Capital markets played a crucial role in financing the recovery from the recent global financial crisis. However, given the significant differences in the size of capital markets across economies, the Committee on the Global Financial System (set up by Bank for International Settlements) believes that central banks can enhance the effectiveness of capital markets in serving the real economy alongside their direct regulatory responsibilities.
The Committee, chaired by RBI’s Viral Acharya and People’s Bank of China’s Li Bo, in a paper titled ‘Establishing viable capital markets,’ thus offered six broad policy recommendations, whose relevance varies by economy, while some even fall outside the direct central bank control. “Nevertheless, they impact the vibrancy of capital markets and central banks’ ability to meet their objectives,” the authors noted.
The Committee’s view
(Extract from policy paper)
* First, greater market autonomy would enhance capital market pricing and funding allocations. Policymakers need to address vestiges of financially repressive policies and fix market failures that create preferential financing terms for the public sector or paternalistic policies that override private allocations. Typically, repressive measures exacerbate market volatility by reducing investor diversity and suppressing securities issuance.
* Second, strengthening of legal and judicial systems for investor protection and raising the efficiency, consistency and fairness of legal proceedings through the creation of specialized financial courts. Policies that ease access to legal recourse lower the cost of private contract enforcement and sanctioning breaches of duty. Besides, policies that raise the predictability and efficiency of insolvency procedures.
*Third, enhancing regulatory independence and effectiveness strikes a balance between investor protection and issuer costs. Clear and well focused objectives and strong governance frameworks for regulators strengthen operational autonomy, thereby protecting against unwarranted influence. Enhancing investigative powers as well as ensuring the adequacy of resources would facilitate enforcement of regulations and timely diagnosis of market failures and vulnerabilities.
Investor protection can be increased by raising accounting and disclosure standards and promoting best practices in corporate governance. In addition, authorities can supplement regulatory efforts by encouraging private sector to develop standards and codes that may help market practices keep pace with evolving market innovation.
*Fourth, policies to promoter penetration on the part of institutional investors like pension funds and insurance companies can dampen volatility as well as create a domestic constituency that raises corporate governance standards and the broader efficiency of capital markets. Achieving greater financialisation of household savings by facilitation cost-effective, transparent and well regulated collective investment products and fostering greater financial literacy will help.
*Fifth, a broad and bi-directional opening of capital markets can exert a general positive influence on domestic capital market development. But to reap the benefits, policymakers need to actively engage with potential market entrants and prepare for spillover risks. Calibrating the pace and sequencing of opening and creating macro policy buffers can help contain the associated risks and provide margins for coping with volatility.
*Finally, enhancing market ecosystems by developing deep complementary markets for derivative, repo and securities lending requires a coordinated effort along multiple dimensions. These include a supportive legal and regulatory environment, regulatory coordination to broaden the investor base and robust and efficient market infrastructures like central counter parties and trade repositories to manage potential financial stability risks.
Space for improvement
While capital markets played a crucial role in financing the world’s recovery from financial crises, given the significant differences in their size across economies, the Committee on the Global Financial System believes that central banks can enhance their effectiveness
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Set up by the Bank for International Settlements, the committee has now offered six broad recommendations via a recently released policy paper, which it says can impact the vibrancy of capital markets and the central banks’ ability to meet their objectives