Jaime Caruana, the IMF's Director of Monetary and Capital Markets, visits IESE
Uncertainty Reins in Financial Markets

“We are still experiencing a period of turbulence,” said Jaime Caruana, director of monetary and capital markets at the International Monetary Fund (IMF) in reference to the turmoil in worldwide financial markets. The IMF director made his comments during a session organized by the IESE Alumni Association in association with the school’s International Center for Financial Research.

Caruana indicated that it is too soon to find complete answers on what lessons the crisis can teach us. But the former governor of Spain’s central bank pointed to rash lending coupled with rising interest rates as the main trigger behind the current credit crunch. “Banks lowered the minimum requirements to secure a mortgage while homeowners have suffered from higher interest rates,” he pointed out.

At the same time, an excess of liquidity led financial institutions to assume greater risks with mortgage-backed securities and increasingly-complicated financial instruments with murky providence. But when U.S. subprime loans went bad, formerly bullish banks withdrew their horns. Interbank lending rates rose as financial institutions became wary of lending to each other, not knowing who had liabilities in subprime mortgages.

“This process prompted a rapid turnaround from an excess of liquidity in financial markets to a credit crunch and obliged certain financial institutions to seek help from the central banks,” Caruana noted. The crisis in the U.S. has had global repercussions. For example, the Bank of England has stumped up billions of pounds of public money to stem a run at Northern Rock, a leading mortgage provider in U.K.
On a more local level, the IMF director suggested that the crunch’s impact will be felt by businesses everywhere. “The current instability in the financial markets will have a profound impact for companies who will experience a further tightening of credit lines with higher lending requirements.”

Looking ahead, the fiasco has prompted the industry and its supervisors to question whether further regulation is required. Caruana stated that he was in favor of Basel II, recommendations on banking laws which aim to create international standards for banking regulators. “We need a certain degree of regulation to make sure mechanisms are in place to respond to situations as complicated as this one."

Basel II will force banks to recognize liabilities that until now they have been able to hide. Caruana highlighted further aspects of the industry which need to be examined such as how complicated financial instruments are valued and how they are used by investors. In short, the IMF director indicated that much more needs to be done to avert future crisises.