Monitoring and surveillance activities are carried out at different levels (national, regional and global) and focus on different aspects (macroeconomic, financial and institutional), varying with the mandate of the specific body involved. Depending on their structure and objectives, monitoring mechanisms employ different methodologies and approaches. There are two general approaches to monitoring and crisis prevention.

The first refers to the traditional practice of surveillance, which is a process by which certain bodies oversee the economic policies of its members to promote global well-being (meaning financial and economic stability). IMF, for example, undertakes bilateral consultations and policy advice under Article IV of its Articles of Agreement. In the G-7 system, surveillance implies policy coordination so that exchange rate and macroeconomic stability are maintained. Under this approach, the forum or specific body takes the initiative in identifying certain worrisome trends that demand correction if global or regional economic stability is to be achieved.

A more recent paradigm, in contrast to the watchdog approach, is to promote transparency and standards in policy formulation at the national level and in business practices at the enterprise or financial firm level. It is now widely recognized that, in the light of the increasing sophisticated and rapidly changing markets, policy makers and regulators must rely increasingly on market-led processes to provide the discipline required to lead to prudent and stabilizing behaviour.¹

Promotion of transparency at all levels - decision-making in the multilateral institutions, domestic policy-making and disclosure by financial entities and business corporations - is deemed a crisis-prevention step insofar as a financial crisis happens as a result of a paucity of information and asymmetries in access to it. Transparency is considered the best solution to contagion because at the core of contagion is the lack of accurate and timely information which would allow economic agents to distinguish which economies or institutions are sound and which are not. Panic often occurs because of uncertainty; better information aids good judgement and minimizes the risk of bad judgement. If the problem is a lack of publicly available information, then the answer lies in better data quality and improved dissemination methods. The rationale is that better-informed investors, creditors or economic agents would be in a more sound position to take prudent decisions with respect to lending, borrowing and investment. It is also expected that the collective action of the (better-informed) markets could impose discipline on countries which are pursuing unsustainable policy mixes. In this sense, the approach of enhancing transparency is more market-oriented and that of traditional surveillance more interventionist.

There are also practical reasons for including standards for transparency in monitoring exercises. The pace of innovation in products, transactions and financial instruments makes it difficult for monitoring agencies to keep track of developments. Furthermore, market participants are engaging in rapidly changing and more complex transactions which regulators cannot be expected to anticipate with appropriate legislation; the regulatory catch-up is a daunting challenge. In addition, the number of players that invest in emerging markets is large and growing, and this is increasing pressure on monitoring agencies. In the light of these changes, rather than respond with stricter regulation of the traditional sort, regulators are increasingly choosing to rely on the judgement of market participants, who are likely to have a better understanding of market developments. Such judgements require standardized information distributed on a frequent basis.

In reaction to these arguments, IMF is taking steps to enhance transparency by promoting the Special Data Dissemination Standard (SDDS) which is intended for countries that have or seek access to international capital markets, and the General Data Dissemination System (GDDS) for the other countries. BIS is also improving the coverage, quality, timeliness and availability of its data series. Further, in 1999, the Group of Ten (G-10)² countries committed themselves to a template for revealing their foreign exchange positions with a view to encouraging emerging markets to do the same.

The two approaches of surveillance and transparency are not exclusive, but rather complementary. Thus, initiatives aimed at improving the provision of information and facilitating its effective dissemination should be considered a concrete modality of crisis prevention.

The setting up of standards and codes for prudential purposes represents another aspect of the new paradigm, as the provision of agreed standards helps policy makers and markets to interpret the data. Standards provide benchmarks (and targets) that can assist authorities in monitoring their financial systems and initiating corrective responses when the actual situation deviates from the prudential standards. Furthermore, international standards help markets make informed judgements about the credit risks of countries as well as allowing them to discriminate sufficiently among countries to prevent contagion. Codes provide best-practice benchmarks for policy formulation. To the extent that standards and codes promote better policy formulation, which, in turn, makes the economic and financial systems of countries more robust, they should be considered as part of any crisis-prevention package. The working groups of the Financial Stability Forum³ have recommended the establishment of standards of best practice in a number of areas affecting financial stability. They are exploring improvements in disclosure by large financial institutions of all kinds that would be most effective for improving systemic stability. They are also considering the feasibility of providing additional aggregate information on activities in currency markets that could improve market stability by enhancing the capability of market participants to identify the potential for large exchange rate movements and for contagion, especially in emerging markets.

The provision of standards and codes through international cooperative efforts can also be justified on the basis of scarce resources and efficiency. Because certain institutions have expertise in specific areas, they are in the best position to formulate the standards. Furthermore, these and other bodies can facilitate the adoption of codes of best practices or standards by providing training and other forms of technical assistance for capacity-building. The concerted adoption of codes and standards could help build confidence. Peer pressure can also be used to push the adoption of transparency and best practices. One strategy is to convince a small number of financially robust countries to adopt the standards, and other countries will then be under pressure to follow. In fact, IMF has moved in this direction with the release of the initial transparency reports, a development discussed later in this chapter.

In the following sections, the processes and technical aspects of the crisis-prevention mechanisms in place in international institutions are discussed in more detail. Annex V.1 provides a succinct summary of measures taken in the last two years by international institutions to strengthen the international financial architecture in terms of surveillance monitoring and transparency. Annex V.2 provides a brief summary, in alphabetical order, of the status of international codes and standards affecting financial markets.

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Footnotes:

¹ See the arguments in support of this in William R. White, "Promoting international financial stability: the role of the BIS", paper presented at the Conference on Coping with Financial Crises in Developing and Transition Countries: Regulatory and Supervisory Challenges in a New Era of Global Finance, organized by the Forum on Debt and Development, Nederlandsche Bank, Amsterdam, 16-17 March 1998.

² The Group is made up of 11 industrial countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States), which consult and cooperate on economic, monetary and financial matters.

³ The Financial Stability Forum is the current modality for coordination on promoting international financial stability set up by the Group of Seven Finance Ministers and Central Bank Governors. The web site is available at <http://www.fsforum.org/Home.html> (26 January 2000).