Financial Sector Regulation and Reform in Emerging Markets

Purpose

The primary purpose of this project is to generate policy-oriented research and provide an effective forum in which to have discussions that would allow for comparison of experiences of different countries in terms of

1. the effects of the crisis on their economies and financial systems; and
2. results of their policy interventions and lessons that can be learned from successes and mistakes.

Participants will engage in the collaborative design of medium- and long-term strategies for strengthening regulatory frameworks that facilitate but also help manage and mitigate the risks from the process of financial development and broadening of financial inclusion. They will also discuss how the policy frameworks should be adapted to a world of more free (and more volatile) capital.

Back to Top

Background

The global financial crisis has ravaged financial systems in the U.S. and other industrial countries while battering financial systems in some emerging market economies and hurting growth prospects in virtually all countries. These shared ramifications have brought into even sharper relief the centrality of sound financial systems for emerging markets as well as low-income developing economies. Sound financial systems are necessary for long-term and balanced development in these countries as well as to absorb various types of shocks.

Emerging markets face particular challenges in stabilizing their nascent financial systems in the face of shocks, both domestic and external. These challenges occur at a fundamental level in emerging markets, many of which are at the point of creating sound banking systems, widening inclusion in the formal financial system, and creating and managing a broader set of financial markets (such as corporate bond markets and basic currency derivatives).

The crisis has highlighted the need for a broad reconsideration of the optimal structure and appropriate regulatory and supervisory frameworks of financial institutions. Indeed, the seismic shifts in the financial landscape clearly call for a fundamental rethinking of the core principles underlying financial regulation.

Financial systems in advanced industrial economies are struggling under the weight of the crisis and obviously have a major stake in each of these structural issues. Most emerging market and low income countries have not experienced the same level of financial devastation, to some extent because their financial systems were narrow and underdeveloped to begin with. Nevertheless, financial reforms are critical to these economies as they deal with the global crisis while simultaneously pursuing sustainable high-growth paths. Well-functioning financial systems in emerging and low-income economies have very direct implications not just for those economies themselves but also for the stability of the global financial system as a whole.

New paradigms for financial development and regulation will have to be suitably reframed for emerging markets, which have a number of varying institutional and capacity constraints. Low-income countries, where the breadth of formal financial systems is severely limited, pose an even greater set of conceptual and practical challenges.

Policymakers in emerging markets will need to grapple with a distinct set of issues once the dust settles on this crisis, chief among them:

• What lessons does the crisis offer for the establishment of efficient and flexible regulatory structures? Even industrial countries will confront these deep, structural questions, which are even more complex in emerging markets due to the lack of regulatory capacity and weak legal and public institutions.
• What avenues should be pursued to enable effective regulation of financial institutions with large operations in multiple countries? Foreign banks and other financial institutions have become key players in many emerging markets and have provided enormous benefits to local financial systems however in times of externally-induced crises, they may prove to be a source of contagion.
• More broadly, raising financial inclusion-increasing access of a broad swath of the population to the formal financial system-is an imperative issue for emerging markets to explore at this critical juncture. Financial inclusion has many implications for allowing households to save and diversify their sources of income, enabling entrepreneurs to have access to finance, and creating a more efficient system of intermediating domestic savings into investment.

Back to Top

Objectives

The conference will take a comprehensive approach to reforming emerging market financial sectors and strengthening their regulatory framework. On the research side, a range of pertinent issues will be examined, including:

• Basic principles of financial regulation
• Dealing with the challenges of limited institutional development and regulatory capacity
• Financial inclusion - how to increase emerging market access to the formal financial system
• Optimal macroeconomic policy frameworks to enhance financial stability
• Mechanisms for dealing with the consequences of de facto and increasingly open capital accounts

Back to Top

Outputs

This activity will produce:

1. Completed conference papers
2. ADBI Research Policy Briefs
3. ADBI Working Papers
4. A collective volume published by the Brookings Institution Press

Back to Top

Partners

Brookings Institution, Washington, DC, US
Cornell University, Ithaca, NY, US
Institute for Financial Management and Research Trust, Chennai, India