INTERNATIONAL FINANCIAL SYSTEM AND THE USE OF ICT

Despite the advantage of easier access to capital that encouraged many countries to liberalize their trade and capital accounts, the Mexican crisis in late 1994 and the recent crisis in South and South-East Asia have raised concerns about the inherent stability of the international financial system. The financial structure, which has facilitated dramatic increases in productive capital flows, has also exhibited an enhanced capacity to create financial bubbles. The use of ICT has initiated a revolution, clouding the distinction between different types of financial markets and instruments, empowering financial institutions to devise and engage in new varieties of transactions that take advantage of opportunities made possible by the new technology itself, as well as those generated by the synergies and competition among financial activities and institutions.²⁷ Rapid progress in computer and telecommunications technologies has enabled a broad unbundling of risks through innovative financial engineering. This not only allows market participants to isolate and manage risks more effectively, but also enables them to leverage their positions, increasing potential losses and gains relative to their equity, and raising their vulnerability to domino or contagion effects. It also makes the entire system more sensitive, increasingly threatened by the contagion effects through financial linkages and leveraging which arise from the use of derivatives. While the benefits of doing the right things become greater, so do the costs of making even minor mistakes. This can be illustrated dramatically by the enormous cost of adjustment required in the recent Asian crisis.

To avoid harsh market reactions to surprises, there arose the "golden rule" of transparency, which is seen as the key for modern management, economic success and rational behaviour of global markets.²⁸ When there are deficiencies in the information available, the behaviour of creditors is interpreted as revealing important information about borrowers' creditworthiness. These interactions between different classes of creditors contribute to the dynamics of herding behaviour, whereby individual investors are significantly influenced by the actions of other investors. Improvements in the quality, timing and easy availability of information, requiring extensive use of ICT, are supposed to contribute to the reduction in volatility by encouraging a more rigorous assessment of risk. The faster reaction time, permitted by modern applications of ICT, has also accelerated the pace with which capital moves in response to the increasingly subtle differences among returns to investments, domestic and foreign. Thus, the recent financial crises to an important degree reflect a limited human capacity to cope with the vastly increased speed, volume and complexity of financial activities.

Although financial markets are still far from forming a single global market, the level of integration is high enough to strongly affect the conduct and effects of macroeconomic, regulatory and prudential policies in developing countries.²⁹ At the macrolevel, the generalized increase in financial openness, facilitated by the use of ICT, has also made the management of the financial sector and monetary policy a very difficult task. In particular, as reflected in analyses of financial institutions seriously affected by the recent financial crisis in Asia, it has been found that an open capital account did increase the potential of these institutions to become insolvent. New and easier entry of financial institutions, including banks, granted under domestic liberalization processes can lead to a proliferation of financial institutions. Many of these did not have the requisite resources, experience or competence to operate on a sound actuarial basis or to be capable of carrying out satisfactory risk assessment of loans. They consequently accumulated unbalanced portfolios of assets and liabilities and an unsustainable volume of non-performing loans and eventually collapsed. The productive enterprises were also faced with a wider range of opportunities to raise finance but with more instability in costs, leading to concerns about their solvency.³⁰

With floating exchange rates, national monetary authorities have greater independence in choosing their inflation objective.³¹ Although monetary policy is strongly influenced by international financial markets, increased financial market integration does not appear to have rendered it totally ineffective. Capital markets which are closely linked through increased openness facilitated by the use of ICT have, however, changed monetary transmission mechanisms by enhancing the role of the exchange rate. The greater independence implies greater responsibility under a more difficult environment, which does not necessarily correspond to less volatility or ensure greater security.

In addition to these fundamental effects, however, there are some artificial and perhaps even more harmful impacts that have arisen in modern financial markets, facilitated by ICT. During the Asian financial crisis, for example, hedge funds played an increasingly important role as an engine of contagion in global markets. With their concerted and colluded efforts, volatility can spread from one market to another rapidly and dramatically. This raises an important issue regarding the degree of transparency warranted in a country under speculative attack but also under pressure to reveal every bit of detailed information, which may increase its vulnerability to predatory hedge funds. Analogously, regulations and disclosure requirements of these funds have also become one of the prime issues under discussion in the current international financial reform efforts.

There has also been an increase in both competition and uncertainties that individual financial institutions themselves need to manage through ICT-intensive information, supervision and monitoring systems, while also using ICT to innovate new services or to improve the quality and efficiency of existing ones. In the context of the recent financial crisis in Asia, attempts have been made, with the assistance of multilateral financial institutions, to cope with this new environment. The measures undertaken include reforms in the regulatory and institutional framework of the banking and securities markets as well as improvements in accounting standards and transparency requirements. These reforms should help to increase the effectiveness of monetary policy and management of financial institutions by reengineering inter- and intra-banking transactional networks either in electronic or in physical forms. They require the application of ICT to establish a smooth functioning of financial markets through an effective operational framework for the mobilization of resources from the private sector, decentralization of foreign exchange operations, improved customer service and effective management of liquidity.

Contagion effects can be reduced by assuring the markets that there will be a supply of capital coming forth in the form of either liquidity provided by the lender of last resort or deposit insurance. Such measures, nevertheless, can have the effect of blunting market discipline by inducing moral hazard. This, in effect, is a central issue in the architecture of the future international financial system.³² Any reforms in this direction will rely on using ICT to monitor international capital flows closely to identify potential trouble spots, particularly with respect to short-term debt flows and exposures, in order to provide both regulators and market participants with a clearer basis for making their decisions.³³

Given the continuous trend towards a new advanced technology-based international financial system, the levels of complexity within the current financial system are likely to increase even further. In such circumstances, it has been postulated that, in order to avoid prohibitive costs or uninformed interference in the market, government financial regulation is likely to be focused on performing oversight or monitoring functions.³⁴ In the twenty-first century, such regulators will probably need to rely increasingly on private counterparty surveillance to achieve safety and soundness. This highlights the central role of information and ICT even further. Obviously, when well-informed investors are expected to bear the consequences of their own actions, they will seek accurate and reliable information and tend to use it to make better decisions.³⁵ Access to reliable, comprehensive and timely information is perceived as essential, particularly by banking and financial institutions. Within the public sector, national and international policy makers will also need access to better information to guide their actions. This provides the rationale for additional disclosure and transparency rules and an increased application of ICT.

For this purpose, within the current reform efforts, IMF has established and maintained a dissemination standards bulletin board on the Internet, which posts information on the statistical practices of subscribers to the special data dissemination standard³⁶ and on the general data dissemination system, where the focus is more on improvement in data quality. In addition, IMF and its members are also planning to promote wider use of public information notices, the publication of more letters of intent and policy framework papers underpinning Fund-supported programmes, and more information on and public evaluation of the Fund's operations and policies, with constant review of confidentiality.

Other proposals on measures to improve the architecture of the international financial system aim either to prevent crises before they occur or to reduce the scale of future crises.³⁷ Several simultaneous attempts are currently being made to identify and disseminate international principles, standards and codes of best practice on monetary and fiscal policies, and auditing and accounting standards as a means to curtail domestic moral hazard in capital markets. Schemes are also being designed to strengthen the incentives for developing countries to meet these international standards, reinforced by official assistance to help these countries to develop their economic and financial infrastructure. In addition, the Bank of International Settlements is to examine the question of appropriate transparency and disclosure standards for private sector financial institutions involved in international capital flows, such as investment banks, hedge funds and other institutional investors.³⁸ All of these proposals are likely to involve intensive and extensive use of ICT, especially those on accounting and disclosure  standards for the collection and dissemination of information. This will require further improvements in the ICT application structures, in particular in central banks and other financial sector regulatory agencies.

In order to strengthen surveillance, IMF is also stepping up its efforts to monitor the financial sector, capital flows and the risks of reversal. It is developing a tiered response for countries that vary in the degrees by which their policies are off course so as to provide appropriate degrees of warning.³⁹ This initiative will need to rely on applications of ICT between IMF and its members.

The crisis in Asia was largely induced by private sector debt and recent policy proposals have therefore been directed towards increasing private sector involvement in crisis prevention and resolution. Proposals have also been put forward regarding the enhancement of good governance and the prevention of corruption. Many of these envisage a role for non-governmental organizations, citizen's movements, transnational corporations, academia and the mass media.⁴⁰ None of this will be feasible without intensive ICT use.

Thus, while in the financial area it is clear that increasing applications of ICT are a significant force behind recent problems, they are also a very important part of the solutions envisaged.