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THE REFORM OF THE

INTERNATIONALFINANCIAL SYSTEM

A Proposal with the Lessons from the Crisis

Foreword by José María Aznar

Directors: Fernando Fernández and Fernando Navarrete


© FAES Fundación para el Análisis y los Estudios Sociales, 2009(Foundation for Social Studies and Analysis)

ISBN: 978-84-92561-07-0Legal deposit:Printed in Spain

“With the support of theEuropean Union: Support fororganisations active at Europeanlevel in the field of active european citizenship”


CONTENTS

Foreword by José María Aznar . . . . . . . . . . . . . . . . . . . . .7

Introduction and aims . . . . . . . . . . . . . . . . . . . . . . . . . .11

1. Diagnosis of the financial crisis . . . . . . . . . . . . . . . . .131.1. The consequences of an excessively lax monetary policy during times of prosperity . . . . . . . . . .141.2. The underestimation of systemic risk . . . . . . . . . .171.3. Management of the crisis: improvisation and partial successes . . . . . . . . . . . . . . . . . . . . . . . .22

2. More independence, credibility and accountability for central banks . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

3. The reform of international financial regulation . . . . . .353.1. Controlling systemic risk: a new macroprudential pillar in minimum capital requirements . . . . . . . . . . . .383.2. Controlling systemic risk: a guarantee mechanism against systemic crises for money markets . . . . . . . . . . . . . . . . . . . . . . . . . . .433.3. Better corporate governance and long-term incentives in senior management compensation schemes . . . . . . . . . . . . . . . . . . . . . . .483.4. Improving the quality and the regulatory use of credit ratings . . . . . . . . . . . . . . . . . . . . . . . . . .503.5. More transparent and less procyclical regulations . .51

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THE REFORM OF THE INTERNATIONAL FINANCIAL SYSTEM

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4. The reform of financial supervision . . . . . . . . . . . . . . .554.1. Supervision with early warning systems and greater pre-emptive capability . . . . . . . . . . . . . . . .554.2. Improving the effectiveness and the incentives in public bailout plans . . . . . . . . . . . . . . . . . . . . . . . . .584.3.The challenge of financial institutions “too big to be rescued” . . . . . . . . . . . . . . . . . . . . . . .69

5. An international financial architecture with greater responsiveness . . . . . . . . . . . . . . . . . . . .755.1. Reinforcing the capacities of the International Monetary Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .785.2. Setting regulatory and supervisory standards with greater effectiveness . . . . . . . . . . . . . . . . . . . . . .87

Epilogue for spaniards . . . . . . . . . . . . . . . . . . . . . . . . . .93

Main conclusions and proposals . . . . . . . . . . . . . . . . .101

Acknowledgements, contributions received and individuals and institutions consulted . . . . . . . . . .119

Appendix: chronology of the international financial crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .123


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FOREWORD

The explosion of the financial crisis in 2007 and itsknock-on effect on the rest of the world economyestablished the breeding ground for renewed criti-

cism of market-based economy with a heavy ideologicalcontent.

Since the end of 2007, Northern Rock, Bear Stearns,AIG and government-sponsored institutions in the UnitedStates, such as Fannie Mae and Freddie Mac, were sub-sequently rescued. The collapse of the investment bankLehman Brothers, public interventions in the financialsystems of several European countries, as in the case ofFortis Bank, and the subsequent and unprecedented col-lapse of credit markets as important as that of interbanklending, made the financial crisis flare-up in autumn2008. In some political and media circles, there was talkof “the 1929 crisis corrected and increased”, the “end ofcapitalism” and the “fall of the Berlin Wall of Capitalisteconomy”.

It was obvious that the international financial systemhad failed, but it seemed equally obvious to me that theharsh criticism of market economy that was being pro-



claimed at that moment lacked the necessary cautious,rational and scientific analysis of recent events.

It was then that I decided to propose to two interna-tionally-recognised Spanish finance experts, ProfessorFernando Fernández, and the economist FernandoNavarrete, an in-depth analysis based on the internation-al financial and economic crisis, away from ideologicaldogmas and aimed at drawing lessons for the future. Iposed two questions: What failed? What needs to beaddressed in order to right these wrongs?

The analysis set out in this report published by theFAES Foundation meets this request in an outstandingmanner. It sets out the underlying factors of the financialcrisis with accuracy:

•An excessively lax monetary policy in times of econom-ic prosperity.

•Failures in financial regulation, with excessive confidencein the self-regulation of financial markets.

•Failures in market supervision, as the supervising bod-ies have failed to suitably develop the tasks that wereassigned to them.

•Lack of precise, accurate, relevant and timely informa-tion in the financial markets.

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•Failures in the design of specific public policies, suchas those put into practice in the United States to pro-mote home ownership.

•Failures in the economic incentives of the financialsystem and in risk management by the financial insti-tutions.

At the same time, it sets out the reforms that canredress the detected deficiencies and improve the effec-tiveness of the international financial system in fulfillingthe vital tasks assigned to it.

There will be those, holding positions of Governmentresponsibility, who will draw upon the lessons from thecrisis and learn pragmatically from experience. Thisgroup comprehends those people who will react to thecrisis with better – and not necessarily greater – regula-tion, better public policies, and an effective and effi-cient undertaking of the roles entrusted to theGovernment in any market-based economy, which are asimportant as they are irreplaceable. For all of them, thisreport from the FAES Foundation will be both useful andproductive.

There will be those, however, guided by dogmatism,who will prefer to react to the crisis with greater – and notbetter – regulation and greater interventionism and pro-tectionism. This report will probably be irrelevant to thelatter.

FOREWORD

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This report is obviously aimed at the former. I am con-vinced that it fulfils an important role in the sphere ofideas and economic debate this year 2009 in which it ispublished.

JOSÉ MARÍA AZNAR

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INTRODUCTION AND AIMS

The depth and scope of the financial crisis according tothe types of market, institutions and geographical areasaffected, have highlighted some of the weaknesses ofthe international financial system and the need forreform. The current financial architecture and its actionprotocols have shown their limitations to withstand, with-out serious instability, growing trade and investmentflows resulting from globalisation.

An economic policy response that fails to deal with theunderlying problems revealed by this crisis could pose aserious burden for long-term economic prosperity.

This report includes proposals and recommenda-tions that tackle the necessary reforms of the interna-tional financial system in order to ensure a sustainedand vigorous growth of world economy. Our proposalsendeavour to establish a line of permanent work in theforthcoming years for the coordination and better man-agement of economic, monetary, regulatory, and finan-cial supervision policies. The aims of the reform thatwe are setting forth are:

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1 Regulatory arbitrage is deemed as the search for business opportunities and pro-fit that arise from the different levels of public intervention among the differenttypes of financial institutions, different financial markets – even within the samecountry – and among different financial products.


•To promote a balanced trade, investment, and interna-tional labour specialisation through suitable financingconditions.

•To accelerate and facilitate the cyclical recovery ofeconomy and make it sustainable through a sound,transparent, competitive and efficient internationalfinancial system.

•To reduce the magnitude of cyclical fluctuations ofworld economy.

•To prevent international crises and cushion the effectsof those that will inevitably take place.

•To improve the coordination and effectiveness of eco-nomic policies.

•To increase the consistency of international monetaryand financial regulations in order to avoid regulatoryarbitrage1 opportunities that could increase risks affect-ing the financial system in its entirety (systemic risk).

•To establish common principles, instruments and sys-tems of financial supervision.

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1DIAGNOSIS OF

THE FINANCIAL CRISIS2

It is tempting, although somewhat futile, to search forthe culprits of a financial crisis that has impoverishedthe world. But the reality is that the crisis is the resultof the excesses made by many of the system’s partici-pants.

It is deeply rooted in the following issues:

•Poor judgement and lack of foresight of all those whoacted in the markets or who based their policies onthe belief that the price of assets could only increaseindefinitely.

•Complacency of regulators that relaxed controls duringtimes of economic prosperity, misguided by too close-ly-tied relations with the financial industry.

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2 The annex to this report includes a chronology of the development of the financialcrisis.



•Short-term incentives, irresponsibility and lack oftransparency of investors and managers who, whenfaced with a drop in interest rates, demandedincreasingly higher returns without realising that thiswould necessarily lead to the assumption of greaterrisks.

1.1. The consequences of an excessively lax monetary policy during times of prosperity

The crisis is the result of years of excessive liquidity intimes of prosperity, due to an unnecessarily lax monetarypolicy applied by the Federal Reserve and other leadingcentral banks of the world after the dot-com bubble burstand the terrorist attacks of September 11, 2001.

During the times of Alan Greenspan as president ofthe Federal Reserve Board, monetary policy becameframed in the mirage of the “Goldilocks economy” era.

An era in which independent and credible centralbanks could maintain inflation low and stable indefinitelythrough discretionary monetary policies.

An era in which it was believed that the central bankswere responsible for setting the lower limit to stockprices to avoid major losses of wealth that would curbthe spiral of consumption and/or investment of manydeveloped countries, with the US at the forefront.

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Furthermore, they appeared to have the ability to dothis, as highlighted by the monetary policy measures putinto place to save the crash of 1987 and the bursting ofthe dot-com bubble. These measures were the same asthose used at the beginning to try to remedy the sub-prime mortgage crisis.

But the coexistence of low interest and low inflationrates in the early years of the millennium is explained notonly by the actions of central banks of industrialisedcountries, nor by the emergence of a new era, but byexogenous effects and unrepeatable changes in the envi-ronment such as the following:

•The technological revolution and its impact on produc-tivity.

•The incorporation of large emerging economies suchas China and India, among others, to internationalcommerce and economy, and their effect on relativemanufacturing and raw material prices.

•The artificial setting of exchange rates far from theirequilibrium values for a significant period of time.

As a consequence of those background changes, sig-nificant global saving-investment imbalances startedaccumulating. Capital flows went from the emergingcountries toward their industrialised counterparts,opposing all established theory. The argument was that

DIAGNOSIS OF THE FINANCIAL CRISIS

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the institutional qualities of the capital markets ofindustrialised countries – and in particular those of theUnited States and the United Kingdom – attractedinvestment because they offered greater liquidity, secu-rity and predictability. Thus, savers were prepared tolose some profitability in exchange for these features.

With hindsight, the reality seems much simpler. TheChinese saver, basically its public sector – whose objectivewas to maintain high rates of savings and growth to guar-antee its political sustainability – just granted a sort ofexport credit to the American consumer. How? Maintainingan artificially low Yuan exchange rate to boost exports.This forced China to gather enormous internationalreserves that it then invested in buying American debtsecurities that financed the dissaving of the United States.

This system of economic development is not thatoriginal. It involves subordinating the logic of financialsystems to development objectives. It was already usedby Japan in the seventies, and after its initial successit led to a long period of economic stagnation whichthat country has still not shaken off.

The size of the imbalances of this decade explainsthe fact that problems have not only, nor mainly, beenfelt in capital-exporting countries, as occurred withJapan in the eighties, but in capital-importing countriesas well, which were used to living as if indebtednesspossibilities were limitless.

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As a result of these policies, sustained credit growthwent far beyond what was reasonable and risk valua-tions were unjustifiably optimistic. Furthermore, all thewarning signals given by the system were ignored.

If there is one demonstrated empirical regularity, it isthat periods of exorbitant credit growth inexorably leadto banking crises. And its corollary is that in order toovercome the crisis an unavoidable deleveraging mustbe done that translates itself into the restructuring ofthe financial sector. The excess of capacity of the finan-cial industry must be purged.

In this deleveraging setting, financial institutionsshould be mainly concerned with managing their bal-ance sheets – inevitably restricting credit – to ensuretheir solvency. This leads to a painful economic crisis.The need to reform thus ensues. Its aim is to achievea proper balance in the financial system, and an effec-tive regulation that encourages a prudent and sustain-able assumption of risks both at times of cyclicalbooms and busts.

1.2. The underestimation of systemic risk

The crisis is also the result of a great collective error:underestimating systemic risk, which affects the econo-my and the financial system as a whole. An error that hasbeen translated into failures in market discipline, failures


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in incentives, and failures in market regulation and super-vision.

A necessary condition for market discipline is theavailability of accurate, truthful, relevant and timely infor-mation. In spite of the Enron scandal, it is obvious thatsince then, market transparency has advanced little inboth the public and the private sector. There was anexcessive confidence in the self-regulating capacity offinancial markets and a lack of authority of regulatoryand supervisory bodies that have failed to suitably devel-op the responsibilities assigned to them.

Furthermore, the design and application of certainpublic policies lacked an essential comprehensive viewthat should have considered their impact on the econo-my and the financial system as a whole. This is the case,in particular, of the inadequate design of financial regula-tion and of monetary and public policies in the US aimedat promoting home ownership.

There were also failures in the economic incentivesunder which the financial system operates. The mostobvious is the short-termism upon which many of thecompensation schemes were designed. But also,expectations of public bailouts, generated especiallyafter the intervention in Fannie Mae and Freddie Mac,may have created perverse incentives for the assump-tion of excessive risks. And without doubt, the searchfor regulatory arbitrage led to the explosion of a shad-

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ow banking system that benefited from the loopholes inthe system.

The accumulation of risks in the financial system wasfavoured by an excessive optimism in economic expecta-tions and by an abusive practice of securitisation as atool to distribute and diversify risks. The “originate-to-dis-tribute” banking model generated an imprecise and oftencounterproductive division of responsibilities betweenoriginators, distributors, rating agencies, and insurerswhere risks were not suitably managed due to a lack ofincentives. In the expansive context prior to the crisis,the objections to this model simply yielded to simplisticand interested visions.

These failures were added to those in the accountingand solvency standards that, together with the tradingstrategies in the markets, left the financial system seri-ously exposed to liquidity and counterparty risks and, ulti-mately, to systemic risk.


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Fernandez de Lis, S. (2009); Chapter 1: La crisis financiera: origen, diagnóstico yalgunas cuestiones [The financial crisis: origin, diagnosis and some issues], inAnalistas Financieros Internacionales (Afi): La crisis financiera: su impacto y larespuesta de las autoridades [The financial crisis: Its impact and the response ofauthorities].

The international financial system, halfway through2007, was more leveraged and globally interconnectedthan ever, and was extremely vulnerable. This was onlypartly known due to the lack of transparency of many ofits transactions and instruments. What is worse, short-term financing of financial institutions depended morethan ever on sources unprotected by traditional depositinsurance, as is the case of wholesale banking financingthrough the money markets. This entailed an intrinsic fac-

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Figure 1. Spread of the crisis

Assetprice

Liquidity

Riskappetite

Financial marketsvolatility

Asset Sales

Deleveraging

Liquidation ofcollateral

Margincalls


tor of instability that was completely ignored during theincubation of the crisis. Finally, wholesale financingshowed to be, in practice, more unstable than that basedon retail deposits3.

A sufficiently large shock was enough to expose thevulnerability of the financial system with all its virulence.This shock was the outbreak of the real-estate crisis inthe United States and the initial losses related with high-risk mortgages.

The development of the financial crisis and the ensu-ing economic recession is well known:

•It started with the materialisation of direct and indirectlosses in a growing number of banking institutions.

•It worsened and spread globally with the paralysis ofmoney markets due to the lack of knowledge of theactual scope and distribution of the losses amongthe different financial institutions.


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3 Traditional banks, retail banks close to their customers, and traditional networks ofbranches that collect deposits, have been reinforced vis-à-vis people, investors andmonetary authorities. It is the second assault they have overcome in just a fewyears. First, in the nineties, it was the Internet that was going to finish with the bankbranches and even with banks themselves, which were to be replaced by virtualoperators. Those that said this, and for many years they were the majority, neverunderstood the banking business and what confidence means in it. In the earlyyears of the 21st century, the qualities of commercial banking and its progressiveand convenient replacement by investment banks, and the substitution of depositcollection for asset management were discussed. And again they were mistaken.



•All this posed serious problems of survival for someinstitutions and generalised credit restrictions to allmarkets and countries.

Governments tried to attack the problem and stem theflow of the crisis to the economy as a whole with subse-quent rescue plans of unequal effectiveness and anunprecedented effort for international coordination in aglobal world.

1.3. Management of the crisis: improvisation andpartial successes

With the outbreak of the crisis and in view of its magni-tude and evolution, international authorities haveembarked on a political maelstrom that has combinedthe following elements:

•High doses of marketing to try to combat lack of confi-dence.

•Political discourses that promise to do everything pos-sible to avoid depression.

•Anti-protectionist discourses in international forawhich, surprisingly, are combined with typical meas-ures of ingenuous “Keynesianism in one country”.

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•Monetary policy measures that involve aggressiveinterest rate cuts.

•Extraordinary injections of unlimited liquidity.

•Almost unlimited extension of guarantees to bankingdeposits.

•Interventions of financial institutions and successivenationalisations.

Some of these emergency measures can be justified buttheir effectiveness was burdened by a basic error: promis-ing that not a single financial institution would fail. The mar-kets and the public in general cannot believe this statementas they are aware that in-depth restructuring is inevitableand they fear that Governments will embark, in fact arealready embarking, on a protectionist path to save nationalinstitutions or those deemed strategic for their country.

Only when transparency measures regarding the sizeand distribution of the losses have been implemented bypublishing stress test4 exercises in the US, does itappear that Government action is collaborating to thereturn of confidence to the financial markets. Only


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4 Stress tests are an exercise to assess the soundness of the financial institutionsfaced with various scenarios of future development of the economy and of thefinancial markets. The US Federal Reserve has published the results of thesestress tests for the largest financial institutions of that country.



through confidence will private capital be able to returnto the financial institutions.

The lack of international liquidity has been palliatedwith the proliferation of currency swap agreementsbetween the main central banks of the world. This is amarket device that appears to have worked well. Foreignexchange markets, normally extraordinarily volatile attimes of crisis, have remained quite stable. There weresome exceptions in Central and Eastern Europe, becausehere other factors came into play, specifically their highindebtedness denominated in a foreign currency like theeuro, in a crisis similar to that in Latin America at the endof the nineties.

The measures taken have brought about an unprece-dented fiscal expansion, more than five points of theworld’s GDP in IMF estimates, and with no limits otherthan a vague request for medium-term sustainability.Neither was there an agreement in the design of thefiscal package and it appears that everything goes inthis case. The only sure thing is that in spite of callsfrom international organisations for fiscal stimuluspackages to be swift, intensive and reversible, theimmense fiscal expansion has caused the followingeffects to date:

•Doubts on the fiscal sustainability of many countries.

•Drops in the credit rating of Government Treasuries.

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•Problems in allocating Government debt.

•Increase of long-term interest rates.

•And expulsion of the private sector from access tofinancing.

The arsenal of measures for crisis management avail-able to economic authorities in mid 2007 was insuffi-cient and inadequate given the magnitude and nature ofthe current financial crisis.

Many of the Government interventions supporting finan-cial institutions in difficulty have broken away from tradi-tional principles. According to them, intervention of centralbanks in their role as lenders of last resort should distin-guish radically between insolvent institutions – which mustbe allowed to fail through an ordered liquidation process –and those with mere liquidity problems. Funds should belent to the latter, always demanding good quality guaran-tees and charging these aids at penalty rates.

All these rules, and some more – as the distinctionbetween commercial banks subject to regulation, andtherefore protection, and investment banks, less regulat-ed and therefore without safety nets – have been deliber-ately breached in the management of this crisis. The rea-son was the powerful and urgent argument of trying toavoid a systemic risk that, in any case, has not beenstaved off completely.


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Some of these differences with traditional anti-crisisknowledge have been unavoidable, others were simplyimprovised when faced with the magnitude of events. Butit is worth raising serious doubts on whether theGovernments’ financial rescue plans were properlydesigned or simply involved a leap forward entailing:

•A threat to the independence of central banks due tothe assumption of credit risks on their balancesheets

•And a loss of credibility in the financial system’s safe-ty nets.

The absence of predictable Government behaviourincreases the uncertainty and undermines the confi-dence in the system. In view of the lack of a contingentapproach in current regulation, the reaction to the crisishas meant the suspension or, in the best case, the flexi-ble application of rules that were not prepared torespond to a crisis of this nature which, in turn, hasimplied a lack of predictability and greater distrust.

Thus, some renovated instruments for financial regula-tion are required that explicitly include new principles andGovernment behaviour guidelines for their application incases of systemic crises.

Financial bailout plans should be devised as contin-gency plans expressly envisaged in the law for periods of

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systemic crisis, with the aim of protecting the legitimateinterests of the citizens.

The long-term well-being of citizens requires Governmentbehaviour guidelines that are suitable, predictable and thatare also enforced during crisis periods.


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2MORE INDEPENDENCE,

CREDIBILITY AND ACCOUNTABILITY FOR CENTRAL BANKS

An analysis of the monetary policy at the turn of the cen-tury is inherent to the origin, development and implica-tions of the financial crisis and it immediately raises thematters on which reform is necessary.

Monetary policies are currently being implemented ina general context of loss of effectiveness caused by avariety of complex factors, many of them prior to theemergence of the financial crisis in 2007:

•The autonomous generation of liquidity by the globalfinancial system in an increasingly integrated worldeconomy.

•The boom of financial disintermediation and the con-sented creation of entities and markets outside theregulatory framework and of off-balance sheet pro-ducts. All this with little transparency.

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•The increased cross-country correlation in the move-ment of long-term interest rates and of stock prices,which reduces the influence of monetary policies out-side the United States.

The solution to this loss of effectiveness is not retur-ning to homogenous national financial markets with strongintervention as yearned by some. The answer is to articu-late suitable reforms regarding the design and applicationof monetary policies.

The aim of reforms must be for monetary policies toeffectively and at all times guarantee price stability andfinancial stability. This is not always simple, as both objec-tives can appear as contradictions at some stage of thecycle. Therefore, it is necessary to avoid monetary policiesfrom becoming again unnecessarily loose during creditbooms, and from setting negative interest rates with mas-sive injections of liquidity at times of crisis.

Ultimately, the problem with the design of monetary poli-cies is similar to that of fiscal policies in the outline of theEU Stability and Growth Pact. It lies in how to guaranteethat they are suitable in times of prosperity, because it isthen that imbalances and the type of market agent beha-viour that subsequently lead to crises are fuelled. As everygood banker should know, although some seem to haveforgotten it, happy-go-lucky decisions made at times ofprosperity are the ones causing crises.

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Although there continue to be serious difficulties inidentifying financial bubbles – and more so to gauge a sui-table response of the monetary policy vis-à-vis fluctuationsin stock market valuations or property prices – the crisisstarted in 2007 has highlighted the key role of asset pri-ces as a source of possible financial instability. Thus, theage-old debate has returned with a vengeance regardingthe convenience or not of incorporating asset prices (finan-cial and real) to the explicit objective of the monetarypolicy.

This incorporation would entail drawbacks in terms oftransparency, credibility, accountability and independenceof the central banks, as:

•The relative weight of the inflation of goods and servi-ces (the current CPI) and asset inflation within theobjective function of central banks would vary duringthe cycle. This would introduce a high level of comple-xity and discretion in the monetary policy actions.

•The incorporation of asset prices to a new wider priceindex would result in an index that would not respondto the consumer’s perception of their purchasingpower. This would undermine the transparency, credibi-lity and accountability of central banks’ behaviour.

•With the incorporation of asset prices, central bankswould be doomed to struggle against theirGovernments and the financial industry. This is a par-

MORE INDEPENDENCE, CREDIBILITY AND ACCOUNTABILITY FOR CENTRAL BANKS

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ticularly sensitive issue in the case of a supranationalbank such as the European Central Bank. The ECB isobliged to defend the stability of the Eurozone as awhole, an aggregate that does not enter into the directcalculation of any politician or voter.

Given the abovementioned drawbacks and that, ulti-mately, bubbles are only created when monetary and cre-dit-growth conditions are sufficiently lax, a more conve-nient alternative would be:

•That the ECB restores the importance of the moneysupply growth target and that the rest of the world cen-tral banks advance in the definition of a monetarypillar in their monetary policy strategies.

•To define and use simple and transparent early war-ning signals, such as credit growth, which could warnof risks to medium-term financial stability.

•Central banks should be accountable for their mone-tary policy measures by means of explicit “correct orexplain” clauses whenever early warning indicatorsexceed some predefined threshold reference values.

A bubble is only possible if monetary conditions and,ultimately, credit growth are sufficiently lax. Using a maxi-mum indicative rate for credit growth as an early warningindicator has the virtue of simplicity. This would isolatecentral banks from political pressures and excessive

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technical requirements, which are normally ambiguousand often paralyse decision-making, at the time of reo-rienting an excessively expansive monetary policy duringbooms.

Whatever it takes to guarantee the independence ofthe monetary authority from Governments and from thefinancial industry, and to reinforce its credibility andaccountability, is a move in the right direction. Settingsome distance, limiting discretion and the possibilities ofconnivance by the application of simple and crediblerules is a good lesson from this crisis.

Monetary policy has a two-fold objective: price stabilityand financial stability. Objectives that are not alwayseasily compatible, even on a national scale. There was atime when it was argued that this duality of objectivessuggested separating both functions into two indepen-dent institutions, the central bank and the financialsupervisor. However, evidence from this crisis is conclu-sive: today it does not seem appropriate to split bothfunctions into two different regulatory bodies.

When facing difficult and urgent decisions that mustbe adopted in times of crisis resolution, monetary autho-rities that are also supervising bodies have worked bet-ter. This is because sensitive information does not circu-late well among institutions, sometimes even within thesame institution, and relations and coordination pro-blems among different agencies are highly complex.

MORE INDEPENDENCE, CREDIBILITY AND ACCOUNTABILITY FOR CENTRAL BANKS

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Therefore, we propose that the Eurosystem – with theECB at its core – be responsible for the regulation andsupervision of at least those financial institutions thatare systemically important within the Eurozone5. Thiswould have to be made both regarding their individualfinancial soundness (microprudential approach) and thesoundness of the financial system as a whole (macropru-dential approach). This proposal shall be developed fur-ther in section 4 of this report.

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5 Unlike the proposals of the European Commission arising from the recommenda-tions of the Larosière report, in our proposal both macroprudential and micropru-dential supervision would be under the responsibility of the same institution.


3THE REFORM OF INTERNATIONAL

FINANCIAL REGULATION

The quality of financial regulation must improve in orderto embrace the lessons from the financial crisis thatstarted in 2007. The current risk is to end up in anexcessively interventionist re-regulation process thatends up strangling the potential growth of economies byeroding the very nature of banking business. Preservingthe risk-return trade-off is essential for the financial sys-tem to effectively fulfil its intermediation function and toenable economic and social development.

There is a risk that an interventionist re-regulationprocess ends up “shooting the messenger”, that is, inval-idating the effectiveness of the early warning indicatorsthat some want to build to assess the soundness of thefinancial system.

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Existing regulation on minimum capital requirements6

should have been designed and applied with greatercelerity and diligence: for instance, the Basel II treatmentfor off-balance sheet risks or accounting standards refer-ring to the consolidation of securitization vehicles. Hadthis been the case, some of the regulatory arbitrageopportunities and many of the excesses that led to thecrisis would have been avoided.

An inappropriate regulatory overreaction would neces-sarily lead to the creation of new regulatory arbitrageopportunities and incentives for a new wave of financialinnovations addressed at eluding the new standards.Financial regulation must adopt a more modern and suit-able approach that avoids promoting again a “regulatoryrace” with the markets.

When bringing about regulatory reforms it is moreappropriate to consider future objectives to be achieved,

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6 To impose a minimum capital requirement on a financial institution – obliging it tohave a minimum amount of own funds per unit of assets –, is not different, in subs-tance, from imposing a limit to its leverage, that is, establishing a maximum level ofdebt per unit of equity. In any case, the key for the effectiveness of both instruments– with a view to covering or penalising the insolvency risk assumed – lies in thecorrect definition of the assets or “risk exposures” and of the “equity”. The lax natu-re of the notions of “risk exposure” and “equity” handled during the period prior tothe crisis largely explains the current scepticism regarding the effectiveness of mini-mum capital requirements. Neither capital requirements nor leverage limits will workwell if (i) “risk exposures” do not include “off-balance sheet” positions that couldcause losses and (ii) “equity” does not suitably discount imminent or expected los-ses, due, for example, to contingent liabilities or the foreseeable deterioration of themacroeconomic situation.


rather than looking back to past failures. Any reform con-cerning financial regulations should provide incentives sothat the necessary self-correcting process in the markettakes place, leading financial institutions to:

•Improve the quality of their risk management models.

•Carry out their activities under an effective supervi-sion, regardless of their legal nature and jurisdiction ofincorporation. This involves an improvement in thequality of regulation and financial supervision so thatits value added is perceived with greater clarity by allparticipants in the markets.

•Adopt strategies and business models promotinggreater financial stability by internalising the contribu-tion of their activities to systemic risk.

The major challenge of regulatory reform is to offerincentives for the prudent behaviour of participants inthe financial markets, not only from the perspective oftheir individual financial soundness (microprudentialapproach) but especially, from the point of the sound-ness of the financial system as a whole (macropruden-tial approach). The ultimate aim must be that systemicrisk is kept within acceptable boundaries, proportionalto the expected returns obtained in terms of wellbeingand sustainable economic growth.

THE REFORM OF INTERNATIONAL FINANCIAL REGULATION

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7 Pillar 1: minimum capital requirements. Pillar 2: microprudential supervisoryreview. Pillar 3: market discipline. We propose the creation of a new Pillar 4: macro-prudential requirements.


3.1. Controlling systemic risk: a new macropruden-tial pillar in minimum capital requirements

The triggering and spreading elements of the crisis dur-ing 2007 and 2008 have highlighted the existence offinancial strategies, products and activities that pose arisk to the system as a whole far beyond their potentialimpact on the balance sheet of those institutions carry-ing them out.

The current prudential regulation focuses almostexclusively on the specific solvency status of each of thefinancial institutions. It does not adequately deal with itsinterrelations or the generation of externalities to thefinancial system as a whole. This causes the accumula-tion of excessive systemic risk.

One of the major challenges currently faced by finan-cial regulation is translating the analyses on the accumu-lation of systemic risk into instruments of prudential reg-ulation. Therefore, we propose that all financial institu-tions carrying out activities that contribute significantly tothe increase of systemic risk should be made subject toa new macroprudential pillar within solvency rules. Thisadditional pillar would be superimposed on the three cur-rent pillars of international regulatory standards on mini-mum capital requirements7.

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Capital requirements for this fourth macroprudentialpillar would be proportional to the marginal contributionof each activity or financial product to global systemicrisk.

A higher capital requirement on those banking strate-gies that contribute to the accumulation of greater sys-temic risk would mitigate the carrying out of these activ-ities8. Such a deterrent would work because financialinstitutions consider that financing via capital is morecostly or difficult to achieve than financing with debtinstruments.

The use of capital requirements with this deterring pur-pose is much less problematic than the introduction of ataxation system. As it has no tax collection implications,it is therefore unlikely to end up far from its aim. It is alsoeasier to delegate to the financial authorities and withoutdoubt it facilitates coordination between different nation-al jurisdictions.

The specification and calibration of this fourth pillar inprudential regulation should have been one of the priori-


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8 Note that the introduction of a fourth macroprudential pillar in the regulation doesnot necessarily imply an increase of the resulting total minimum capital require-ments for the system as a whole as it operates as a modification factor of the rela-tive capital charges for the different activities and financial products.Notwithstanding, the evidence from this crisis suggests the convenience that, attimes of cyclical booms, the financial sector as a whole operates with higher levelsof capitalisation.



ties of the working agenda of the Financial StabilityBoard that arose from the G-20 leaders’ meeting in April2009 in London.

The most important technical challenge that theFinancial Stability Board would face regarding this issuewould comprise improving prudential regulation as toallow a suitable coverage of microprudential risks, anddiscouraging the accumulation of excessive systemicrisk. All this, using an inspection and sanction system ofreasonable cost.

Once the contribution made by the activities of eachfinancial institution to global systemic risk is estab-lished, determining the systemic importance of eachfinancial institution would be largely resolved. This is rel-evant when articulating contingent bailout plans and foroptimally assigning supervisory resources.

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41

Certain analytical developments to objectively measure the mar-ginal contribution of decisions and financial products to syste-

mic risk are required to carry out this proposal. Even though thislist is by no means comprehensive, we consider that the workloadof the Financial Stability Board should focus on the followingaspects:

• Maturity mismatches between assets and liabilities and depen-dence on wholesale financing

Maturity mismatches can have systemic consequences that arenot internalised well enough by financial institutions. Maturity mis-matches between the assets and liabilities in US banks that usedthe “originate to distribute” model, and mismatches of traditionalglobalised banks were not much greater than those in traditionalbanks decades ago. Granted, they were measured worse due tothe lack of transparency. They were more neglected also due to theunanimous belief that, at least in developed countries, money mar-kets would never fail. And probably, they were also much more dan-gerous.

Methods to assess refinancing and liquidity risks should bedeveloped. The expected costs to maintain the safety net that pro-tects the system from panic could be substantially reduced. Inorder to do this, it would be enough to make relatively small reduc-tions of (i) maturity mismatches accumulated by the system and (ii)of the dependence on short-term wholesale financing.

A useful solution would be to impose on financial institutionscapital requirements proportional to short-term wholesale liabili-

PTO

Box 1. Technical development of a fourth macroprudential pillar under the regulations on minimumcapital requirements of financial institutions



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9 Standardising, issuing or negotiating in organised markets, surveying matched posi-tions, and clearing house activities are not free of charge. As well as obvious orga-nisation costs, it is worth mentioning possible costs in terms of flexibility, incenti-ves for financial innovation, incentives for the generation of information, obstaclesto competition, problems associated with a possible centralisation of operations ina market under the jurisdiction of a specific country and inaccessible to the controlof the remaining national supervisors. There is also a risk that, after swallowingthese costs, the results are products or markets so stringent that they could impli-citly promote a new wave of financial innovations based, again, on over-the-counter(OTC) transactions and parallel institutions that are looking to escape regulation.

ties, weighted by the maturity mismatch between the assets andliabilities. This solution would provide a more flexible and less dis-tortionary scheme than a rough quantitative limit to maturity mis-matches or to wholesale financing volumes.

• Issuance and trading standards of securitization assets, creditderivatives, and other non-standardised OTC products.

To avoid falling into regulatory excesses that limit innovation,encouraging the standardisation and creation of organised mar-kets should be promoted, but without aspiring to prohibit or elimi-nate over-the-counter (OTC)9 operations. This could be achieved byimposing greater capital requirements to positions in non-standar-dised assets or on those deemed to be more risky for the system.It is a simple procedure, with few application and verificationcosts. It is an example of intelligent, non-prohibitive regulation,which endeavours to make socially responsible behaviour attracti-ve and profitable in light of externalities. It does not forbid opera-tions which may also be individually rational, nor does it imposeregulatory approvals prior to innovating, rather it encourages bestpractices.

(Continued)


3.2. Controlling systemic risk: a guarantee mechanism against systemic crises formoney markets

One of the lessons drawn from this crisis is the greaterinstability of wholesale financing in the money marketscompared with traditional deposits. The development ofthe crisis serves very well to illustrate this point.Negative news during the summer of 2007 and thedoubts and lack of transparency with regard to the distri-bution by entities of losses caused by toxic assets start-ed a neo-bank panic on a global scale. This panic led tothe paralysis of money markets, which are an essentialpart of the links among banking institutions, more global-ized and interconnected than ever before.

Through the illiquidity of the money markets, the ele-vated level of accumulated systemic risk became plain tosee. The risk of panic suffered by institutions that arefinanced through liquid liabilities to invest in illiquidassets is due to the self-confirming nature of that panicand its destructive power. The sudden loss of creditorconfidence can lead to withdrawals of deposits and canhinder the renewal of short-term wholesale financing.This finally leads to solvency problems.

Money markets have proved to be essential to guar-antee international liquidity and the efficient internation-al operations of payment systems. Thus, one of the chal-lenges posed by the crisis is devising a mechanism that


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stabilises wholesale money markets in order to makethem immune to panic. This way, they would be able tocontinue operating in the event of systemic crisis andthey would not become mechanisms of massive conta-gion.

The aim is in some way similar to that endeavouredwith the deposit insurance schemes with regard to retailfinancing10. Obviously, the institutional nature of investorsin the wholesale markets makes it essential for the guar-antee mechanism to be different in nature. The mecha-nism should not be concerned with insuring the value ofthe assets and much less with guaranteeing thatinvestors do not lose money. Instead, it should focus onavoiding contagion and the spreading of banking prob-lems to solvent institutions.

The guarantee mechanism would have a contingentnature. This means that it would only be triggered in theevent of systemic crisis and in no case because of liquid-ity problems in individual institutions.

A report from the Financial Stability Board should becompulsory to activate the guarantee mechanism. In this

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10 Historically, attempts were made to try to correct the potential liquidity problems offinancial institutions by forcing them to maintain an increased percentage of reser-ves. With the development of the financial system and the modernisation of theregulations, this rough mechanism was replaced by a more sophisticated one as (i)the suspension of convertibility (ii) the provision of liquidity by the lender of lastresort, and (iii) the insurance of deposits. Gradually, almost all developed countriesadopted an explicit system to insure retail deposits, although of differing nature.


report, a systemic crisis situation in any of the main cur-rencies would be determined based on some pre-estab-lished objective indicators11. The definition of these indi-cators and the guidelines for the drafting of reportsshould be included in the agenda of international finan-cial organisations.

By triggering this mechanism a provisional public guar-antee of all short-term wholesale banking liabilities andaccess to emergency liquidity would automatically beestablished. This coverage would be available exclusive-ly for those financial institutions subject to additionalcapital requirements resulting from the application of thefourth macroprudential pillar set forth in the previoussection.

The additional costs entailed by the capital require-ments arising from the fourth macroprudential pillarwould not only act as a deterrent to excessive accumu-lation of risk. They would also serve as a sort of insur-ance premium, in other words, it would anticipate part ofthe cost of banking crises. Thus, incentives would begenerated to avoid regulatory arbitrage and attempts toescape from the regulatory scope in times of prosperity.


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11 The use of spreads in the money markets, such as the LIBOR-OIS spread, as stressindicators of the money markets has been recurrent during this crisis, and could beuseful for this purpose.



Activating the guarantee only in cases of systemic cri-sis and never due to problems of individual liquidity prac-tically eliminates the costs of losing market discipline orgenerating ”moral hazards”, as generally involved by theuse of public guarantee mechanisms.

The effectiveness of the panic-prevention mechanismin the money markets ultimately lies on the prior knowl-edge and credibility by the agents of the public commit-ment to extend guarantees to bank liabilities.

It must always be taken into account that, in the eventof systemic crises, taxpayers are the ultimate lenders.There is no central bank balance sheet or profit and lossaccount capable of withstanding the magnitude of theintervention necessary to confront a systemic crisis with-out seriously threatening its future viability.

In the case of the European Union, it is obvious thatthere is no European taxpayer, but rather national taxpay-ers. But a lesson from this crisis is that in an area aseconomically integrated as the EU, the solvency of thefinancial system as a whole is, to a great extent, a pub-lic good.

To ensure an optimum assignment of responsibilitiesand duties, the distribution of the total volume of publicguarantees among the Governments participating in themechanism should be proportional to the contribution ofeach country’s financial institutions to systemic risk. In

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practice, these ratios could be calculated based on thecapital requirements stemming from the fourth macro-prudential pillar.

Although a coordinated international implementationof a mechanism of this type would be desirable, we con-sider that this guarantee mechanism would be of partic-ular importance in the European Union. The reason isthat it would help to move resolutely forward in the cre-ation of a single financial market that could boost theadvantages arising from the single currency.

This guarantee mechanism includes, in the form of arules-based setting known in advance, a large part of themeasures carried out by the financial authorities inautumn 2008 in an uncoordinated, improvised, delayed,and non-predictable form to prevent money markets fromcollapsing. Furthermore, it would contribute to create anew system for the regulation and crisis managementbased on credible rules known beforehand. This wouldallow restoring the predictability of Government actionsand thus building greater confidence.

Mitigating the probability and impact of future financialcrises requires Government actions to be predictable, togenerate confidence, and precisely because of this, to beeffective.


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3.3. Better corporate governance and long-termincentives in senior management compensation schemes

The problem with senior management compensationschemes in some financial institutions is not their mag-nitude, as outraging as some events may appear ininstitutions that have had to rely on public financial sup-port. Using moral criteria to try to reopen debates thatwere already solved decades ago regarding the so-called fair or unfair rewards for work or savings is notvery useful. The problem lay in an incentive system thatfocused excessively on the short-term. A system thatoffered personal profits through variable remunerationbefore the complete outcome of the transactions hadmaterialised.

The compensation schemes of banking managers willhave to be revised to encourage a more prudent behav-iour that meets the long-term implications of their man-agement decisions. The proposals in this area are:

•To encourage good governance of financial institutionsin order to achieve greater shareholder participation inestablishing salary conditions of managers.

•And to promote absolute transparency in decisionsinvolving the complete retribution, pertaining or not tosalary, of its managers.

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Strict interventionist rules or quantitative limits gener-ate incentives to by-pass them and are not familiar withthe reality of the executive international market. Theytherefore run the risk of forcing the fleeing of talent tomore opaque sectors regarding their compensations. Allof which goes going against the principle of increasingtransparency.

A voluntary standard of good corporate governancethat increases the effective limit of pecuniary liability ofsenior management should be promoted. For this pur-pose, top management hiring contracts should establisha time lag of several years for the payment of variableremunerations that surpass a certain percentage of thefixed pay.

The outstanding remunerations of managers accumu-lated during that time-lag should be deposited in anotherfinancial institution. They would serve to face the lossesin case of insolvency or of serious financial problemsarising in the managed financial institution.

The potential reversion of these funds to the financialinstitution itself comprises an aspect of little relevancequantitatively speaking, but of great symbolic and didac-tic value. This is particularly so at a time when populismis using these incidents to undermine the credibility ofmarket-based economy vis-à-vis public opinion.


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3.4. Improving the quality and the regulatory use ofcredit ratings

Public opinion has mostly blamed rating agencies forthe crisis. Their image has been further tarnished bythe fact that the market is dominated by only threeAnglo-Saxon agencies and that the price of the serv-ice is paid by the issuers of the rated issuers them-selves.

They have been blamed for not warning of the riskssoon enough and for having allowed the bubble to grow.But at the same time, they have been criticised for chang-ing their minds very quickly about this and therefore pre-cipitating the crisis by triggering a chain of disorganisedsales that could have been avoided.

The reality is that their rating methods were notdesigned to detect increases in systemic risk. The sameapplies to management and risk-monitoring models offinancial institutions and of public supervisors as well.Therefore, there is a wide margin for improving the quali-ty of the ratings of these agencies without the need forexcessive interventionism.

A challenge for the rating agencies’ methods involvesimproving the ratings system to provide two-dimensionalratings. As well as informing on the probability of defaultof each asset, they should inform on the correlationbetween individual defaults and provide an added meas-

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ure of the global default risk. Furthermore, this would bea useful contribution to develop a new macroprudentialfocus in financial regulation.

Regulatory agencies could promote these improve-ments in the quality of rating methods by allowing themto be used to calculate minimum capital requirementsunder the fourth macroprudential pillar aforemen-tioned.

Two additional proposals to improve the quality of rat-ings would be:

•Promoting a greater transparency of the methodsused by these rating agencies through the approvalprocedure of the regulatory use of their ratings.

•Avoiding potential conflicts of interests by guaran-teeing a greater separation between the rating andconsulting activities undertaken by these agencies.

3.5. More transparent and less procyclicalregulations

Market transparency and the informative value ofaccounting figures should be reinforced. In order to dothis we propose keeping uniform valuation standardsthroughout the cycle and leaving regulations on minimum


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capital requirements undertake the task of accommodat-ing cyclical effects.

It is contradicting to defend a provisional abandon-ment of fair value accounting for some assets or thecyclical adaptation of their valuation standards, while atthe same time demanding full transparency and the totaldisclosure of losses.

Changing valuation standards during the cycle gener-ates a feeling of preferential treatment and distrustamong economic agents and the general public. If stan-dards change according to circumstances, economicagents will be more encouraged to bring about legalchanges at times of crisis that are more favourable tothem than solving their underlying problems.

The anticyclical provision was successfully implement-ed as a pioneering measure in Spain in 2000. Its cush-ioning impact has demonstrated at an international levelthe need for regulatory reforms that tighten minimumcapital requirements during expansions and relax themduring contractions.

Given that the accumulation of systemic risks takeplace during the long periods of prosperity, it is reason-able to expect that adding a fourth macroprudential pil-lar to solvency rules may also help reduce the currentprocyclical trend of regulations on capital require-ments.

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All this would allow a smaller expansion of credit dur-ing booms and a smaller contraction during crises.Therefore the generation of bubbles and the impact ofcrises would be mitigated.


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4THE REFORM OF FINANCIAL

SUPERVISION

4.1. Supervision with early warning systems andgreater pre-emptive capability

The aim of financial supervision is to ensure a healthysystem, to avoid problems of liquidity and solvency with-in institutions, and when these do happen, avoid theircontagion and the spread of systemic risk.

The financial supervision system is conceived and jus-tified to detect problems within institutios in advance anddemand timely corrective measures. The great challengeinvolves generating instruments to facilitate an early andeffective management of financial crises. All availableevidence highlights that fiscal and economic costsdecrease the sooner corrective or clean-up actions areput into place.

An early warning system is necessary to guaranteeeffective, pre-emptive supervisory action. This systemwould provide information in real time on the financial sit-uation of supervised institutions and on their foresee-able evolution. For this, the following are required:

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•A suitable inspection system and of information deliv-ery on a regular basis.

•An on-site supervision system, with regular and/orcontinued physical presence of supervisors at thefacilities of those supervised. This, far from being anexcessive interference, would be an added value ofprudence and solvency. This lesson should be includ-ed in the international supervisory principles arisingfrom this crisis.

•A constant analysis of the foreseeable solvency evolu-tion of the supervised institutions vis-à-vis differentpotential macroeconomic and financial market scenar-ios. We propose that the so-called stress test exercis-es cease being an extraordinary requirement usedonly in times of crises and start being a regular fea-ture of a more modern supervision.

The key to success of a more pre-emptive supervisionlies in designing response plans that:

•Are gradual in their sanctions.

•Do not only consider as sanctions business liquidationor removal of senior management.

•Establish an incentive scheme to encourage a prudentmanagement, especially in times of prosperity, whichis when excessive risks are taken.

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However, interventions will continue to be necessary.Therefore, we must facilitate that they are adopted withsufficient speed and legal certainty for all parties, includ-ing the supervisor, its collaborators and, of course, thosesupervised.

The independence of the supervisor, its impartiality,the equality of treatment and, especially, the applicationof technical criteria that are known beforehand, must actas a guarantee of the rights of those supervised. This isparticularly so in a decision as important as the interven-tion of a financial institution.

Building an effective supervision system alwaysinvolves a delicate balance between:

•The rights of control of financial institutions by theirowners when the solvency of the entity is not in dan-ger, that is, in the absence of default.

•And the principles of Government intervention to safe-guard the legitimate interests of citizens when theirsavings are in danger due to the potential insolvencyof the institution.

A lesson drawn from this crisis is that the actual defi-nition of failure – traditionally a negative net accountingvalue – should be further specified and extended ex anteto include objective circumstances that justify pre-emp-tive action by the supervisor. For instance, those circum-

THE REFORM OF FINANCIAL SUPERVISION

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stances that pose an obvious threat, albeit perhaps notimmediate, to the solvency of the institution or the stabil-ity of the financial system as a whole.

This approach would require increasing the obligationsof transparency of the supervisors even more. The coun-terpart of an inevitable discretion can only be full trans-parency and accountability ex post, not only legal but,especially, from the political point of view.

4.2. Improving the effectiveness and the incentivesin public bailout plans

In spite of all the previous approaches and proposals toimprove the quality of regulation and supervision, as suc-cessful as they could be, it will continue to be necessaryto establish bailout plans if a future crisis – howeverunlikely it may be – represents a sufficiently seriousthreat for the system.

Margins of uncertainty on the course of action of pub-lic powers should be avoided. Therefore, it would be con-venient that their actions regarding the bailout of finan-cial institutions are part of contingency plans expresslyenvisaged in financial legislation.

Recapitalisation schemes must be an explicit part ofcontingency plans. These would be temporarily activated

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where the need arises to guarantee the stability of thefinancial system. The fact that their existence would beknown beforehand and the perspective of their early acti-vation could even mitigate the severity of many potentialcrises.

It is also true that the pre-existence of these plans, ifthey are not well designed, could create problems relat-ed to the loss of market discipline and “moral hazard” (inthis case, the adoption of excessive risks due to bailoutexpectations).

There will always be certain margins of discretion, thisis impossible to avoid. But knowing the personal andinstitutional consequences derived from the excessiveassumption of risks should be a good deterrent to irre-sponsible behaviour. These consequences must be spec-ified with regard to the possibilities and modes of inter-vention, to management liabilities, and to the cost thatshareholders and bond holders will have to assume.

Interventions at times of crisis must follow the basicprinciple of rewarding prudent behaviour. Those institu-tions that have neither incurred in excesses nor requiredsupport from Government funds should be rewarded. Orat least they should not be harmed in their competitiveposition.

There are serious doubts that this has been the casein the current crisis. It is more than possible that the gen-


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eralised recapitalisations set up in many countries mayhave harmed solvent banks in the following ways:

•Firstly, by obstructing their access to new private cap-ital. This is so because investors, at times of uncer-tainty, prefer to invest in public funds or in State guar-anteed securities.

•Secondly, by making the market demand greater sol-vency ratios from all financial institutions to cover fore-seeable problems in the asset quality of recapitalisedinstitutions. This prevented the market from respond-ing to the deleveraging needs of the entire financialsystem instead.

•And thirdly, by allowing a greater credit growth of thoseinstitutions recapitalised with public funds in detrimentof the market share of well-managed institutions.

When insolvent institutions are rescued, an excellentopportunity arises to reward the prudent behaviour viathe auction of deposits, of financial assets, or of net-works of branches of the failed institutions. Putting partof the assets of institutions in default into the hands ofsurviving financial institutions at a competitive pricecould be a justified reward for their prudence. This is anadditional argument to escape from the indiscriminateincentives to the mergers between institutions or thegeneralised recapitalisations. These have been thefavourite instruments of many Governments because

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they avoid explanations and cover up the true extent ofthe problem.

It would have been desirable for the G20 meetings tohave fully considered the design of a coordinated rescueplan of financial institutions. A broad international agree-ment on this matter would be appropriate, as it is neces-sary to avoid the negative externalities to the financialsystem posed by uncoordinated and ill-designed nationalmeasures.

It would also have been desirable, at least within thescope of the European Union – and doubtless in theMonetary Union – for this matter to have been coveredmore fully. At least beyond vague declarations of principlesrelated to the necessity of avoiding financial protectionismand making rescue packages for the financial sector com-patible with the European doctrine on State aid.

The episodes of financial nationalism spurred bynational bailout plans are particularly worrying in aMonetary Union. They should urge the European Union tourgently reach an agreement on clear rules for State aidto the financial sector at times of crisis and on theirenforcement.

Banking crises always require the recapitalisation ofaffected institutions to prevent their losses from beingpaid by the citizens who have deposited their savingsthere.


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The funds for recapitalisation can come from:

•Other local investors. This only occurs in isolatedcases of problems in certain institutions due to poormanagement of its senior executives.

•International investors. This is common in nationalcrises caused by macroeconomic problems.

•Government money. When neither of the previoussources is available in sufficient size due to problemsof information and incentives.

Financial institutions have been incapable in this cri-sis to fully cover their new capital needs through the mar-kets due to:

•The international extent of the crisis and its concurrencein time in practically all developed countries.

•Lack of transparency on the distribution by individualinstitutions of the losses derived from “toxic assets”and their medium-term impact on the financial sound-ness of said institutions.

In crises of this nature, the lender of last resort is thetaxpayer. This has led to the need of orchestratingGovernment bailout plans.

To prevent future collapses of the money markets,

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such as those that occurred in autumn 2008, it is neces-sary to quickly clarify the solvency situation of the differ-ent financial institutions and ensure the soundness ofthe overall system.

Government guarantees awarded to the issuance ofnew bank liabilities that currently support the system areprovisional. Extending their term would involve risking cit-izens’ confidence in the intrinsic soundness of the finan-cial system.

It is essential to address the final recapitalisation ofthe financial system in every country with transparencyand determination. As long as the financial system is notsuitably capitalised, the confidence and credit flow thatfeeds a booming and sustainable economic recovery can-not be restored.

Recapitalising strategies must have a three-foldobjective:

•Restoring soundness and confidence in financial insti-tutions.

•Protecting the legitimate interests of depositors andtaxpayers.

•Providing the market with credible information on themedium-term viability of the business models of thedifferent financial institutions.


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The lack of this credible information when faced withthe first episodes of losses in the financial institutionsdue to subprime mortgages was one of the elementsthat led to the rapid spread of the crisis through anadverse selection mechanism that made wholesalefinancing markets collapse.

The recovery of normal market operations requires thefull transparency of this information. This should comple-ment the information arising from the publication ofstress test exercises under the scrutiny of supervisors.

Therefore, we propose the drafting by the FinancialStability Board, of recommendations for the immediateimplementation of a coordinated plan to restore the sol-vency of the international financial system. This planshould meet the following principles:

•Total transparency in the use of public funds: bothregarding their criteria and modes of disbursement, aswith respect to the volume of public funds necessaryand their distribution among individual institutions.

•Fully transparent valuations via competitive proce-dures. In the recapitalisation procedures of financialinstitutions, the application of poorly transparent orarbitrary valuation criteria must be avoided. The rea-son is that they could lead to public resources beingtransferred to the senior management or shareholdersresponsible for the deterioration of the solvency.

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•Efficiency in the use of public funds. The enormoustask of restoring the solvency of the internationalfinancial system with the reduced strength of strainedpublic accounts requires focusing aid, searching forthe maximum impact of each action, and avoidingindiscriminate actions.

•Maximum taxpayer protection. It involves the demandof responsibilities to former senior management, theirremoval, and the assumption of the losses by the own-ers. Furthermore, the public sector should have prefer-ence regarding compensations for its share in recapi-talised institutions.

•Minimum political interference in the management offinancial institutions. Keeping the management offinancial institutions far away from political pressuresis a guarantee of efficiency in the use of resourcesand minimises the temptation of financial protection-ism.

•Need for a clear exit strategy. Only with a predefined,clear and well-known exit strategy of the public sectorfrom financial institutions, citizen confidence in thesystem will be restored.

In light of these principles, we propose the use of pub-lic-private partnership schemes in recapitalisation pro-grammes. Under these schemes, public funds would sup-plement the recapitalisation of those entities that – in


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spite of their current solvency problems – manage todemonstrate in the market that they have a businessmodel and a strategy both viable and profitable in themedium-term.

The best sign of the future viability of an institution isthat new private investors are prepared to risk theirmoney after an in-depth due diligence process of itsfinancial statements.

Private capital, which under the current circumstancesof uncertainty is not available in sufficient magnitude tocover this recapitalisation process, would be attractedthrough an explicit commitment of the public sector toleverage or supplement private contributions to recapi-talised institutions. If no private investor is willing toinvest their money in a problematic institution, the Stateshould proceed with its transparent and ordered liquida-tion, applying market mechanisms and guaranteeing, inall cases, the legitimate interests of its depositors.

The entry of the public sector in recapitalised institu-tions, which should be always carried out in company ofprivate investors, could be implemented through the pur-chase of preference shares. The mechanism would beclosed with the commitment of the public sector to sellthese preference shares under market conditions infavour of private investors when circumstances enable it.This would act as an exit outlet and would allow the resti-tution to the public sector of its funds.

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The application of these efficient public-private part-nership mechanisms requires the removal of currentobstacles that limit or hinder the entry of privateinvestors in the capital of some financial institutions. Inparticular, in the case of Spanish savings banks, it isessential to give political rights to non-voting shares(“cuotas participativas”). It is likewise necessary toreform the configuration of their Governing Bodies toensure a corporate governance that responds to the cri-teria of economic efficiency without political interference.

Applying the principle of efficiency in the use of publicfunds implies, in particular, that these funds are no to beallocated to:

•Keeping in operation financial institutions with solven-cy problems and incapable of demonstrating theirfuture viability in the market. This concerns the so-called zombie banks, which would burden the econom-ic recovery process. Starting up an orderly liquidationmechanism that protects the interests of depositorswould be necessary for these banks. Additionally, theauction of their assets, liabilities, and network ofbranches would reward the prudence of surviving insti-tutions.

•Improving the situation of viable financial institutionsthat lack current solvency problems. These entities, ina clean-up of “toxic assets” scheme, would also haveincentives to use public money to improve their situa-


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tion. Public funds, which are scarce, must be allocat-ed where their use will have a greater impact given theimportant recapitalisation necessities in parts of thefinancial system.

Applying the principle of efficiency in the use of publicfunds also dismisses generalised recapitalisations andindiscriminate public incentives to mergers betweenfinancial institutions, as they involve an unnecessarytransfer of public funds to where they are not necessaryto ensure the soundness of the system. Non-compliancewith this principle can pose a risk for the final success ofbailout plans by withdrawing resources from where theyare really needed.

Whilst efforts are not focused, and the necessary dis-crimination in the market on the status and viability ofthe different institutions is not allowed, the financial sys-tem will not be able to perform its task of efficiently chan-nelling savings. This is essential for an energetic andsustained economic recovery.

Asserting that no financial institution shall be liquidat-ed is not very sensible. All those that are not viable willhave to be liquidated.

In the aforementioned public-private partnershipscheme, solvent financial institutions would emerge aspotential private investors that – with the supplementaryaid of public funds – would recapitalise those entities pos-

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ing solvency problems but that are viable in the mediumterm. This action would guarantee that the necessaryreordering and restructuring of the financial system is car-ried out by meeting the criteria of economic efficiency, with-out political interference, and rewarding those entities thathave developed a more prudent and suitable manage-ment.

4.3. The challenge of financial institutions “too big to be rescued”

During the current crisis, the problems related with res-cuing large internationally active financial institutionshave been highlighted. The most extreme case is that ofinstitutions that are “too big to be rescued” due to theirexcessive size vis-à-vis the GDP of the home supervisor’seconomy.

In particular, and in spite of what current internationalagreements may establish, in this crisis there havealready been cases of countries that have reneged a pos-teriori on their obligations with the depositors of othercountries. The renegotiation between the Governmentsinvolved can cause delays and uncertainties with fatalconsequences for the bailout. In any case, they involvean alarming insecurity on the distribution of bailoutcosts. All this does is deepening the crisis of confidencethat underlies the financial crisis.


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Recent experience of western European banks inCentral and Eastern European countries are a goodexample of the growing macroeconomic interdependencethat arises from the transnational expansion of financialinstitutions.

An unsuitable response to these challenges canforce the international expansion of financial institu-tions to be done via subsidiaries (capitalised andsupervised separately, and that can be segregated fromthe parent company in case of crisis) instead of throughbranches.

Although for some financial institutions – in particu-lar, large Spanish banks – the change would not haveany major consequences, for other transnational finan-cial institutions it could mean exiting certain markets.In any case, the cost in terms of segmentation of theEuropean banking market could be very high, and thebenefits with regard to the decline of the financial con-tagion, minimal.

The European Union, and certainly the Eurozone, mustunhesitatingly advance towards the creation of a true sin-gle financial market without regulatory barriers betweenMember States in order to:

•Minimise the risks of market fragmentation.

•Avoid financial protectionism.

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•Give a stronger support to the single currency andincrease its benefits for all citizens.

Therefore, we propose the drafting of an ambitiousaction plan. Its ultimate aim would be to set upon theEurosystem (comprehending the national central banksof the euro countries, with the ECB at its core) theresponsibility of regulating and supervising, at least,those financial institutions with systemic significance inthe Eurozone12. This responsibility would be developedboth with regard to the individual financial soundness(microprudential approach), and to the soundness of thefinancial system as a whole (macroprudential approach).

Only for the purposes of regulating and supervisingsystemically important institutions, those national cen-tral banks of EU countries that do not belong to theEurozone, and that have been appointed with prudentialsupervision tasks may be included voluntarily in theEurosystem.

The counterpart to this accumulation of functions inindependent institutions is a reinforced framework of


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12 Unlike the proposals of the European Commission derived from the recommenda-tions of the Larosière report, we propose that both the macroprudential and themicroprudential supervision of systematically important entities are undertaken bythe Eurosystem of central banks. In the same line as the proposals included in thisreport, the proposals of the US Government on the New Foundations for FinancialRegulation point towards the strengthening of the regulatory and supervisorypowers of the Federal Reserve of those financial institutions classified as systemi-cally important.



transparency and accountability. This is facilitated by asupervision and intervention system based on contingentrules such as the ones set forth in this report.

The Eurosystem would delegate to national centralbanks the implementation of traditional banking inspec-tion tasks at the level of each systemically importantinstitution, but following harmonised supervisory criteria,systems and procedures. In other words, it would work ina similar way to the way monetary policies are imple-mented in the Eurozone.

A precondition is that the Eurosystem itself harmonis-es banking regulation applicable to all systemicallyimportant banks in the EU.

Financial institutions without systemic significancecould remain outside the Eurosystem’s supervision andcontinue under the supervision of the current nationalsupervisors.

Some of the lessons learnt from this crisis are con-densed in this proposal. One of them is the need, due toreasons of financial stability, for central banks to under-take the macroprudential supervision and the monitoringof the individual soundness of the systemically importantfinancial institutions.

A non arbitrary measure of the systemic importanceof an institution would be the magnitude of capital

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requirements derived from the application of a fourthmacroprudential pillar as proposed previously in thisreport.

Undertaking the costs and tasks arising from the man-agement of the crisis is not possible if it is not pairedwith regulatory and supervisory capacity. The great obsta-cle for an integrated supervision of systemically impor-tant financial institutions in Europe is that theEurosystem would need to have access to potentiallyhigh quantities of public funds from the Member States.This would be possible through a pre-agreed and bindingsystem of contributions that would allow the Eurosystemto have a non-inflationary rescue capacity that is credibleex ante.

To specify the system of such contributions – especial-ly in the case of systemic crises – the solutions proposedfor the guarantee mechanism of money markets can beapplied.

The final objective is highly ambitious and poses agreat technical and political challenge. For this reason, itshould be specified in an action plan that attracts thenecessary political agreement and where terms andintermediate stages are specified.


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5AN INTERNATIONAL FINANCIAL ARCHITECTURE WITH GREATER

RESPONSIVENESS

Avoiding the commercial wars or protectionist races thatcould harm the potential growth of world economyrequires certain international economic, monetary, andfinancial coordination. This coordination is necessarydue to the accumulation of macroeconomic imbalancesduring the long period of prosperity prior to the crisis anddue to the non existence of a perfectly flexible exchangerate regime in all countries.

This coordination in a global world requires solid, inde-pendent and professional institutions that supervise thesystem, give early warning signals when any memberfails to fulfil their basic obligations, and establish eco-nomic policy recommendations.

At the proposal of the United States, the G-20 hasplayed a special role in the debate on the reform of the

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international financial architecture. The incorporation oflarge emerging countries to this debate is due to therecognition of their relevance in defining solutions thatshould be implemented in a coordinated form, and espe-cially, due to the quantity of international reserves theyaccumulate.

From the point of view of international financial archi-tecture, it is not necessary to create new internationalfinancial institutions, but rather make better use of thecapacities and know-how of those already existing. Thisseems to have been understood by the leaders of the G-20. The changes must be addressed at:

•Improving their way of operating, their governance,legitimacy, effectiveness and representation.

•Limiting and clearly defining their functions.

•Strengthening the coordination between existing bod-ies.

In an unplanned fashion, a sort of functional special-isation of institutions is emerging in the financial world,such as the one addressed by the G-20 members attheir meeting in April 2009 in London. The FinancialStability Board would assume the role of forging a par-ticular international consensus with a solid technicalbasis regarding reform projects on regulation and super-vision. Meanwhile, the IMF would be responsible for

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overseeing the implementation of and the compliancewith these agreements by the method of best practicesand emulation.

Although institutional and organisational problems ofcurrent international financial institutions are important,these are only secondary when compared to the prob-lems underlying the crisis. These are:

•A poor management of the monetary policy.

•And the existence of an inadequate or poorly appliedfinancial regulation, due to poor supervision, in highlyinterconnected financial markets.

To overcome the crisis and reduce the impact andprobability of future crises, it would be advisable toreach broad international agreements on these under-lying matters. Notwithstanding, it would be sufficient ifthe main countries and organisations drew the lessonsfrom the crisis and set up the necessary reform meas-ures.

The need for coordination and international consen-sus was emphasised at both meetings of G-20 leadersheld to date. However, there have been no relevant dec-larations on in-depth aspects, perhaps so as not to high-light the disagreements.

AN INTERNATIONAL FINANCIAL ARCHITECTURE WITH GREATER RESPONSIVENESS

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5.1. Reinforcing the capacities of the InternationalMonetary Fund

During the years prior to the outbreak of the financial cri-sis, the IMF was losing political and financial sway in theface of exuberant private markets that appeared to pourscorn on its disciplinary role. It found itself involved inminor tasks, for which it had no special preparation orany defined international mandate.

The crisis returned a large part of the lost leadershipto the IMF, and not only in emerging countries. The crisishas even served to overcome debates that had beenparalysed for decades in the Board13.

The IMF has recovered its active role but adaptingitself to the new situation requires changes in a series ofmatters such as:

•Increasing and redistributing the quotas and votingpowers among countries.

•Revising its financing sources.

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13 This is the case, for example, of the development of new instruments for tacklingthe crises such as the “Flexible Credit Line” for the countries that need temporaryliquidity but that have sound policies. These are offered a type of immediate opencredit line, without limitations of amount and to be returned in 3 to 5 years. Thiscredit facility has been discussed since 1999. The IMF directors were opposed toautomatic loans but the crisis has altered their perspective. After having beenfinally approved, it has been used by Mexico, Colombia and Poland.


•Specifying and increasing its responsibilities in taskssuch as the supervision of macroeconomic stability, inorder to include financial supervision, crisis preventionand the creation of an early warning system.

•Extending loans to countries with difficulties in the bal-ance of payments.

•Improving technical assistance to countries thatrequire it.

•Reinforcing some of its traditional capacities, such asits role of public assessment of the policies of system-ically significant countries.

•Adapting the structure of the institution to its newtasks.

The evolution of the crisis and the subsequentdeleveraging process has highlighted the need to payincreasing attention to the development of internation-al liquidity.

The current liquidity needs are higher than at any othertime in the past. They are also higher than those that theIMF can provide as lender of last resort, even after hav-ing tripled its credit capacity as a consequence of theagreements reached at the meeting of the leaders of theG-20 in London.


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In any case, the increased financial capacity of the IMFis not the only alternative available to provide liquidity tothe international markets. Not even the most demanded.The main central banks of the world – the FederalReserve, the ECB, the Bank of Japan and the Bank ofEngland, among others – have set up a currency swapsystem that endeavours to guarantee liquidity and con-vertibility in the interbank markets14.

This mechanism of specialised institutional coordina-tion, which does not require new transfers of sovereign-ty or sweeping institutional reforms, has worked reason-ably well. Evidence of this is the absence during this cri-sis of severe stress in foreign exchange markets – tra-ditionally the most volatile financial market – and thesigns of a certain return to normality in interbank mar-kets.

For the IMF to be able to use resources for emergencytransactions in countries without the possibility ofobtaining funds from capital markets, we propose a lim-ited reform of the Articles of Agreement15 of the IMF.

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14 The Federal Reserve has advanced more than 600 billion dollars in short-term cre-dit to fourteen central banks. The ECB and the National Bank of Switzerland, fortheir part, have advanced lower quantities in Europe and are prepared to continuedoing so.

15 The Articles of Agreement of the IMF are available in Spanish on: http://www.imf.org/external/pubs/ft/aa/spa/aa.pdf; and in English on https://www.imf.org/external/pubs/ft/aa/index.htm.


This reform would allow it to swap Special DrawingRights16 for the currencies of those IMF member coun-tries considered to be key for the good working order offinancial markets.

We also propose that the IMF be allowed to obtainresources in the private market as a supplementary contri-bution to quota resources17, as already done by the WorldBank. Furthermore, this reform would also allow a marketassessment be done regarding the probability of successof the different loan programmes developed by the IMF.This would add certain market discipline to its operations.

The distribution of quotas between countries, andtherefore of voting powers, in the IMF basically respondsto historic reasons and not to the current economic orpolitical weight of those countries. This is a source oflegitimacy problems for the institution. Aware of this lim-itation, in March 2008 the Executive Board of the IMFapproved a new formula to calculate quotas18. In addition


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16 The Special Drawing Right (SDR) is the account unit of the IMF. It is a basket of curren-cies comprised of 63 US dollar cents, 41 euro cents and nine pence.

17 The IMF has approved issuing bonds that may be bought by the central banks of themember countries, which unlike what happens with the contributions to the GeneralAgreement to Borrow, it allows them to continue entering the contributions as reser-ves. China and Russia have already announced that they will buy them. Our proposalgoes beyond this as it would mean the issuing of securities by the IMF which could bebought by private investors, normally institutional, and which would be listed in thestock markets.

18 The new formula for calculating quotas is a linear combination of the GDP at exchangerates (with a weight of 30%), the GDP at purchasing power parity (PPP) rates (with a weightof 20%), the trade openness (30%), the variability of current receipts and net capital flows(15%), and international reserves (5%).



to this, tripling the basic votes of each country (which donot depend on the quota) was approved.

With these reforms, the United States has the right toveto certain decisions that require 85% of the votes to beapproved. The changes proposed to date reduce the votingpower of European countries from 32.5% to 30.9%. Butthey maintain their broad representation on the ExecutiveBoard, between 7 and 10 seats out of the 24.

The agreement also establishes that the assignmentquota procedure will be more dynamic in the future byrecalculating quotas every 5 years. Recently, the commit-ment to finish an integral renewal proposal by January2011 has been added to the agreement.

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Figure 1: Percentage of votes per country in theInternational Monetary Fund

0USA

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6,0 5,94,9 4,9

3,7 3,2 3,2 2,9 2,7 2,3 2,1 1,9 1,6 1,5 1,4 1,4 1,4 1,3 1,2


With respect to the negotiations to renew the quotadistribution planned for 2011, Spain should adopt a clearand sustained policy in defence of its interests. Spain,unlike the rest of large European economies, has signifi-cantly less voting power in the IMF than what it shouldhave considering its current weight in the internationaleconomy.

Large emerging countries – such as China, India,Brazil, Turkey and Mexico – will try to force a redistribu-tion of quotas so that their voting power reflects to agreater extent their current economic weight.

Spain should support this redistribution of quotas,which would also improve its own representation in theIMF, currently undervalued. This position would allow togain positions as an ally of the large emerging coun-tries.

The loss of weight of the rest of the large Europeancountries could be compensated by a single Europeanvoice system. This requires Spain to have leadershipwithin Europe so that the Spanish position is suitablyrepresented in the common position. A single voice sys-tem would give Europe a similar weight to that currentlyheld by the United States.

What is not a future solution for Spain is to accept thestatus quo with resignation in exchange of being invitednow and then to the group of deciding countries.


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In recent years, the IMF has lost the capacity to makesignatory countries fulfil the Articles of Agreement, in par-ticular their obligations related to exchange rate policies.The cause is that breaching countries are no longer smalland peripheral but nuclear, such as the United States,China or Brazil. It is not a minor matter because it affectsone of the more publicised agreements of the G-20 meet-ings: avoiding protectionism.

Fulfilling the obligations of article IV is essential toensure that a chain of competitive devaluations is nottriggered in response to the crisis. The reform of 2007(which introduced in the annual report of member coun-tries concepts such as “external stability” and “funda-mental misalignment” of exchange rates) has not beenespecially useful. Essential underlying matters such asthe multilateral supervision of exchange rates were leftout then, and return with a vengeance now. It is not arhetorical discussion. The misalignment between theexchange rates of the Dollar, the Yuan and the Euro hasbeen behind the excess of liquidity worldwide and theresulting financial bubble.

Supervising different exchange rate regimes and thesuitability of their exchange rates to the economic funda-mentals can only be carried out satisfactorily by theInternational Monetary Fund if it has the suitable instru-ments. Therefore, we propose to guarantee:

•Equal treatment for all countries.

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•The IMF’s faculty to make its voice heard – albeit notimpose sanctions – with the necessary energy andindependence so private agents could act accordingly.

•The IMF’s access to relevant information of the differ-ent countries.

•The capacity of the IMF to make their recommenda-tions public without political conditionings.

We propose the IMF’s Articles of Agreement be revisedto clarify its capacity regarding the liberalisation of thecapital accounts of the member countries. The aim wouldbe to establish that, once the free movement of capitalis implemented by a country, it may not go back on thisprocess even in a crisis context (in a similar way to theG-20 agreement regarding the free movement of goods).

It is also necessary to reinforce the IMF’s capacities ofsurveillance of the soundness of national financial sys-tems. Since the end of the 90s, a highly ambitious, omni-comprehensive, monitoring and assessment programmeof national financial systems has come into effect in lightof the best international practices and standards. It isknown by its English acronym FSAP (Financial SectorAssessment Program). It analyses both the situation ofprivate financial institutions – liquidity, profitability andsolvency – and the system as a whole – soundness, levelof competition – and the formal and material quality ofthe regulation and supervision.


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The problem is that it concerns a two-fold voluntaryprogramme. Voluntary regarding the countries that par-ticipate in it (and curiously enough, none of the mainfinancial countries initially affected by the crisis had par-ticipated), and voluntary also with regard to the publica-tion of its results, which remains at the discretion ofeach country.

With these self-imposed limitations, the IMF is seri-ously restricted as a supplier of relevant strategic infor-mation for decision-making by investors and savers.

Therefore, to increase the soundness and transparen-cy of the financial systems, we propose that:

•The IMF can define its own working programme accord-ing to the systemic importance of the different membercountries and their respective financial systems.

•The IMF member countries cannot refuse to beassessed.

•The publication of the results of these assessmentsshould be compulsory.

This proposal would also involve the need to give theIMF the human and material resources to fulfil thiscapacity with professional solvency, punctuality and pre-cision. This entails dealing with the matter of coveringthe operating costs of the institution.

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The IMF, because it is unable to generate its ownresources during times of international economic pros-perity, is an organisation that sees its independenceconditioned by the budgetary decisions of the memberstates.

With the increase, as a result of the crisis, of thedemand for IMF funds, of requests for aid, and of theincreasing number of programmes, the structural problemof financing the IMF is transitorily resolved, as incomesgenerated from the loans granted to the countries is alsoincreasing. In fact, now the urgent problem is the lack ofqualified personnel to deal with so many programmes.

But the structural weakness remains, unless weshould consider this an organisation only necessary fortimes of crisis, which would be a mistake. It is preciselyat times of prosperity when surveillance must be max-imised to detect any increase of systemic risk; and anindependent analysis must be guaranteed. Tasks wherethe IMF cannot be easily replaced.

5.2. Setting regulatory and supervisory standardswith greater effectiveness

The importance of the Bank for International Settlements(BIS) in the international financial architecture comes,rather than from its role as bank of central banks, from


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the relevance of the standards set by its committees19

which are subsequently applied voluntarily by the differ-ent countries.

The best example is the Basel Committee on BankingSupervision and the regulation on minimum capitalrequirements known as Basel I, and its reform, Basel II.These standards have no binding powers, but havebecome, in practice, the international standards thatmust be fulfilled by internationally active banks. TheEuropean Union, the United States and the large majori-ty of countries including China have approved internallegislation to enforce these recommendations.

Regardless of their technical merits, the BaselAccords are a good example of true effective and volun-tary international cooperation with the aim of creatingtechnical consensus that, in the end, are included innational legislations.

The Basel Committee on Banking Supervision and theIMF are two antithetic organisations. The former has noregulatory capacity and its responsibilities do not involveany transfer of national sovereignty. Nevertheless, it hascarved out a niche within the international arena due toits effectiveness and specialisation. The IMF, on the

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19 The BIS backs the Basel Committee on Banking Supervision, the Committee on theGlobal Financial System and the Committee on Payment and Settlement Systems.The three committees take part in the Financial Stability Board.


other hand, has always thought that the responsibilitiesof the BIS and its Committees are within its capacities.However, the technical complexity and long-term impactof some of the matters that have arisen from the presentcrisis recommend keeping them at a technical level andaway from daily political debates.

With all its limitations, the Basel Committee onBanking Supervision is, without doubt, the internationalreference with regard to banking regulation matters. Thefact that the discussions take place among specialists ofthe national monetary and supervisory authorities hasbeen of help. It is unknown to the general population andhas remained peripheral to criticisms of globalisation.The relevance of its standards arises from their technicalusefulness and quality.

To guarantee the relevance and a high technical levelfor its standards, the accession of new countries tradi-tionally assumed that they had excellent technical andanalytical capacities in their national supervisory bodies.Therefore, the increase in the number of members in thediscussions did not undermine its operational capacity.

Growing political attention on the tasks of expert tech-nical committees and the decision driven by the G-20 forthe Basel Committee on Banking Supervision to substan-tially increase its composition, may cause it to lose itsspecialised nature and could have a detrimental effecton its capacity for expert technical response.


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Even before the decision of the G-20, that capacity forexpert technical response was already criticised for thedelay in designing and approving the Basel II Accord. Adelay that in practice left, for too long, the door open tomany of the regulatory arbitrage that are at the origin ofsome of the spreading mechanisms of the crisis, such asthe abuse of securitization.

Reforms in the internal organisation of the BaselCommittee on Banking Supervision are necessary torestore its effectiveness and capacity of response. Inthis sense, and in line with the harmonisation process ofthe internal financial regulation of the EU, we proposethat the European Union speak with a single voice in theCommittee. Furthermore, we suggest an Executive Boardbe formed within that Committee, comprised of a limitednumber of representatives responsible for the drafting ofproposals and that meets, at least, once a month.

The new Financial Stability Board (FSB), formerly theFinancial Stability Forum has extended its membership toinclude all member countries of the G-20, plus Spain. Itis the body that will continue to be responsible for coor-dinating the drafting of regulations, standards and bestpractices for the financial sector, like those that for thebanking sector are drafted by the Basel Committee onBanking Supervision.

For the suitable implementation of these regulations,standards and best practices in all member countries

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of the international community, and for their effectivecompliance in a coordinated and rapid manner, closecollaboration with the IMF is appropriate as it is thebody responsible for supervising their effective imple-mentation.

In the area of macroprudential supervision, the FSB isundertaking the design of “early warning systems” andthe assessment of financial vulnerabilities. In parallel,the IMF has started to develop methods to assessmacrofinancial risks and systemic vulnerabilities.

The experience of the former Financial Stability Forumin all these matters has no substitute and it seemsappropriate that it continues to be responsible for thesenow as the Financial Stability Board. They are technical,highly complex matters that need time and professionalattention, removed from the political and media pressurethat surrounds the work of the IMF. Regulation andmacroprudential supervision cannot be divided intounconnected compartments, we therefore propose thefull responsibility of the FSB on these matters.

It is in accordance with this assignment of responsibil-ities plan that we have proposed, in previous sections,that the FSB be responsible for the following tasks:

•Coordinating the development of a new macropruden-tial pillar for the regulations governing minimum capitalrequirements so that financial institutions may inter-


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nalise their contribution to global systemic risk.

•Drafting the technical report in charge of triggering theguarantee mechanism of money markets in case ofsystemic crisis.

•Preparing recommendations for an internationallycoordinated plan to recapitalise the financial system.

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EPILOGUE FOR SPANIARDS

The Spanish financial system faced the onset of thefinancial crisis from a relatively solid position. Its unques-tionable strengths were:

•Spanish banks have mainly chosen a universal bank-ing model. In it the commercial network of branchesand the task of collecting deposits from the publicwere their main sources of financing. The Spanishbanking system was basically focused on retail bank-ing and not on investment banking.

•The Spanish financial system has followed a pioneer-ing financial regulation, which involved the implemen-tation in the year 2000 of what are commonly knownas “anticyclical provisions”, and an accounting andprudential treatment of off-balance sheet risks thatencouraged good practices. These approaches actas a model in current international discussions toreform the regulations of the international financialsystem.

•The on-site supervision model, that is, the continuedphysical presence of inspectors of the Bank of Spainin supervised entities and requirements for periodic

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information, have allowed real-time knowledge of liq-uidity and solvency problems as they were takingplace.

•The experience in management of banking crises, bothby the supervisor and by bank managers.

•A strong domestic market that offered abundant busi-ness possibilities without having to resort to the acqui-sition of sophisticated and poorly transparent financialproducts, which constitute an important part of the so-called “toxic assets”.

As predicted, however, an exorbitant credit growth inrecent years and a high concentration of risks in thehousing market have caused significant damage to theSpanish financial system.

The history of banking crises in the world presents twoundeniable empirical regularities:

•An excessive and prolonged credit growth inexorablyleads to a banking crisis.

•Every bursting of housing market bubbles inexorablyleads to banking crises.

The Spanish economy showed significant weaknessesthat made it especially vulnerable to a financial crisis andto suffering intense effects because of it.

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•Excessive growth of individuals’ and corporate indebt-edness to unsustainable levels.

•Recurrent and growing external deficit. This is notonly a sign of loss of competitivity but also a mani-festation of insufficient domestic saving, which caus-es the Spanish economy to rely on foreign sources offinance.

A particularity of the Spanish financial system is thatSavings Banks approximately represent half of the bank-ing system. The reports from the OECD and the IMF warnof the differential risk posed by the specific legal natureof Savings Banks and the deficiencies of their corporategovernance bodies. This differential risk responds to thefollowing facts:

•Their management has displayed an obvious politi-calization that has translated into an investmentpolicy that was not guided by economic profitabilitycriteria.

•Their expansion process outside their regions of ori-gin was intensified during the final years of the realestate cycle, which has led them to working withcustomers with a higher risk profile.

•Furthermore, savings banks pose technical andpolitical difficulties to their efficient recapitalisationand restructuring.


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Financial policies in Spain have been guilty of compla-cency since the onset of the crisis. The time lost in deci-sion-making to deal with this crisis is difficult to justifygiven the weaknesses that make the Spanish economyespecially vulnerable to a financial crisis and to sufferingintense effects because of it.

The Spanish financial system needs to immediatelydeal with a restructuring process and a reinforcement ofregulatory mechanisms that ensure its soundness andefficiency. In Spain we have to deal with this processurgently and appropriately to recover precious time lost ina strategy of political denial that threatens to abort eco-nomic recovery.

Other countries are many months ahead of us in therecapitalisation of their financial systems. We must beaware that the national and international funds availablefor recapitalisation are scarce, the capacity of public debtis limited and the extraordinary conditions of very lowinterest rates to aid the process of Spanish financialrestructuring will not last forever.

Without a healthy financial system capable of recover-ing confidence, a sustained and strong economic recov-ery will not be possible in Spain. The heralded recapital-isation process of the Spanish financial system shouldcomply with the principles established in section 4.2. ofthis report. The application of these principles to the spe-cific case of Spain requires, among other things, that:

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•The recapitalisation is made with the minimum possi-ble cost to the taxpayer.

•The Government aid is focused and provides informa-tion and incentives to the market. Across the boardpublic sector shareholdings or indiscriminate publicincentives to mergers between financial institutionsmust be avoided in the recapitalisation process.

•Government participation in the recapitalisation of thefinancial institutions must avoid the risk of manage-ment politicalization. This can be guaranteed throughthe use of preference shares and an explicit agree-ment for their subsequent sale under market condi-tions to private investors.

•The implementation of efficient mechanisms of public-private partnerships for the recapitalisation processesof the Savings Banks requires giving to non-votingshares (“cuotas participativas”) unrestricted votingpowers. It also requires reforming the configuration oftheir Governing Bodies to enable the essential partici-pation and discipline of private capital that would guar-antee the viability of the business model.

•The eventual privatisation of the Savings Banks towhich this mechanism could lead, would help toreduce the vulnerabilities of the Spanish financial sys-tem and mitigate its differential risk.


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•Liquidation of those institutions that fail to demon-strate the viability of their business model in the mar-ket must be explicitly considered.

•The eventual liquidation of non-viable entities must becarried out via auction under market conditions – as inprevious experiences – in such a way that it does notharm the competitive positions of those institutionsthat have had a prudent and adequate management.

•Government intervention in those financial institutionswith solvency problems that are unable to demon-strate their future viability in the market must lead tothe dismissal of their managers.

Spain must demonstrate the value of its regulatingand supervising experience as well as the internationalimportance of its financial system to gain greater weightwithin the new international financial architecture.

Spain must take advantage of its presence on the newFinancial Stability Board to actively participate and influ-ence the configuration of the new financial regulatoryframework.

•Spain must support a strong revision of the quotas inthe International Monetary Fund to hold a representa-tion that reflects its current international economicweight. This revision, in turn, would involve theincreased weight of emerging countries.

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•Spain should take advantage of the opportunity ofrevising quotas to promote a single voice of theEuropean Union in the International Monetary Fund.Spain should have a relevant role in the configurationof that single voice.




MAIN CONCLUSIONS AND PROPOSALS

The crisis is the outcome of excesses of all participantsin the system and the result of years of excess liquidityduring times of prosperity as a consequence of anunnecessarily lax monetary policy. The crisis is also theresult of a great collective error: underestimating sys-temic risk, which affects the economy and the financialsystem as a whole. With the outbreak of the crisis and inview of its magnitude and evolution, international author-ities embarked upon a frequently improvised politicalturmoil with no further criterion than that of preventingcollapse. Nonetheless, there is room for a differentapproach.

In short, the 30 main conclusions and proposals ofthis report are summarised below:

1.Renovated instruments of financial regulation arerequired for their application in cases of systemic

crises. Financial bailout plans should be devised as con-tingency plans expressly envisioned in the law for peri-ods of systemic crisis, with the aim of protecting thelegitimate interests of the citizens.

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2.Monetary policies are currently being implement-ed in a general context of loss of effectiveness

caused by a variety of complex factors. The solution tothis loss of effectiveness is not returning to homoge-nous and highly intervened national banking markets.The problem with the design of monetary policies is sim-ilar to that of designing fiscal policies, and lies in how toguarantee that they are suitable in times of prosperity,because it is then that the imbalances and the type ofagent’s behaviour that subsequently lead to crises arefuelled.

3.Given that, ultimately, bubbles are only createdwhen monetary and credit-growth conditions are

sufficiently lax, a more convenient alternative would be:

•That the ECB restores the importance of the moneysupply growth target and that the rest of the worldcentral banks advance in the definition of a monetarypillar in their monetary policy strategies.

•To define and use simple and transparent early warn-ing signals, such as credit growth, which could warnof risks to medium-term financial stability.

•Central banks should be accountable for their mone-tary policy measures by means of explicit “correct orexplain” clauses whenever early warning indicatorsexceed some predefined threshold reference values.

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4.Monetary policy has a two-fold objective: pricestability and financial stability. Objectives that are

not always easily compatible, even on a national scale.There was a time when it was argued that this duality ofobjectives suggested separating both functions into twoindependent institutions, the central bank and the finan-cial supervisor. However, evidence from this crisis is con-clusive: today it does not seem appropriate to split bothfunctions into two different regulatory bodies. Monetaryauthorities that are also supervising bodies haveworked better. As a result, we propose that theEurosystem – with the ECB at its core – be responsiblefor the regulation and supervision of at least thosefinancial institutions that are systemically importantwithin the Eurozone.

5.The quality of financial regulation must improve inorder to embrace the lessons from the financial cri-

sis but it is necessary to avoid the risk that an interven-tionist re-regulation process ends up “shooting the mes-senger”, that is, invalidating the effectiveness of the earlywarning indicators on the soundness of the financial sys-tem. Existing regulation on minimum capital requirementsshould have been designed and applied with greater celer-ity and diligence. For instance, the Basel II treatment foroff-balance sheet risks or accounting standards referringto the consolidation of securitization vehicles. Had thisbeen the case, some of the regulatory arbitrage opportuni-ties and many of the excesses that led to the crisis wouldhave been avoided.

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6.Any reform concerning financial regulations shouldprovide incentives so that the necessary self-cor-

recting process in the market takes place, leading finan-cial institutions to:

•Improve the quality of their risk management models.

•Carry out their activities under an effective supervi-sion, regardless of their legal nature and jurisdiction ofincorporation.

•Adopt strategies and business models promotinggreater financial stability by internalising the contribu-tion of their activities to systemic risk.

7.One of the major challenges currently faced byfinancial regulation is translating the analyses on

the accumulation of systemic risk into instruments ofprudential regulation. Therefore, we propose that allfinancial institutions carrying out activities that con-tribute significantly to the increase of systemic riskshould be made subject to a new macroprudential pil-lar within solvency rules. This additional pillar would besuperimposed on the three current pillars of interna-tional regulation standards on minimum capitalrequirements. Capital requirements for this fourthmacroprudential pillar would be proportional to the mar-ginal contribution of each activity or financial product toglobal systemic risk.

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8.One of the lessons from this crisis is the greaterinstability of wholesale financing in the money

markets compared with traditional deposits. Thus, one ofthe challenges posed by the crisis is devising a mecha-nism that stabilises wholesale money markets in orderto make them immune to panic. This way, they would beable to continue operating in the event of systemic crisisand they would not become mechanisms of massive con-tagion.

•The guarantee mechanism would have a contingentnature. This means that it would only be triggered inthe event systemic crisis and in no case because ofliquidity problems in individual institutions.

•By triggering the mechanism a provisional public guar-antee of all short-term wholesale banking liabilitiesand access to emergency liquidity would automatical-ly be established.

•This guarantee would be available exclusively forthose financial institutions subject to additional capi-tal requirements resulting from the application of thefourth macroprudential pillar.

•Although a coordinated international implementation ofa mechanism of this type would be desirable, we con-sider that this guarantee mechanism would be of partic-ular importance in the European context. The reason isthat it would help to move resolutely forward in the cre-

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ation of a single financial market that could boost theadvantages arising from the single currency.

9.The problem with senior management compensa-tion schemes in some financial institutions is not

their magnitude. The problem lay in an incentive systemthat focused excessively on the short-term. The compen-sation schemes of banking managers should be revised:

•To achieve greater shareholder participation in estab-lishing salary conditions of managers.

•To promote absolute transparency in decisions involv-ing the complete retribution, pertaining or not tosalary, of banking managers.

•To promote a voluntary standard of good corporategovernance that increases the effective limit of pecu-niary liability. For this purpose, top management hir-ing contracts should establish a time lag of severalyears for the payment of variable remunerations thatsurpass a certain percentage of the fixed pay.

10.Public opinion has mostly blamed rating agen-cies for the crisis. The reality is that their rating

methods were not designed to detect increases in sys-temic risk. A challenge for the rating agencies’ methodsinvolves improving the ratings system to provide two-dimensional ratings. As well as informing on the proba-bility of default of each asset, they should inform on the

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correlation between individual defaults and provide anaggregated measure of the global default risk.Regulatory agencies could promote these improvements.

11.Market transparency and the informative valueof accounting figures should be reinforced. In

order to do this we propose keeping uniform valuationstandards throughout the cycle and leaving regulationson minimum capital requirements undertake the task ofaccommodating cyclical effects. It is contradicting todefend a provisional abandonment of fair value account-ing for some assets or the cyclical adaptation of their val-uation standards, while at the same time demanding fulltransparency.

12.The anticyclical provision was successfullyimplemented as a pioneering measure in Spain

in 2000. Its cushioning impact has demonstrated at aninternational level the need for regulatory reforms thattighten minimum capital requirements during expan-sions and relax them during contractions.

13.A great challenge for financial supervisioninvolves generating instruments to facilitate an

early and effective management of financial crises. Thefollowing is required for this:

•A suitable inspection system and of information deliv-ery on a regular basis.

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•An on-site supervision system, with regular and/orcontinued physical presence of supervisors at thefacilities of those supervised. This should become astandard of international best practice.

•A constant analysis of the foreseeable evolution ofthe solvency of the supervised institutions vis-à-visdifferent potential macroeconomic and financial mar-ket scenarios. We propose that the so-called stresstest exercises start being a regular feature of a moremodern supervision.

14.However, interventions will continue to be nec-essary. Therefore, we must facilitate that they

are adopted with sufficient speed and legal certainty forall parties, including the supervisor. The actual definitionof failure – traditionally a negative net accounting value –should be further specified and extended to include objec-tive circumstances that justify pre-emptive action by thesupervisor. For instance, those circumstances that posean obvious threat, albeit perhaps not immediate, to thesolvency of the institution or the stability of the financialsystem as a whole. Increasing the margin of supervisorydiscretion, would require an even greater increase of theirtransparency and accountability.

15.Recapitalisation schemes must be an explicitpart of contingency plans. These would be tem-

porarily activated when the need arises, to guarantee thestability of the financial system.

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•Plans that must specify the possibilities and modes ofintervention, management responsibilities, and thecost that shareholders and bond holders will have toassume.

•Recapitalisation plans must follow the basic principleof rewarding prudent behaviour. Those institutionsthat have neither incurred in excesses nor requiredsupport from Government funds should be rewarded.There are serious doubts that this has been the casein this current crisis.

•When insolvent institutions are rescued, an excellentopportunity arises to reward the prudent behaviourvia the auction of deposits, of financial assets or ofnetworks of branches of the failed institutions.

•It would have been desirable for the G20 meetings tohave fully considered the design of a coordinated res-cue plan of financial institutions.

•It would also have been desirable, at least within thescope of the European Union – and doubtless in theMonetary Union –, for this matter to have been cov-ered beyond vague declarations of principles.

16.It is essential to address the final recapitalisa-tion of the financial system in every country

with transparency and determination. Therefore, we pro-pose the drafting, by the Financial Stability Board, of rec-

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ommendations for the immediate implementation of acoordinated plan to restore the solvency to the interna-tional financial system. This plan should meet the follow-ing principles:

•Total transparency in the use of public funds.

•Fully transparent valuations via competitive procedures.

•Efficiency in the use of public funds.

•Maximum taxpayer protection.

•Minimum political interference in the management ofthe financial institutions.

•Need for a clear exit strategy.

17.The design of public-private partnershipschemes for bailout programmes is proposed in

order to attract private capital to the recapitalisation offinancial institutions with problems via the leverage ofthese contributions by the Government. The schemewould comprise the issue of preference shares that com-plement essential private investment, which is what guar-antees the viability of the institutions without a permanentGovernment subsidy. If no private investor is willing toinvest its money in a problematic institution, the Stateshould proceed with its transparent and ordered liquida-tion, applying market mechanisms and guaranteeing, in allcases, the legitimate interests of its depositors.

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18.To minimise the cost for taxpayers and max-imise the efficiency in the use of public funds,

these should not be allocated to:

•Keeping operatinal financial institutions with solvencyproblems and incapable of demonstrating their futureviability in the market.

•Improving the situation of viable financial institutionsthat lack current solvency problems.

19.The European Union, and certainly theEurozone, must unhesitatingly advance towards

the creation of a true single financial market withoutregulatory barriers between Member States. Therefore,we propose the drafting of an ambitious action plan. Itsultimate aim would be to set upon the Eurosystem (com-prehending the national central banks of the euro coun-tries, with the ECB at its core) the responsibility of regu-lating and supervising, at least, those financial institu-tions with systemic importance in the Eurozone. Thisresponsibility would be developed both with regard to theindividual financial soundness (microprudentialapproach), and to the soundness of the financial systemas a whole (macroprudential approach).

20.The harmonisation of banking regulationsapplicable to all systemically important banks

in the EU is a precondition for the Eurosystem toundertake inspection capacities. The great obstacle

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for an integrated supervision of systemically importantfinancial institutions in Europe is that the Eurosystemwould need to have access to potentially high quanti-ties of public funds from the Member States. Thiswould only be possible through a pre-agreed and bind-ing system of contributions that would allow theEurosystem to have a non-inflationary rescue capaci-ty that would be credible ex ante.

21.From the point of view of international financialarchitecture, it is not necessary to create new

international financial institutions, but rather make bet-ter use of the capacities and know-how of those alreadyexisting. This seems to have been understood by theleaders of the G-20.

22.The crisis has returned a large part of the lostleadership to the IMF. However, adapting itself

to the new situation requires changes in a series of mat-ters such as:

•Increasing and redistributing the quotas and votingpowers among countries. Here, Spain should adopt afirm policy defending its interests and in alliance withthe clearly underrepresented emerging countries.

•Revising its financial sources, enabling it to obtainresources directly from the private market.

•Specifying and increasing its responsibilities of super-

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vision with the explicit aim of including financial super-vision, crisis prevention and devising an early warn-ing system.

•Reinforcing some of its traditional capacities, such asits role of public assessment of the policies of system-ically significant countries. Therefore, Financial SectorAssessment Program (FSAP) reports should bemandatory and public.

•And adapting the structure of the institution to its newtasks, which demands a revision of its Articles ofAgreement.

23.With all its limitations, the Basel Committee onBanking Supervision is, without doubt, the

international reference with regard to banking regulationmatters. A resposibility that has to be maintained. Forthis reason, reforms in its internal organisation are nec-essary. In this sense, and in line with the harmonisationprocess of the internal financial regulation of the EU, wepropose that the European Union speak with a singlevoice in the Committee. Furthermore, we suggest anExecutive Board be formed within that Committee, com-prised of a limited number of representatives responsiblefor the drafting of proposals.

24.The renamed Financial Stability Board is thebody that will continue to be responsible for

coordinating the drafting of regulations, standards and

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best practices for the financial sector. Therefore, we pro-pose the following tasks:

•Coordinating the development of a new macropruden-tial pillar for the regulations governing minimum capi-tal requirements.

•Drafting the technical report in charge of triggeringthe guarantee mechanism of money markets in caseof systemic crisis.

•Preparing recommendations for an internationallycoordinated plan to recapitalise the financial system.

25.The Spanish financial system faced the onsetof the financial crisis from a relatively sound

position. As predicted, however, an exorbitant creditgrowth in recent years and a high concentration of risksin the housing market have caused significant damage tothe Spanish financial system.

26.Financial policies in Spain have been guilty ofcomplacency since the onset of the crisis. The

time lost in decision-making to deal with this crisis is dif-ficult to justify given the weaknesses that make theSpanish economy especially vulnerable to a financial cri-sis and to suffering intense effects because of it.

27.The specific legal nature and the deficienciesof corporate governance bodies of Savings

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Banks involve a differential risk for the Spanish financialsystem. This is explained by the fact that their manage-ment has displayed an obvious politicalization and posetechnical and political restrictions to their efficientrecapitalisation and restructuring.

28.It is necessary to immediately deal with arestructuring and recapitalisation process of

the Spanish financial system to recover precious timelost in a strategy of political denial that threatens toabort economic recovery.

29.Without a healthy financial system capable ofrecovering confidence, a sustained and strong

economic recovery will not be possible in Spain. Theheralded recapitalisation process of the Spanish finan-cial institutions should comply with the principles estab-lished in section 4.2. of this report. The application ofthese principles to the specific case of Spain requires,among other things, that:

•The recapitalisation is made with the minimum possi-ble cost to the taxpayer.

•Aid should must be focused and provide informationand incentives to the market. Generalised recapital-isation processes with indiscriminate public incen-tives and across the board public shareholding mustbe avoided.

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•Government participation in the recapitalisation of thefinancial institutions must avoid the risk of manage-ment politicalization. This can be guaranteed by anexplicit exit agreement under market conditions.

•The implementation of efficient mechanisms of public-private partnerships for the recapitalisation process-es of the Savings Banks requires giving to the non-vot-ing shares (“cuotas participativas”) unrestricted vot-ing powers and reforming the configuration of theirGoverning Bodies to enable the essential participationand discipline of private capital that would guaranteethe viability of the business model.

•The eventual privatisation of the Savings Banks towhich this mechanism could lead, would help toreduce the vulnerabilities of the Spanish financialsystem and mitigate its differential risk.

•Liquidation of those institutions that fail to demon-strate the viability of their business model in the mar-ket must be explicitly considered. The eventual liqui-dation of non-viable institutions must be carried outvia auction mechanisms under market conditions.

•Government interventions in those financial institu-tions with solvency problems that are unable todemonstrate their future viability in the market mustlead to the dismissal of their managers.

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30.Spain must demonstrate the value of its regula-tory and supervisory experience as well as the

international importance of its financial system to gaingreater weight within the new international financialarchitecture.

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As part of the creation of this document, many seminars,meetings, and conferences have taken place.Collaborations and consultations were requested whichwere extremely valuable in the creation of the report.

Nevertheless, only FAES is responsible for the finalpublished text.

The Foundation would like to thank the following peo-ple and institutions for their opinions, reflections andcontributions.

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ACKNOWLEDGEMENTS, CONTRIBUTIONSRECEIVED AND INDIVIDUALS AND

INSTITUTIONS CONSULTED

Raquel Barras Tejudo Economics Department Advisor Partido Popular’s ParliamentaryGroup, Spanish Parliament

Francisco Cabrillo RodríguezProfessor of Applied EconomicsUniversidad Autónoma de Madrid.President, Economic and SocialCouncil of the AutonomousCommunity of Madrid

Juan E. Castañeda FernándezProfessor of Applied EconomicsUNED

Miguel Crespo RodríguezState Attorney (on sabbatical) Equipo Económico

José Carlos Díez GangasProfessor of EconomicsUniversidad de Alcalá



Román Escolano OlivaresGovernment-accredited TradeExpert and Economist

José Luis Escrivá BelmonteChief Economist BBVA Group

José Luis Feito HigueruelaPresident of the SpanishAssociation of Turnpikes, Tunnels,Bridges and Other Toll RoadConcessionaire Companies(Asociación de Autopistas dePeaje – ASETA). Government-accredited Trade Expert andEconomist

Santiago Fernández de LisDirector of the InternationalDepartment Analistas FinancierosInternacionales (AFI)

Federico Ferrer DelsoFormer Director World Bank

Juan E. Iranzo MartínProfessor of Applied EconomicsGeneral Manager Instituto de Estudios Económicos

Gregorio Izquierdo LlanesResearch Director Instituto de Estudios Económicos

Luis María Linde de CastroGovernment-accredited TradeExpert and Economist

Ángel Luis López RoaProfessor of Applied Economics, Universidad Autónoma de Madrid

José María Marín QuemadaProfessor of Applied Economics

Luis Martí EsplugaEconomist

Pedro Antonio Merino GarcíaDirector of Studies andEnvironmental AnalysisREPSOL

Blanca Moreno-DodsonSenior Economist World Bank in Washington DC

Álvaro Nadal BeldaMP for Albacete. Secretary ofEconomy and Employment of thePartido Popular. Government-accredited Trade Expert andEconomist

María Jesús Nieto CarolBank of Spain

Marta Pérez-Cameselle GarcíaPhD in Economics and Attorney

Manuel Pizarro MorenoMP for Madrid.Member of FAESBoard of Trustees

Luis Ravina BohórquezProfessor of InternationalEconomics.Former Dean. Faculty of EconomicSciences, University of Navarra.

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Stefano RielaScientific DirectorFondazione Res Publica

Guillermo Rodríguez GarcíaHead of the Analysis and AdviceDivision. Bank of Spain

José María Romero VeraAssociate. Economics andInternational BusinessEquipo Económico

José María Rotellar GarcíaProfessor of Economic TheoryUniversidad Autónoma de Madrid. Director General of Economics,Statistics and Innovations of theRegional Government of Madrid

Pedro Schwartz GirónRoyal Academy of Moral andPolitical SciencesProfessor of Economics, SanPablo University (CEU). Member of FAES Board ofTrustees

Rudolf StrohmeierEuropean CommissionHead of Cabinet of CommissionerViviane Reding

Javier SuárezProfessor of FinanceCentre of Monetary and FinancialStudies (Centro de EstudiosMonetarios y Financieros – CEMFI)

Baudilio Tomé MuguruzaMP for ZaragozaTreasury Spokesperson for theParliamentary Group of thePartido PopularMember of FAES Board ofTrustees.

Juan José Toribio DávilaProfessor of Economics Director Institute of Advanced BusinessStudies (Instituto de EstudiosSuperiores de Empresa - IESE)

Mariana Valeva-HristchevaPermanent representative forBulgaria in the European Union.Minister Plenipotentiary, Head ofUnit, Ecofin, Economic andFinancial Committee

Alejo Vidal-QuadrasVice-President of the EuropeanParliament. Member of FAESBoard of Trustees

ACKNOWLEDGEMENTS, CONTRIBUTIONS RECEIVED AND INDIVIDUALS AND INSTITUTIONS CONSULTED

121

The entire FAES Foundation has collaborated in this report, especially theDepartment of Economics and Public Policies and the Publishing Department.



APPENDIXCHRONOLOGY OF THE INTERNATIONAL

FINANCIAL CRISIS


MARCH 2007

D.R. Horton, one of themajor US construction companies,warned that it was experiencinghuge losses and that sales of newhouses had fallen by 28% duringthe first fiscal quarter.

The mortgage crisis in theUS claimed its first victim: NewCentury, suspended its listing on the Stock Exchange after falling 56% in the preopeningsession.

The US Mortgage BankersAssociation revealed that thedelinquency rate in the mortgagesector had reached its highestpoint in seven years.

House prices recorded theirfirst year-on-year drop since 1996.

APRIL 2007

Citigroup acknowledgeshaving posted losses of over 5billion dollars in the first quarter.

JULY 2007

Bear Stearns, one of themost important investment banksin the US, acknowledged the lack ofliquidity in two of its hedge funds.The investment bank had bailed outthese funds in June, which had betheavily in the high-risk mortgagemarket.

The chairman of the USFederal Reserve, Ben Bernanke,warned that the crisis in thesubprime mortgage market couldderail the US economy.

A third hedge fund managedby Bear Stearns filed for Chapter11 bankruptcy protection.

Due to their exposure to the UShousing market, several Germanbanks such as Mittelstandsbank,IKB, Sachsen LB, WestLB andBayernLB suffered significantlosses.

AUGUST 2007

The secretary of the USTreasury, Henry Paulson, tried to

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allay fear in the markets and saidthat the problems of the US high-risk mortgage sector were wellcontained.

American banks such as WellsFargo and Wachovia tightened uplending criteria after verifying thatsome 70 mortgage companies werebankrupt.

American Home Mortgage,the tenth largest mortgage lenderin the US filed for Chapter 11bankruptcy protection.

The European Central Bank made its largest interventionin the money market since the9/11 2001 attacks. The ECBinjected 94.8 billion euros into themarket and the Federal Reserve 24 billion dollars.

The US Securities andExchange Commission announcedthe investigation of GoldmanSachs, Merrill Lynch and BearStearns accounts.

HomeBanc declared itself bankrupt.

The US Federal Reserveinjected 2 billion dollars, shortlyafter the European Central Bank(ECB) had disbursed a further 65billion and the Bank of Japan 5billion into its market.

The US president, GeorgeW. Bush attempted to calminvestors and financial institutions.

The Euribor in Europe reached4.661%, its highest level in sevenyears.

SEPTEMBER 2007

The German industrial bank(IKB), one of the first affected inEurope by the subprime crisis,warned that it forecasted a loss of1 billion euros due to its exposureto high-risk mortgages in the US.

The British bank NorthernRock, the fifth largest mortgagelender in the country collapsed inthe London Stock Market. The Bankof England announced that, for thefirst time since the seventies, it

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would give financial support to abank.

In the United Kingdom,Northern Rock customers crammedits branches to withdraw theirsavings after the bank requestedan emergency loan from the Bankof England due to a lack of liquidity.

Merrill Lynch made job cuts in itshigh-risk mortgage subsidiary.

For the first time in fouryears, the US Federal Reserve cutinterest rates by half a percentagepoint, to 4.75% and the marketsrallied in the main stock marketindexes.

The chairman of the USFederal Reserve, Ben Bernanke,assured that the losses triggeredby the crisis of the mortgage sectorin the US had exceeded even themost pessimistic calculations.

OCTOBER 2007

El The Swiss bank UBSwrote-down assets by 3.4 billion

dollars due to poor results ininvestments made in mortgagecredits in the US. At the sametime, it announced the decision toreplace some of its executives andcut 1,500 jobs.

The investment bank Merrill Lynch announced that itwould have to assume losses of5.5 billion dollars due to poorinvestments related with high-riskmortgages.

The International MonetaryFund (IMF) warned that next year,the world economy could shrinksignificantly due to the turmoil infinancial markets.

The dollar plummeted againto an all-time low against the euro.The drop took place after the Bankof America announced poor resultsin its third quarter, attributed largelyto the growing losses in the creditmarket.

The president of the USinvestment bank Merrill Lynch, StanO’Neal, resigned after the companyacknowledged that its level of

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doubtful assets reached 7.9 billiondollars.

The Federal Reserve cut the interest rate by a quarterpercent to 4.5%.

NOVEMBER 2007

Citigroup posted a drop of57% in its quarterly profits, drivenby the losses in the market of high-risk loans. The chief executiveofficer and chairman of thisinstitution, Charles Prince, resignedfrom his position.

Wachovia, the fourthfinancial institution in the US,announced losses of 1.1 billiondollars in October.

The three major US banks,Citigroup, Bank of America and JPMorgan Chase, all agreed to a planto stimulate the local credit market,hit by the crisis in the mortgagesector.

The Bank of Englandadmitted that the US mortgagecrisis would affect growth in theUnited Kingdom.

Adam Applegarth, chiefexecutive officer of Northern Rockresigned due to the crisis of theinstitution. The stock market valuefell in two months from 3 billion to500 million pounds.

US house prices felldrastically in the third quarter totheir lowest level in 21 years.

DECEMBER 2007

President George W. Bushannounced a plan to freeze theinterests of some high-riskmortgages for the next five years toprevent further mortgageforeclosures. The plan expected tocover 1.2 million people.

UBS announced new losses adding up to 10 billion

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dollars in its financial assetsexposed to the real estate sector.

The Federal Reservedecided to cut interest rates by aquarter percent, to 4.25%.

The US, UK and Europeancentral banks announced measuresto help the banking sector tackle theworld credit crisis and the increasedcost of lending. These threefinancial institutions, together withthe National Bank of Switzerlandand the Bank of Canada, announceda plan to inject 100 billion dollars inemergency funds.

The investment bankMorgan Stanley posted losses of 9billion dollars due to the problemsof the US real estate market sectorand announced the sale of 10% ofits shares to a Chinese sovereignwealth fund.

JANUARY 2008

Citigroup announced a netloss of more than 9.8 billion dollarsduring the last quarter of 2007.

The financial institution alsoannounced that it would reclassifyassets adding up to more than 18billion as doubtful debts, due to itshigh exposure to subprimemortgages.

The US investment bankMerrill Lynch announced losses of9.8 billion dollars in the fourthquarter.

President George W. Bush proposed a plan of 145billion dollars to stimulate the economy.

The world Stock Marketsrecorded their worst losses since the 9/11 2001 terroristattacks.

The US Federal Reserveslashed interest rates by half apercent point to 3.5%.

The FBI announced that itwas investigating 14 companiesinvolved in the crisis of subprimemortgages.

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The Federal Reserve cutinterest rates from 3.5% to 3%.

FEBRUARY 2008

Wall Street stocks sufferedtheir worst losses in almost a year,after it was announced that activityof the US services sector had fallenunexpectedly in January.

Treasury ministers andcentral bank governors of the G7warned of the worsening economy.They estimated losses caused bythe US mortgage crisis could reach400 billion dollars.

The Japanese FSA, agencyresponsible for overseeing thebanking system, announced that the losses suffered by Japanesefinancial companies due to the USmortgage crisis had doubled in thelast three months of 2007.

The British governmentnationalised Northern Rock bank.

Freddie Mac, the USgovernment-sponsored enterprisefor mortgage financing togetherwith Fannie Mae, posted losses of2.5 billion dollars in the fourthquarter of 2007.

MARCH 2008

The US Federal Reserveinjected 100 billion dollars into themarket.

The US Federal Reserve,the European Central Bank and thecentral banks of United Kingdom,Canada and Switzerland madeanother coordinated attempt atalleviating the credit marketconditions with an injection of 200billion dollars.

Carlyle Capital fell victim tothe credit crisis. It left 16.6 billiondollars of debt.

Bear Stearns was bought by its rival JP Morgan for 236million dollars (2 dollars per share)to save it from collapsing.

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The investment banksGoldman Sachs and LehmanBrothers revealed that their profitshad been halved due to the lack of credit during the first quarter.

The Federal Reserve reduced ratesby 0.75% to 2.25% and the bankdiscount rate to 2.5% to tackle thecrisis.

APRIL 2008

UBS announced losses ofalmost 7.7 billion euros.

Deutsche Bank announced lossesof 141 million euros in the firstquarter of 2008.

The IMF estimated that thelosses arising from the crisisamounted to 600 billion euros.

The ECB and the Federal Reserveinjected a further 65 billion dollarsin a new joint operation.

The Bank of England cutinterest rates by a quarter point, to5%, and in Germany the WeserBankclosed.

MAY 2008

Barclays, the third bank inUnited Kingdom announced a fall inprofits after write-down of its assetsamounting to 1 billion pounds.

The Swiss bank UBS issuedpreference shares worth of 15.5billion dollars.

JUNE 2008

The FBI arrested 406people, including stock brokers andreal estate developers, supposedlyinvolved in a mortgage fraud of 1billion dollars.

JULY 2008

The Government intervenedin IndyMac, one of the mainmortgage lenders in the US. Itinvolved the second largest bankingcollapse in the history of the US.In the eleven days preceding the collapse, depositors hadwithdrawn 1 billion dollars from its deposits.

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Merrill Lynch announcedlosses of 6.6 billion dollars in thefirst six months.

The US bank WashingtonMutual announced losses of 4.5billion dollars in the first quarter.

The US Congress approvedaid to the mortgage sector for 3.9billion dollars.

AUGUST 2008

The Federal Reservemaintained interest rates at 2%.

The French Group Société Généraleposted a drop in profits of 63% inthe first six months and reducedthe value of its asset portfolio.

Freddie Mac announcedlosses amounting to 972 million dollars in the first six months.

SEPTEMBER 2008

US credit giants FreddieMac and Fannie Mae were placed under US Governmentprotection.

The US bank WashingtonMutual lost more than half of its stock market value in just one week.

Lehman Brothers, one ofthe most important investmentbanks in the US was declaredofficially bankrupt.

“Black Monday” on WallStreet. The New York StockExchange suffered its major losssince the 9/11 attacks, 4.42%after the collapse of LehmanBrothers and the sale of MerrillLynch.

The US Federal Reserveannounced a bailout package tosave the insurance giant American

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International Group (AIG) frombankruptcy with a credit of 85billion dollars, which meant that thegovernment held almost 80% of thecompany.

The British bank Lloyds TSBannounced the purchase of its rival,Halifax Bank of Scotland (HBOS),for 21.8 billion dollars to save itfrom collapse.

The US Federal Reserve, theEuropean Central Bank, the Bank ofJapan, Bank of Canada, Bank ofEngland and the National Bank ofSwitzerland announced acoordinated intervention of 180billion dollars.

The US TreasuryDepartment and Federal Reserveapproached Congress with apackage of legislative measures toalleviate the “systemic risks” in thecapital markets and to tackle thecollapse of prices of financialassets. President Bush advocatedfor Government intervention in themarkets. Stock Markets worldwidereacted with significant rises.

Goldman Sachs and MorganStanley renounced their investment

bank status and becamecommercial banks.

The US Treasury Secretary,Henry Paulson and the chairman ofthe Federal Reserve, Ben Bernanke,urged Congress to quickly approvea series of financial bailoutmeasures to avoid a worsening ofthe crisis or a recession.

Members of the USCongress expressed theirscepticism over the country’sbanking system bailout plan drivenby the Bush administration.

The Treasury secretary, HenryPaulson assured congressmen andwomen that a delay in the approvalof the 700 billion dollar packagecould risk the entire country’seconomy.

The assets of WashingtonMutual were auctioned.

Ireland was the first euro-zonecountry to enter into recession.

US Democrats andRepublicans reached an agreement

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of principles to approve a plan tohalt the financial crisis. However,just a few hours later theagreement was blocked.

The Congress rejected thebailout plan during the first vote bya vote of 228 to 205. The New YorkStock Exchange closed with a fall of 6.71%, the largest drop to date in the history of the market.

Santander Group acquired, throughits subsidiary Abbey, the network ofbranches and deposits of theBritish-based bank Bradford &Bingley.

In a US government-backedagreement, Wachovia passed to thehands of Citigroup.

Hypo Real Estate was rescued withan aid plan of the GermanGovernment of 35 billion euros.

El The US Senate approvedthe financial bailout plan of 700billion dollars.

Belgium, France and Luxemburginjected 6.4 billion euros in Dexiabank.

The Irish Government decided toguarantee all deposits of the

country’s six major banks for twoyears.

OCTOBER 2008

After the House ofRepresentatives approved a newversion of the financial aid plan, theUS president George W. Bush finallyenacted the law.

The United Kingdom extended theguarantee to bank deposits.

High level summit in Paris todeal with the financial crisis,attended by heads of State andGovernment of Germany, Italy,United Kingdom and France, as wellas the president of the Eurogroup,the president of the EuropeanCommission and that of theEuropean Central Bank.

The German governmentannounced a total guarantee fordeposits.

The Ministry of Finance ofGermany announced that theGovernment and a group of banks

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had reached an agreement on aplan of 70 billion dollars to rescueHypo Real Estate.

The French Bank BNP Paribasagreed to buy 75% of operations inBelgium and Luxembourg of theEuropean financial group Fortis.

Ministers of Economy andFinance of the EU (Ecofin) assuredthat they would not allow thebankruptcy of any financialinstitution that could drag down therest of the system. The ministersagreed to increase the guarantee ofdeposits to a minimum of 50,000euros. Spain, for its part, increasedit to 100,000 euros.

The prime minister of Iceland, GeirHaarde, warned of “StateBankruptcy” and took control of thebanking system.

The Tokyo stock exchangefell by 9.38%, its largest drop since1987.

The British government announceda bailout plan of 50 billion poundsto stabilise the UK financialsystem.

The Federal Reserve, the EuropeanCentral Bank and the central banks

of England, Switzerland, Swedenand Canada agreed to asimultaneous cut in interest ratesto tackle the crisis. In time, othercentral banks joined, such as thatof China.

In the US, the Treasury Secretary,Henry Paulson, warned that somebanks could collapse in spite of thebailout plan approved by theCongress for the financial sector.

Day of freefall in the Asianand European markets ending thestock markets’ worst week of thefinancial crisis.

The Eurogrup reached anagreement on the action plan thatestablished guarantees tointerbank loans and arecapitalisation of the financialinstitutions.

The German Governmentpresented a banking bailout plan of500 billion euros.

France presented another plan for360 billion euros.

The British government announcedpublic injections of capital to

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control 60% of the Royal Bank ofScotland and 40% of the mergerbetween Lloyds TSB and HBOS.

Other EU countries also announcedbailout plans, which incorporatedguarantees to bank liabilities andpartial nationalisation of institutions.

The US announced a record budgetary deficit of 450billion dollars. The figurecorresponded to 3.2% of its GDP,almost three times the oneregistered on the previous year.

JP Morgan Chase, Bank of America,Citigroup, Morgan Stanley, Bank of New York Mellon, Wells Fargo,Merrill Lynch, State Street andGoldman Sachs accepted theintervention of the Federal Reserve.

The US president, GeorgeW. Bush offered to host aninternational summit on thefinancial crisis.

The president of Caissed’Epargne resigned afterannouncing that the entity hadposted 800 million dollars inlosses.

The Dutch government announcedthe injection of 13 billion dollarsinto the bank ING.

The industrial production ofChina fell for the third consecutivequarter.

The acting EU president,Nicolas Sarkozy, championed thecreation of European sovereignwealth funds.

The Stock Markets of the main Latin Americaneconomies endured “unluckyWednesday”. The Merval index of the Buenos Aires StockExchange fell by 10.1%. The IPSindex of Mexico dropped 7%.

The White House called a summit of G-20 leaders forNovember 15.

A committee of the USHouse of Representatives accusedcredit rating agencies of havingabused the confidence in them andhaving ignored the early warningindicators of the crisis.

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In Denmark, the centralbank increased by 0.5 percentagepoints the official money rate to5.5%.

The Tokyo Stock Marketreached its lowest level in 26years.

The euro was valued at itslowest level since April 2006.

The US Federal Reservereduced the interest rate from 1.5%to 1%.

NOVEMBER 2008

Commerzbank and theregional banks HSH Nordbank andWestLB applied for the rescue planof the German Government.

The German Governmentapproved an economic aidprogramme for 35 billion euros.

The ECB dropped interestrates again to 3.25%. The IMFpredicted a world recession in2009.

American Express became acommercial bank.

The US governmentrenounced the strategy of buyingbanks’ “toxic assets” to investdirectly in the capital of theseentities.

Italy entered recession.

The G-20 leaders held theirfirst summit in Washington, wherethey committed themselves torestimulate world economy,promote free trade and start areform of the international financial system.

Japan entered recession.17

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Iceland obtained a loanfrom the IMF and aid from itsNordic neighbours.

The Federal Reserveannounced an injection of 800billion dollars in the mortgage andconsumer loan securitizationMarkets.

DECEMBER 2008

The ECB dropped interestrates by 75 basic points, to 2.5%.The Bank of England and the Bankof Sweden also dropped theirinterest rates.

The French President, NicolasSarkozy announced an aid packageof 26 billion euros to stimulate theeconomy.

The Bank of Americaannounced 35,000 job cuts overthe next three years.

The US Federal Reserve cutits interest rate from 1% to 0.25%.

The credit ratings agencyStandard and Poor’s reduced itsrating for monoline insurers,specialised in insuring bonds.

JANUARY 2009

The Bank of England againreduced its official interest rate to1.5%, the lowest to date in its 315 years of history.

The European Central Bankcut interest rates to 2%.

The US Governmentreached an agreement to inject 20billion dollars into the Bank ofAmerica.

Citigroup announced plans to splitthe company in two and postedlosses amounting to 8.3 billiondollars.

The UK entered recessionwith a fall of 1.5% of GDP in thelast quarter of 2008.

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The Bank of Spainannounced that Spain had enteredinto recession for the first timesince 1993.

FEBRUARY 2009

UBS posted losses of over13 billion euros in 2008.

The United States announced anew financial bailout plan for 789billion dollars.

The G7 member countriesagreed to reform the IMF.

Japanese GDP shrank by12.7% in the last quarter of 2008.

The US president, BarackObama allocated 60 billion dollarsto reduce mortgage foreclosures.

The IMF warned of a secondbanking shock and warned thatworld growth could be close to zeroin 2009.

The German Governmentapproved its second economicstimulus package for an amount of50 billion euros.

The US economy fell by 6.2%in the fourth quarter of 2008.

MARCH 2009

The President of theEuropean Central Bank, JeanClaude Trichet, did not dismiss the idea of further drops in interest rates after leaving them at 1.5%.

China presented an economicstimulus package for an amount of600 billion euros.

The new US Treasurysecretary, Timothy Geithnerannounced a public-privatepartnership programme for the purchase of ‘toxic assets’ towhich the US Government allocated 500 billion dollars thatcould be extended up to 1 trilliondollars.

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The Bank of Spainintervened in Caja Castilla laMancha. The Government approvedguarantees for an amount of 9billion euros for its financing.

APRIL 2009

The second meeting of G-20 leaders was held in London.They agreed to reinforce the creditcapacity of the InternationalMonetary Fund and advance with the reform of financialregulations.

The IMF increased itsestimate of losses in the bankingsector to 4.1 billion dollars, andcalled for more injections of public money into the financialsystem.

The IMF agreed to distribute250 billion dollars among themember countries to strengthenmembers’ economies with needs of external financing.

MAY 2009

The ECB cut interest ratesto 1% and announced that it wouldbuy mortgage bonds for 60 billioneuros. Jean Claude Trichet did notdismiss further cuts.

The IMF predicted economicrecovery in Europe would start inthe second half of 2010. To exit negative growth, the IMFcalled for new measures, especiallyin the financial sector.

France entered intorecession.

The Bank of Spainannounced that delinquency ratesin Spanish credit institutionsreached 4.17% in March, itshighest level since 1996.

JUNE 2009

General Motors wasdeclared bankrupt.

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The US President BarackObama presented the newfoundations for the reform offinancial regulations in the UnitedStates.

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SISTEMA FINANCIERO INGLES:NATOok.qxd …fundacionfaes.org/file_upload/publication/pdf/...Lehman Brothers, public interventions in the financial systems of several European countries,