order to promote the capital markets in Brazil, a number of obstacles need to be removed, such as the burden of financial transaction taxes on companies, an inefficient bankruptcy law, the malfunctioning of the judicial system, and inadequate corporate law and corporate governance practices. 25) Various agents are coming forward with initiatives aimed at either fixing or getting around these problems. The government is seeking to act on various fronts. It has started by informing and encouraging a public debate on corporate governance. Private sector representatives and academics acknowledge that enormous progress has been made in the past year putting the corporate governance issue in the spotlight. A concrete government initiative has been to submit to congress a new corporate law. 26) Another important initiative taken by the country s main stock exchange (BOVESPA) has been the launch of the New Market, which means a parallel equity market to the existing one, but governed by stricter corporate governance rules. In parallel to Bovespa s initiative to create the New Market, the country s security commission (CVM) is making efforts to improve its legislation in the area of securities and move it towards international standards. However, Bovespa and CVM officials face acute lack of human and financial resources to carry out their tasks, particularly in negotiations with other countries, at FTAA and at IOSCO. Thus they see a great need for technical assistance in that area. 27) Still on capital markets, it is important to mention that Brazil has a well-developed future markets, whose activities are conducted under the Bolsa de Mercadorias e Futuros (BM&F). BM&F offer a wide range of financial instruments, such as futures, options and swaps. Brazil s financial institutions and non-financial corporate sector have relied on these instruments to hedge against risks. Hedging was quite widespread in Brazil in the wake of the 1999 currency crisis, a phenomenon that greatly helped avoid major devaluation effects across the financial and corporate sectors, thus ensuring the stability of the whole financial system. 28) In summary, this report shows that Brazil is making huge efforts to implement C&S of international best practice. As part of these efforts, the country is currently pursuing reforms in its domestic financial system, in order to conform it to international rules, like the Basle ones, which are aimed at ensuring domestic financial stability. However, a new institutional format of the financial system that may result from this process may lack some basic instruments and mechanisms to promote growth and especially credit to poorer people and to SMEs. Therefore, there seems to be a conflict between the stability objectives associated with the adoption of C&S and the need to have mechanisms in place to support development finance. 9

10 Introduction Brazil is the largest economy in Latin America, and one of the largest developing economies in the world. For this, it is expected in the next few years to take an increasingly leading role among developing countries in the international negotiations for a better international financial architecture (IFA). Moreover, Brazil is potentially a systemic risk country (due to the size of its economy). It experienced a currency crisis in early 1999, caused by the sudden reversal of short-term capital flows, with negative economic effects on the Latin American region, especially on neighbouring countries. It is therefore crucial to know better what reforms of the IFA the country see as necessary to reduce the likelihood of crises in the future and the spread of contagion, and what it thinks can be done to support growth and development. A further reason for analysing Brazil is that this is one of the few countries among the emerging economies that still have institutional and financial mechanisms in place to support development finance and those sectors associated with higher incidence of poverty, and to deal with regional inequalities. It would be interesting to see the extent to which efforts towards meeting codes and standards of best practice (geared mainly towards improving financial stability) could put these mechanisms in jeopardy, and reduce the scope of the government to promote policies aimed at combating poverty and supporting growth and development. Furthermore, it is important to note that Brazil is the only developing country that has experienced a currency crisis without a major impact on growth (though growth in Latin America was adversely affected by the Brazilian crisis, with some countries like Argentina experiencing negative growth). This may be related to particular features of the country s financial system, which this study aims to highlight. The current assessment of the Brazilian economy and its prospects is fairly optimistic. Government officials, the private sector and the international financial institutions (IFIs) are all sharing this optimism, to a large extent explained by the country s recent achievements, which include a rapid economic recovery after the 1999 currency crisis, and a strong macroeconomic adjustment, especially in the fiscal area. These facts together with further reforms being undertaken at present are seen as factors that may help the country regain a sustainable growth path, after years marked by relatively slow growth. There are concerns of course, that a sharp slowdown of the US economy, the lack of recovery in Japan and a worsening of the Argentinean situation may become important elements that could undermine the current path of recovery. It is against this background that this study will assess the main views, priorities and concerns of the government, the private sector based in Brazil and others on the IFA. The focus will be on the implementation of codes and standards (C&S), as well as the criteria that have been used to assess them. The study will firstly report the country s views on the international financial architecture more generally, and secondly assess the state of art of different codes and standards in Brazil, and the areas in which Brazilians believe external technical assistance is particularly welcome. 10

11 Part I. Views, priorities and concerns of the government, private sector and others on reform of the IFA. 1. Progress so far Senior officials in Brazil have expressed a clear desire for a new financial architecture. They recognise that important progress has been made so far, but they believe more needs to be done in order to reduce the instability of the international financial system, and to support growth and development. As senior government officials see it, before the currency and financial crises of the late 1990s, short-term private capital flows to the emerging economies predominated, the capacity of international bodies to regulate the international financial system was very limited, and the instruments and mechanisms to deal with the crises were very few. Since then, it is believed, the situation has considerably changed, and for the better. Today, there is much less reliance on short-term capital flows, with foreign direct investment (FDI) replacing them as a main source of external financing. This is seen as a very positive development, albeit Brazilians call attention to the fact that, whilst emerging markets had too much of private bank lending and portfolio flows for most of the 1990s, now perhaps there is too little of these flows. FDI is very welcome by Brazilians, but largely relying on such a single source of external financing is seen as risky. A potential problem with FDI is whether it will be sustained, at current levels, once privatisation finishes. Also, Brazilian policy-makers point out that FDI also has volatility elements, including hedging to cover exchange rate risk, that may exert pressure on exchange rates in similar ways to short-term capital flows. Brazilians also identified as other recent positive developments the creation of new instruments to prevent and better manage crises, such as the IMF Supplemental Reserve Facility (SRF) and the IMF Contingent Credit Line (CCL), and the creation of the Financial Stability Forum (FSF), to identify systemic risk situations and regulatory gaps in the international financial system. Also, the IMF is seen now as much more pro-active in crisis situations, an example of this being the way it has dealt with the crises in Mexico, Brazil, and Turkey and Argentina more recently (though they point worryingly to the risk of a hands-off approach in the future, due particularly to the possible position of the Bush administration). Another major change noted by Brazilians has been a more positive private sector involvement (PSI) in crisis management, particularly in countries seen in a period of crisis to have conditions to regain access to markets in a post-crisis period. All these aspects greater reliance on long-term capital flows as a source of external finance, the creation of new mechanisms to deal with crises, the more pro-active attitude of the IMF towards crisis-threatened and crisis-affected countries, and a more effective PSI for the category of countries seen as capable of regaining access to the international capital markets characterise a first phase of important changes in the IFA after the crises of the late 1990s. 11

12 2. The New Agenda Brazilian senior officials see now the beginning of a second phase, which has an agenda that includes important issues and initiatives: implementing and improving Codes and Standards of best practice in developing countries, the new Basle Capital Accord, new proposals for improving the CCL, and developing a framework for private sector involvement (PSI) in crisis prevention and management. In what follows we report Brazilian officials views on each of these areas. This will be complemented by the views of private sector representatives and others. a. Codes and Standards (C&S) Brazilian officials see efforts to adopt Codes and Standards of best practice as very important; in this regard they reported that a lot has recently been done in Brazil in a wide range of areas, from macroeconomic policy transparency to financial regulation and corporate governance (as will be seen below). They also welcome the fact that C&S can be seen as a soft law, to which countries can adhere voluntarily rather than by force. Voluntary standards allow governments and companies to adopt those that best suit their circumstances and give them a sense of ownership. Private sector representatives equally stress the importance of C&S, and welcome efforts in Brazil to implement them. They note that the country is acting on various fronts simultaneously, and as a consequence the degree of transparency has increased dramatically in the recent past, particularly in monetary and fiscal policies. Although awareness of C&S is still not widespread within the private sector, this will be gradually achieved, though at different speeds. For example, it will be seen below that whilst public awareness of C&S in corporate governance has increased very rapidly, other C&S remain unknown. However, government officials raised a number of issues and concerns. First, they believe there are too many C&S 66 so far -, this being especially true for poor countries, which just lack the institutional capacity to implement them. Moreover, countries have different needs, given their different stages of development and circumstances, while C&S are too uniform. This means that the one size fits all approach is not appropriate, and that a more flexible approach should be pursued instead. Second, Brazilian officials emphasise the need to distinguish between implementing C&S and the practice of assessing implementation. Implementing C&S is in itself a very resource-absorbing and time-consuming activity. As a policy maker noted, the work being done on C&S (and more broadly on improving financial regulation, corporate governance, etc) at the Central Bank and elsewhere is absorbing so much in terms of time and human resources, that they are even considering creating a department just for that. Moreover, implementing standards involves adopting new practices, procedures and processes. For these reasons they see assessment mechanisms such as the Reports on the Observance of Standards and Codes (ROSCs) 12

13 and even the Financial Sector Assessment Programme (FSAP) 1 as somewhat premature. This helps to explain why Brazil is moving more slowly than other countries in preparing ROSCs and FSAPs, despite the fact that work has been intensively done on different fronts simultaneously towards meeting C&S. Third, Brazilians are uncomfortable not only with the timing, but also with how assessment is pursued. For example, they find unfair that what is usually measured is how much the country still has to improve to meet the standards of international best practice, rather than the amount of progress a country has achieved in implementing and/or improving them. The latter seems a useful methodological point, for how to assess C&S. A further issue refers to pressures from the markets for reports like ROSCs to become more quantitative based. Brazilians see these demands as very worrying. They believe that it will be very harmful and unwelcome, if the markets start to judge and compare sovereign and corporate risks using scores. 2 In their view, this would mean making a process simplistic that is complex by nature and aimed at achieving greater transparency. Qualitative reports are believed to lead to a higher degree of transparency, so they welcome ROSCs current format. But even outside the assessment framework, comparability remains a problem. For example, how to compare banking supervision between Argentina and Brazil? Or how to compare the fiscal accounts of different countries, given the large differences in the way they are presented today? Efforts towards harmonising the different statistics must be made, but this may create many problems for the countries. Moreover, the comparability problem has to do not only with how information is displayed (and this reflects institutional and political factors that are not easy to overcome), but with fundamental underlying differences in what is being compared. A private sector consultant illustrated well this problem. She pointed out that within the Mercosur area, financial and capital markets regulations are marked by enormous differences, that efforts have been made in the past towards mapping these differences and proposing recommendations for reducing them, but that very little has been achieved since then. It follows that for Brazilian authorities adherence to C & S should be seen as a longterm process, rather than a short-term effort towards meeting assessment criteria and obtaining immediate benefits. They noted that countries like Argentina that have been champions in the process of implementing C&S are, however, currently facing credibility problems. 3 Indeed, Brazilians do not think that better transparency would play a large role in improving these countries credibility. A senior official with large experience with international crises noted that he does not know of a crisis where lack of information was a serious issue. Another senior official shared this view, to whom even if all C&S were in place, still crises would continue. A further aspect pointed out was that too much emphasis on more information on C&S would be very 1 Although the FSAP focuses mainly on the health of the country s financial sector, it has an element of C&S as well. 2 Worryingly, markets are already doing this. 3 However, such credibility problems may as in the case of Argentina be largely caused by other problems. 13

14 worrying, as it would put even more pressure on countries to adopt standards for which they are still not prepared. Some Central Bank officials have a more positive view towards C&S. They believe that the culture of C&S has been increasingly disseminated, and society is starting to perceive as positive standards that are established on a voluntary basis, as soft laws. According to them, financial authorities from all over the world have become increasingly interested in knowing whether governments and corporations are adopting C&S of international best practice. Private sector representatives believe that C&S can influence markets perceptions, but recognise that to date the private sector has not heard much about them. Thus, they welcome initiatives aimed at informing the sector about C&S and the fact that implementation of C&S will enable the private sector to have greater access to various sorts of information. They concede, however, that too much information may become counterproductive, leading to higher volatility (e.g. daily publication of reserve levels could make markets nervous ), but they also think that Brazil has not yet reached that phase of excessive information being made available. Interestingly, Brazilians expressed concern that whilst developing countries are being required to disclose information, the same has not been required from the international financial community. More information on how international players operate would be highly welcome. In addition, they observed that rating agencies, supposedly vehicles of information to the international markets, have themselves been very obscure as regards the methodologies they use to generate their ratings. Brazilians also note that the methodologies used by export credit agencies are very secretive. This is equally, if not even more worrying, in face of the new Basle Accord, which proposes reliance on the ratings of export credit agencies and private rating agencies for establishing adequate capital levels in the banking system. 4 Therefore, they think it is crucial that rating agencies, both public and private, become more transparent. Finally, the authorities believe C&S should not be part of the IMF conditionalities, which would be in conflict with the Fund s announced intention of streamlining conditionalities, a move they very much welcome. Indeed, they emphasise the importance of less conditionalities and more country ownership in the design and conduct of IMF-supported programs, a point they noted has been made even by the Fund s current managing director. 4 There was also concern about the very low rating unrelated to current conditions that the UK s export credit agency (ECGD) has given to Brazil. 14

15 b. The New Basle Capital Accord Brazilians welcome the fact that the new Basle Accord being currently discussed aims to introduce more flexible rules in determining the ratio of capital to risk-weighted assets. However, they expressed concern about the idea of allowing banks to use their own internal risk assessment systems to determine the levels of capital adequacy. For them, this proposal entails a number of problems. First, it would increase pro-cyclicality in bank lending. 5 This is very serious, and it is not clear what mechanisms could be used to reduce that tendency. A possibility would be to create forward-looking provisions, to be invoked in times of booms. A senior policy maker remarked, however, that this mechanism could also discourage apparent booms that were actually just a normal phase of economic sustainable expansion. Second, in addition to the risk of increased pro-cyclicality, it was pointed out that overall lending to developing countries could be reduced, as a reflection of a tendency towards risk aversion. As a senior academic put it, the current reduction of exposure of banks to the emerging markets would be validated by the regulatory framework. A further problem is that, whilst in normal times the internal assessment models may be effective, in situations of market instability, they become counter-productive (Griffith-Jones and Spratt 2001). The answer the Basel Committee on Banking Supervision gives is that stress testing could be performed at the individual and at the Central Bank levels, but again it is feared that this may not work sufficiently well either (e.g. due to lack of historical data). In the view of a senior Central Bank official with large experience in banking supervision, the new proposal of internal risk assessment would only fit for the larger international banks of developed countries. In Brazil, very few banks four or five would be able to apply sophisticated models. Moreover, it would be very difficult to supervise this new scheme. The fact that only a few major banks would be able to rely on their own assessment models could lead to banking concentration. To avoid a situation that puts Brazilian banks at a disadvantage the Brazilian authorities are encouraging their banks to prepare for the Internal Ratings Based (IRB) approach. 6 This may require technical assistance. Finally, the proposed Basle Accord does not propose any measure to protect small borrowers, which might suffer from higher borrowing costs caused by stricter requirements being imposed on banks. This is a problem that the European Commission aims to address in the European context, 7 but no such concern has been expressed for developing countries, where higher borrowing costs would particularly 5 One interviewee noted that regulation should be neutral instead. 6 The new Basle proposal suggests three possible approaches for measuring credit risk: 1. The Standardised approach, the Foundation Internal Ratings Based approach, and the Advanced Internal Ratings Based approach. 7 As reported in The Economist April 21 st 2001, page 97, it is highlighted in the European Commission s consultative document, which is adapted from the new Basle proposal (Basle 2) the special need for banks to finance small and medium-size enterprises (SMEs), most of which have no public credit rating. 15

16 affect the ability of their small- and medium-size enterprises (SMEs) to survive and expand. The option envisaged for those banks still not ready to adopt internal risk assessment systems, of relying on the external assessment provided by export credit agencies, is also seen with worry. They believe that the quality of the agencies assessment of sovereign risk is very poor. They suspect that the scores they generate are based on rudimentary methodology, and probably affected by political and commercial interests. c. New proposals for improving the CCL As noted earlier, Brazilian authorities see as very positive the Fund s initiative to create new mechanisms to better manage and particularly prevent crises, such as the SRF and the CCL. The SRF was successfully used by Brazil during the 1999 currency crisis, thus proving to be a very important mechanism of official liquidity provision. As regards the CCL, Brazilians welcome its recent changes, but believe that further improvements can be made. Today a country has to pre-qualify in order to be entitled to a CCL. As stated recently by the IMF first deputy managing director, pre-qualification may include compliance with codes and standards of good practice, in addition to the more common macroeconomic conditions a country is normally expected to fulfil. As mentioned earlier, Brazilians are against the inclusion of codes and standards as part of IMF conditionalities, and they particularly object such inclusion in the CCL mechanism. They propose instead greater automaticity, so that the right to a CCL can become a reality (as of today, no country has applied for a CCL yet, though some have demonstrated interest in doing so). Greater automaticity could for example mean a dispensation from an evaluation process undertaken especially for the purpose of granting a CCL, using instead information from routine assessments applied to all countries, such as the IMF Article IV Consultation. 8 Moreover, the idea of greater automaticity could also be used when a country that has already been pre-qualified for a CCL, needs to be evaluated again in order to have access to the money, needed when a crisis hits. 9 It is very important that such steps be taken, as preventing crises is always better than having to manage them. (A senior official would however take a different position; for him there is already an implicit CCL, in the sense that countries that are just unlucky but otherwise deemed as good can have access to the Fund s resources very quickly when facing a crisis situation. In this sense fighting for a better CCL would be unnecessary). 8 However, given that the CCL has been recently modified, further changes may not be attainable in the short run. 9 That is, CCL mechanism has two phases. The first consists of a country s pre-qualification, and the second, of activating it when an already pre-qualified country becomes in need of immediate official assistance to countervail a crisis. 16

17 d. PSI Although Brazilian policy-makers emphasise the importance of having international mechanisms for crisis prevention, they note that mechanisms for crisis management should be readily in place, should a crisis occur. In this regard, they see as crucial the provision of official liquidity, which can come in the form of a SRF, but they also stress the need to envisage ways to facilitate a private sector involvement (PSI) in crisis management, so that private finance can complement official finance. This, they believe, would make a crisis less painful and more manageable, and would bring to the process an important burden-sharing element. However, the Brazilian position is that no strict rules should be set as how PSI should be, given that countries face different financing situations and prospects of market access in the future. As a senior official put it, our experience with voluntary PSI is that there are shades, a continuum of possibilities. In the specific case of Brazil, PSI (in the form of a standstill) happened on a voluntary basis in the 1999 crisis 10, mainly for rolling over short-term bank credit lines. In order to make the process more manageable, the government created committees for each creditor country. Although each credit country had its own committee, the government did its best to make it sure that general rules were adopted across the committees. Moreover, it was important that creditors were informed that all committees were guided by the same rules, so they could feel secure about the negotiation process (they were also told that all the information would be shared with them). In order to reduce communication problems, it also created a general committee. According to Brazilian officials, markets like general rules, a major reason being that they are easy to explain to their boards. Brazilian officials believe that they could adopt this light-touch approach (i.e. no predefined rules, with PSI being voluntary), because the country was seen as capable of regaining access to capital markets, making it easier for the private sector to step in to provide complementary finance. There are instances, however, in which a more heavy-handed approach that implies debt restructuring is made necessary, as was the case of Ecuador, for which the FMI should be more active and PSI should take place within a different framework. Although their recent experience with PSI has involved on banks, Brazilian officials also expressed their opinion about the use of collective action clauses (CACs) in bond contracts, a key instrument to facilitate debt re-negotiation with bond holders. 11 Brazilian officials know that, like in London where CACs have been included in bond contracts for some time, in New York bonds that include CACs are becoming 10 It should be noted that as IMF (2001) points out initially the private sector resisted to co-operate, doing so only after the IMF encouraged it to do so. 11 There are basically four types of collective action clauses: majority action clauses, collective representation clauses, sharing clauses and non-acceleration clauses. Under English law, bonds normally include majority action clauses, which allow bondholders to convene and change the terms of payments of a bond contract by a qualified majority (normally 75%) of bondholders. Collective representation clauses permit bondholders to be represented collectively, for example by a trustee, thereby reducing co-ordination problems in the negotiation process. Sharing clauses require any payments received to be distributed on a pro-rata basis among all creditors (Dixon, 2000). 17

18 increasingly accepted. Whilst not knowing for certain the cost effects that this inclusion may have, they reckon there would be very small costs, if any at all. For a senior official, whether and how countries use the above instruments and mechanisms in crisis prevention and management, very much depends on the conditions the country exhibits. According to him, broadly three categories of countries can be found. The first category is that of very good countries, which will hardly have a crisis or be affected by contagion (though he acknowledges that the very fact that the country is perceived as such may lead people to take very high risks). The second category is an intermediate case, in which a country facing a crisis should respond to it with strong policies, hopefully obtain prompt IMF lending and benefit from voluntary PSI. And the third case, seen as more complicated, is that of countries facing a crisis in which the official sector has to intervene and involve the private sector in the negotiations on debt restructuring. 3. Further Issues of Concern Having expressed their views on what they see as the new agenda of the IFA, they pointed to a number of issues they are currently focusing on. These are: a) the development finance role of the multilateral development banks (MDBs) and distribution of capital flows across countries, b) illegal money in international transactions, and c) the need of a greater role of developing countries in the discussions of a new IFA. a. The provision of development finance by MDBs and distribution of capital flows across countries As pointed out earlier, Brazilian officials observed that since the crises of the late 1990s, private capital flows to the emerging economies are on the whole rather scarce. This is partly due to a greater caution by banks and markets to lend to and invest in the emerging markets, and partly due to recent economic developments in the industrial countries, particularly the US. However, middle-income countries still need substantial amounts of external capital to finance their balance of payments (BOP) and growth needs. As seen above, the new Basle Capital Accord if implemented will reinforce rather than reverse the declining trend of private capital flows, particularly bank lending, to middle-income countries. Thus, official lending in normal times remains crucial to this category of countries. In this context, Brazilians view that the MDBs, and in particular the World Bank, should create new products for middle-income countries. To date, Brazil has primarily had access to structural adjustment loans (SAL), a source of long-term finance which has been used for balance of payment financing. This kind of loan is seen as very important, as least for two reasons: first, it helps fill in financing gaps and, second, it helps reduce the costs of external borrowing. This is because if a country can count on official lending to meet part of its rollover needs, it will have more leverage power to negotiate better loan conditions with private creditors. World Bank lending to Brazil has been considerable when compared to the country s level of reserves, but very limited when compared to the country s overall investment 18

19 levels. Thus, new products should be created to support middle-income countries, which in addition to the benefits mentioned above, would help countries tackle their urgent development needs (e.g. infrastructure, education, health), which cannot be met by private finance alone due to market failures and externalities. Brazilians emphasise, however, that such lending should be seen in the context of macro policies. That is, lending to micro projects of governments at different administrative levels may create budgetary problems, which according to senior government officials, should be avoided if the country wants to meet its fiscal targets. Indeed, a senior official proposes a wholesale financing of the budget, with general conditionalities and not related to specific projects. If you are borrowing from abroad, the money has to be part of your budget, and produce a counterpart result. If this does not happen, nobody will borrow anymore, since the planning of the budget will lose force. Still in the context of development finance, Brazilians welcome the proposal made by the World Bank Middle Income Task Force to create a new lending instrument, called Committed Loan Facility (CLF), which a country could draw on when needed. The advantage of this instrument is that it could be used at a most convenient point of the country s business cycle (and most interestingly, that it could have a counter-cyclical role) and in line with the country s budgetary planning. In the same way that Brazilians see that MDB lending should go not just to the poor countries, but also to middle-income countries, they believe that measures should be taken in the industrial countries to encourage more private capital flows to the poorer countries, thereby reducing the current concentration of these flows in the middleincome countries. b. Illegal Money in International Transactions As regards illegal money in international transactions, this is seen as an issue that affects middle-income countries as well, in the form of its impact on tax evasion. Thus, Brazilians suggest that the FSF and IMF should enforce regulatory measures on offshore financial centres (OFC). c. Participation of developing countries in the building-up of a new IFA Brazilians believe that though having improved slightly, participation in the discussions and in the decision-making process of a new IFA is still very asymmetrical. Greater participation by developing countries is needed, first because the larger emerging countries have a bearing on the stability of the international financial system, and were the ones that suffered most from the recent crises. Second, from their own experience they see a clear difference between being involved in the discussion and decision-making and being just informed only after decisions have been taken. Third, participation helps them better understand the issues, and therefore adopt the most appropriate strategy to deal with them. Their participation in the G-22 and G-20 has been an example of this. It helped them have a greater 19