Francisco Lopez Lubian

Now that the conference of next November 15th to discuss reforms to the international financial system is coming, there is a debate about whether the international economy needs a new financial system.

Do we need a new system? I don´t believe we do. What I do believe is that we need a better use and application of the present financial system, re-focusing traditional ideas and new ways for innovation.

Perhaps the most difficult task in management is to reconcile short term activities with long term outlook. In that sense, proposed reforms in financial system should take into account the following guidelines:

1) Reward sustainable economic value creation versus generation of apparent profitability measured through convenient shortcuts.

2) Define and implement effective tools to measure systematic risk.

3) Increase regulation in order to improve transparency in the information provided by financial entities. Higher transparency would be needed in topics like:
• the use of off-balance sheet entities to hide risky and unclear positions;
• the standardization of derivative products and higher transparency of these products by trading them in organized markets;
• the definition of internal credit rating procedures in financial entities, in order to disclose level of risk associated to new products;
• the criteria used in the rewarding system at the different management levels, including the board of directors.

4) Define and regulate eventual conflict of interests in financial entities operating actively with customers in investment banking and commercial banking.

5) Avoid to identify better regulation with higher government intervention in the day to day operations of financial entities.

6) Avoid to undermine possible competitive advantages, discouraging financial innovation and fair risk taking. By discouraging innovation we may be limiting one source of economic growth.

Good practices of crisis management are crucial in order to start solving the problems. These practices are both ex ante and ex post. In any case, effective regulation and control of financial market from financial authorities will imply a good understanding of the activities to be regulated, including some degrees of flexibility, realism and imagination.

Posted on 12 Noviembre 2008

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