BIS outlines 'narrow path ahead' in annual report

BASEL - The Bank for International Settlements (BIS) has released its annual report outlining the "narrow path ahead" for the banking industry and the need to pay attention to medium-term macroeconomic and financial policies.

The BIS report, entitled Rescue, recovery, reform - the narrow path ahead, stresses microeconomic and macroeconomic causes of the financial crisis, including an "under-appreciation of risk", distorted incentives and regulatory failure to prevent the build-up of excess leverage.

The BIS says export and leverage-led models must be banished in favour of a long-term, sustainable approach to growth, and that authorities must encourage this shift through their financial rescue and policy efforts.

The macroeconomic role of supervisors - policing systemic risk - is highlighted most by the BIS, and is crucial in moderating "the pro-cyclicality inherent in the system".

A future role for standards-setting organisations and new macroeconomic watchdogs, such as the Financial Stability Board, is outlined in the report, alongside that of the BIS through its Basel Committee on Banking Supervision.

Part of reform for institutions, says the BIS, "means the comprehensive application of enhanced prudential standards that integrate a system-wide perspective" - that is, international adherence to Basel II in its amended, post-crisis form.

For financial instruments, the BIS says reform means better mechanisms to rate risks, limit their availability and provide effective warnings when they are inappropriate.

For over-the-counter markets, the bank has joined the chorus of opinion calling for trading and clearing through central counterparties and exchanges - as is already being promoted by US regulators and in the EU.

The bank also suggests that, while the crisis period of September and October 2008 forced crucial regulatory measures to ensure financial stability, more is required to cleanse banks' books of remaining toxic assets to properly repair the system.

The report says authorities must "persevere until the job is done" and that national responses to encourage growth should steer clear of the sometimes "unintended consequence" of protectionism.

The report can be read here.