Today we have released the three analytical chapters in our upcoming Global Financial Stability Report. These chapters cover some of the most relevant areas facing policymakers as they devise financial reforms that address the systemic risks that arose during the crisis and deal with potential forthcoming vulnerabilities.

Chapter 1 comes out next week. Chapter 2, published today,  focuses on two questions facing policymakers attempting to reform the financial landscape. One, whether systemic risk would be reduced by placing all regulatory functions under the purview of one entity—be that a single agency or an overseeing council? And two, if we were to use capital surcharges on financial institutions to try to limit the systemic risk associated with domino-like failures, how would we construct such surcharges?

Let us stress that, we do not have “the” answer to these difficult questions, but we think we have been able to frame the debate in a constructive way and provide guidance to policymakers on these important issues. For instance, we do not necessarily see a capital surcharge on systemically important institutions as the only way to reduce systemic risk, but as one method of a multipronged approach. There is a need to examine a number of approaches to see which one or which combination will do the job best.

Chapter 3 takes a slightly different tack by delving into how we can improve market infrastructure to help limit systemic risk. As you are aware, the over-the-counter derivatives market has been under scrutiny since problems in the credit default swap market arose with Lehman’s bankruptcy and AIG’s near miss. The IMF looks closely at the how central counterparties for clearing these contracts can be a shock-absorber in the financial system.


Chapter 4 looks ahead to the vulnerabilities that may be building up in some countries partly as a result of the low interest rates and ample liquidity that has characterized the main advanced economies’ current monetary policy stances. The chapter documents that global liquidity plays a role in capital inflows to emerging and some other advanced countries where interest rates are higher and growth prospects are stronger.

Certainly, an increase in capital inflows is a positive development following their dramatic decline during the height of the crisis, but they can be too much of a good thing if they add to inflation pressures or asset price bubbles.

The chapter looks closely at the policy options that liquidity receiving economies can use. It suggests that, as a first-best solution, macroeconomic policies, including flexible exchange rates, and enhanced prudential regulations for the financial sector, can go a long way in managing a surge of capital inflows. It also reviews the international experience with capital controls.