Istanbul - The International Monetary Fund (IMF) has said that better regulation and supervision of financial institutions is critical for financial stability as the global economy embarks on recovery.

In its latest World Economic Outlook report, the IMF said the world output is expected to contract by just 1.1 percent in 2009 before growing by 3.1 percent in 2010.

"The most straightforward lesson of the crisis is that financial stability demands regulation and supervision.

While we can identify many factors that contributed to the crisis, one key failure was inadequate regulation and supervision,” Dominique Strauss Kahn, the Managing Director of IMF told a press briefing on Friday in Istanbul.

"Even where appropriate regulation was in place, implementation and enforcement could have been much stronger,” he said, adding that because the regulatory environment focused on risks of individual institutions and markets, the potential for a buildup of systematic risks was not sufficiently appreciated.

"We need to move faster to repair bank balance sheets, this matters because financial institutions still loaded with impaired and illiquid assets that are slowing credit creation, with worrisome knock on effects for growth,” Kahn observed.  

The alert echoes recommendations by IMF team findings to Rwanda recently, urging the Central Bank to strengthen the functioning and supervision of the banking system in the country as key mitigating factor for the sector to shake-off external shocks.

During their assessment of Rwanda’s performance for last year under Poverty Reduction and Growth Facility (PRGF) program, the IMF team identified weaknesses in risk management and governance of commercial banks, forcing them to tighten credit standards and leading to a decline in credit growth.

To facilitate payments and avoid credit stagnation, the Central Bank injected sizable amounts of liquidity into the banking industry, a process that begun early this year.

However, IMF said that despite abundant liquidity in the banking sector, credit growth stagnated.

"Additional policy adjustments may be required should the world economic crisis and its impact on Rwanda worsen beyond current expectations or should the domestic banking situation deteriorate further,” the IMF Team said.

The National Bank of Rwanda says it is addressing the existing problems.

"Right now we are shifting our focus on how banks manage risks.

This is a work in progress and this problem is common in most developing countries,” Governor François Kanimba told Business Times recently.

In a bid to encourage longer -term investment lending to sustain economic growth, the BNR will make a limited transfer of some government’s deposits to commercial banks, a move that was approved by the IMF team.

According to the latest Global Financial Stability Report by the institution, while bank balance sheets have benefited from capital-raising efforts and positive earnings, there are still serious concerns that credit deterioration will continue to put pressure on banks’ balance sheets. 

"Financial institutions need further restructuring to ensure their ability to lend and support economic recovery.” 

What is needed is a way to benefit from increasing financial integration the report said, while ensuring that potential negative spillovers are contained and clarity exists about the role of home and host authorities.

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