By Rex Nutting, MarketWatch
WASHINGTON (MarketWatch) -- If bank regulators are going to succeed next time where they failed before, they'll have to build systems that limit the risks that big financial companies pose to the global economy, according to a report released Tuesday by the International Monetary Fund.
"It is not enough to mandate that regulators 'monitor' systemic connections," the IMF said in its Global Financial Stability Report. "Better tools would also be needed to combat systemic risks."
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The IMF released the so-called analytic chapters of the semiannual report on Tuesday. The meat of the report - the IMF's analysis of current conditions - will be released next week ahead of the annual combined meetings of the fund, the World Bank and the G20.
The report argues that bank regulators will have to consider "more direct methods to address systemic risks" - the kind of interconnected links that proved so damaging to the global financial system and economy after Bear Stearns, Lehman Bros., and American International Group failed in 2008.
In response to the 2008 crisis, national and multinational banking supervisors are suggesting closer monitoring of systemic risks. In the United States, the Congress is now working on legislation to create a systemic risk regulator. In the United Kingdom, the Financial Services Authority has proposed stricter regulations over large, interconnected banks.
While not endorsing any one approach, the IMF suggested that regulators levy risk-based capital surcharges "that are related to an institution's contribution to systemic risk or, perhaps, even limiting the size of certain business activities."
"In the absence of concrete methods to formally limit a financial institution's systemic importance -- regardless of how regulatory functions are allocated -- regulators may tend to be more forgiving with systemically important institutions compared to those that are not," the IMF said.
Implementing new risk-reducing regulations can be complicated. Poorly designed controls could add to cyclicality, by requiring less capital during boom times and more during downturns, the report said.
In addition, regulators will have to work closely together across borders to reduce regulatory arbitrage.
The report also recommends tougher regulation on over-the-counter derivatives to reduce risk and to give supervisors more information about them. During the Lehman and AIG crisis, regulators "had to make expensive decisions" based on very little information, the fund said.
Rex Nutting is Washington bureau chief of MarketWatch.
