• Steps to bolster Spanish savings banks welcome, but stronger Euro Area actions needed towards fiscal and financial integration.
• Pause now needed on new financial regulation.

Washington D.C., June 14, 2012 — Next week’s Group of 20 Summit in Mexico is arguably the most important G-20 event since the London Summit in April 2009, stated the Institute of International Finance. It stressed that financial markets will be looking to the Summit for globally coordinated actions targeted to revive economic growth prospects worldwide on a sustainable basis.

The IIF, the leading global association of financial services firms with more than 450 member institutions, emphasized in a policy letter to the Summit leaders meeting in Los Cabos, Mexico, next week, that additional measures by Euro Area leaders are vital to address today’s crisis resolutely. The IIF added that, “At this juncture, global coordination—beyond Europe alone—is of the utmost importance. More coordinated monetary policy and fiscal efforts would be much more powerful than anything individual countries could accomplish on their own.”

IIF Managing Director Charles Dallara said, “We welcome recent measures taken by the Euro Area to bolster the Spanish savings bank sector, which demonstrate evidence of a willingness to take collective and coordinated action. While this important recapitalization is a vital near-term crisis-fighting measure, it also highlights the potential benefits to be derived from authorizing the ESM to make direct investments to recapitalize weak banks wherever needed in Europe.”

With regard to Greece, Mr. Dallara said “The voluntary private-sector debt exchange led to an unprecedented level of debt reduction, which presents Greece with an excellent opportunity to move forward. Significant progress has also been made on necessary fiscal adjustment and structural reforms, with the strong support of the official community. However, it is clearly important following the June 17 elections that a new Greek government reaffirm its commitment to the central tenets of its reform program—liberalizing labor and product markets, advancing privatization, and strengthening the competitiveness of the economy with a greater focus on fiscal and structural reforms.”

Further, the IIF noted that given the severe contraction of Greece’s economy, the pace of short-term budgetary adjustment needs continuous examination for potential easing: it should be recognized this might require modest additional financing support. With this approach, the efforts being made to carry out Greece’s difficult adjustment program should begin to bear visible fruit.

At the same time, official creditors should recognize that in an environment of severe economic contraction, the pace of short-term budgetary adjustment needs continuous examination for potential easing: The point about the short-term budgetary adjustment may be applicable well beyond Greece, with a suitable degree of differentiation depending on individual countries’ circumstances. Such a balanced approach may allow for stronger growth in the near term while permitting more determined reform effort in the medium term.

The IIF argued that strengthening the Euro Area monetary union requires a far greater degree of fiscal integration, which in turn demands greater fiscal risk sharing with some form of debt redemption fund or Eurobonds, conditional on more centralized fiscal governance. Mutualization of fiscal responsibility and risk is an essential ingredient of an effective monetary union, though perhaps the most politically challenging aspect of the process. As a medium-term objective, consideration should be given to some form of banking union involving a centralized supervisory authority; region-wide bank deposit insurance; and common bank recapitalization funds such as the ESM.

Mr. Dallara noted that adding to current economic uncertainties are “Regulatory changes and the potential for layering on of additional requirements that continue to further restrict credit provision to the real economy.” He added, “It is important that the regulatory reform program does not add to unplanned private-sector deleveraging, and on the contrary, is supportive of a level of risk taking appropriate to the economic growth sought by the G-20. This is therefore an opportune moment to reflect whether there should be a pause in adding further to the aggregate of regulatory reform already in place and in train. It may even be timely to review the pro-cyclicality of many of the current requirements and determine if this remains appropriate in the current environment.”

The IIF said capital requirements, resolution and liquidity proposals by the Financial Stability Board and the Basel Committee need to be finalized and implemented in ways that avoid further ring-fencing of assets, capital and liquidity. Moreover, it added, “Consistent implementation of the basic Basel III framework – without “top-up” or additional measures – remains essential. A risk-based approach will create the best incentives to safe and sound operation of the financial institutions, and should be embedded in all aspects of regulatory reform including review of the trading book.”

Today’s policy letter drew attention to ongoing economic challenges in the United States, Japan and China, in addition to those confronting Europe. The IIF said, for example, that in the U.S. a strong case can be made for a decision now to extend the Bush tax cuts and take other measures to avoid a possible “fiscal cliff.” This would contribute to a strong process of global coordination, boosting market confidence when it is sorely needed.

Mr. Dallara asserted, “The priority given by the Mexican G-20 leadership to revitalizing global economic growth and job creation should be emphasized in Los Cabos. At the same time, market confidence would be bolstered by charting a clear destination for the Euro Area and establishing a path for regulatory reform that sets a better balance between financial stability and sustainable growth.”