MercoPress. South Atlantic News Agency

Reviving the damaged financial system

Restoring financial health will require a three-pronged approach, involving the continued provision of ample liquidity and term funding support from central banks, dealing promptly and aggressively with distressed assets, and recapitalizing viable institutions with public funds.

Immediate, short-run policies and actions taken need to be consistent with the long-run vision for the structure of a viable financial system and with medium-term fiscal sustainability. If the financial sector is not restored to health, an enduring recovery will not be possible. Various approaches may be used to resolve distressed assets, tailored to individual institution and country circumstances. Cleaning bank balance sheetsâ€"including through a transparent process for valuing distressed assets and putting a ceiling on lossesâ€"will be critical to restore confidence in financial institutions and reduce counterparty risk. An approach that would ensure maximum transparency and greatly reduce uncertainty, although entailing high upfront fiscal costs, would be to transfer the assets to a "bad" bank. Such an approach has been tried and tested in previous crises and has yielded generally favorable outcomes. Recapitalization using public balance sheets should make a clear differentiation between viable and nonviable institutions to enable greater consolidation in the financial sector. Most critically, recapitalization must be of a sufficient size to decisively address solvency concerns, especially by ensuring that it is resilient to further deterioration in bank balance sheets as a result of the worsening macroeconomic environment. International cooperation on a coherent set of financial policies should receive high priority. The application of substantially different conditions when supporting financial institutions should be avoided in order to prevent unintended consequences that may arise from competitive distortions and regulatory arbitrage. International coordination is also needed to avoid excessive "national bias" to the detriment of other countries