Regulation of the financial industry is set to become broader and more focused on system-wide risk, according to Laura Kodres, chief of the global financial stability division at the International Monetary Fund.

Speaking in Toronto on Wednesday, Kodres said the financial crisis has underscored the vast interconnectedness of the global financial system, and the need for regulators to give more focus to cross-border risks.

“This crisis has driven home the point that we need to think a little bit more about macro regulation,” Kodres said. “This was not a problem in one jurisdiction that was easily solved in one jurisdiction. It became global relatively quickly. So we need to understand how these exposures are linked across countries.”

According to Kodres, each country should have a body that oversees systemic risk, such as a central bank or major regulatory organization. A similar role should be played at the global level, by a body such as the Financial Stability Board, a Joint Forum, or the IMF. An international regulator is crucial to prevent some of the inconsistencies between highly connected countries that caused problems in recent crisis, she said.

“Individual countries did things that compromised their neighbours, or other countries to which they were connected,” she said.

Currently, however, international regulatory bodies lack the necessary tools to effectively oversee systemic risk across the global financial system.

“Frankly, we don’t have the right data to do it. We don’t have the ability to collect the right data,” Kodres said, but she added that the IMF is working to establish the appropriate framework. “We’re developing the tools to be able to measure and monitor these sorts of things.”

A key focus for the IMF going forward, Kodres said, would be seeking effective ways of overseeing cross-border financial firms.

The crisis has shown that even specific regulatory matters should be considered in the context of the broader financial system, Kodres said. For example, she said leverage should be considered at the system-wide level, not just in the context of individual institutions.

“There should be a maximum amount of leverage that’s permitted,” she said. “One has to think carefully about how much of a build up of leverage is your society, is your banking system, is your financial sector willing to take on?”

Disclosure requirements are also set to become stricter going forward, according to Kodres. A key issue in the financial crisis was a lack of information disclosed on complex financial instruments.

But greater disclosure can be costly, she acknowledged. Rather than focusing on increasing disclosure, regulators should set requirements to make disclosure better, she said. “We need to think about what the relevant information is for people to know about.”

Ultimately, any potential regulatory changes to emerge from the crisis should be carefully considered first, Kodres said. She warned that hastily adopted regulation can create further problems.

“We definitely need to think about what the failure was, think about why the failure occurred, and then, think very carefully about whether it needs a regulatory solution or not,” she said. “There are often unintended consequences of regulation.”

IE