With financial markets worldwide facing growing turmoil, internationally coherent and decisive policy measures will be required to restore confidence in the global financial system, says the IMF in its latest Global Financial Stability Report.

"Failure to do so could usher in a period in which the ongoing deleveraging process becomes increasingly disorderly and costly for the real economy. In any case, the process of restoring an orderly system will be challenging, as a significant deleveraging is both necessary and inevitable," it adds.

"Confidence in global financial institutions and markets has been badly shaken," notes the IMF.

"The intensifying worries about counter-party risks has created a near lock up of global money markets," it says.

The IMF says in the report that while the precise measures will inevitably differ across countries, experience from earlier crises indicates that five principles could serve to guide the scope and design of measures that could form the basis for a restoration of confidence in these exceptional circumstances.

Clear communication

Firstly, countries should employ measures that are comprehensive, timely, and clearly communicated. They should encompass the principal challenges arising from the strains of deleveraging: namely, improving funding availability, cost, and maturity to stabilise balance sheets; injecting capital to support viable institutions with sound underpinnings that are currently unable to provide adequate credit; and buttressing troubled assets by using public sector balance sheets to promote orderly deleveraging. In applying existing or new regulations, authorities should avoid exacerbating procyclical effects. The objectives of the measures should be clear and operational procedures transparent.

Next, countries should aim for a consistent and coherent set of policies to stabilise the global financial system across countries in order to maximise impact while avoiding adverse effects on other countries.

Then they should ensure rapid response on the basis of early detection of strains. This requires a high degree of coordination within each country, and in many cases across borders, and a framework that allows for decisive action by potentially different sets of authorities.

Fourthly, countries should assure that emergency government interventions are temporary and taxpayer interests are protected. Accountability of government actions is important for all stakeholders and the conditions for support should include private participation in downside risks and taxpayer participation in upside benefits. Intervention mechanisms should minimise moral hazard, while recognising the exigency of the situation and the evident need for public support.

Medium term

Lastly, countries should pursue the medium-term objective of a more sound, competitive, and efficient financial system.

"Achieving this objective requires both an orderly resolution of nonviable financial institutions and a strengthening of the international macro-financial stability framework to help improve supervision and regulation at the domestic and global levels, as well as mechanisms to improve the effectiveness of market discipline. Funding and securitisation markets critical to pricing and intermediating credit should be strengthened, including by reducing counter-party risks through centralised clearing organisations," says the IMF.

While satisfying these guiding principles, concrete actions are needed to tackle three interrelated areas associated with deleveraging: insufficient capital, falling and uncertain asset valuations, and dysfunctional funding markets.

"Arresting the spiralling interaction between these three elements is essential if there is to be a more orderly deleveraging process," concludes the IMF.

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