The Orderly Resolution of Financial Crises – A G20-Led Initiative How could a Leaders ’ Level G20 make a difference?

Preparing today for the next financial crisis is a bit like buying fire insurance in a flood, in that the likelihood of the problem occurring in the short run is limited. Currently, financial stability in emerging markets is supported by three conditions: strong prudential policies, current account surpluses, and low interest rates. The premise of this paper is that this constellation of stability-making circumstances is temporary and sooner or later problems will recur.2 • While there has been progress in terms of prudential policies, much remains to be done. Emerging markets have further to go in terms of strengthening their banking systems, building domestic financial markets, limiting the growth of public debt, improving corporate governance, and moving to greater exchange rate flexibility. So long as these institutional reforms are incomplete, emerging markets will remain more vulnerable than their developed-country counterparts to disruptions to market access and sudden capital outflows.3 • In terms of current accounts, the emerging markets of Asia and Latin America will notrun surpluses indefinitely. When their growth slows or commodity prices decline, they will again want to run deficits in order to smooth consumption and sustain investment – precisely as textbook models suggest they should. To the extent that they have been motivated to run balance-of-payments surpluses by the memory of recent crises, which has created a desire to build reserves, it is hard to argue that this process of reserve-building has further to run