FSF Recommendations and principles to strengthen financial systems

On 2 April 2009, the Financial Stability Forum (FSF) issued reports covering:

Recommendations for Addressing Procyclicality in the Financial System;

Principles for Sound Compensation Practices; and

Principles for Cross-border Cooperation on Crisis Management.

The Forum also published today an update on the implementation of the recommendations contained in the FSF's April 2008 Report on Enhancing Market and Institutional Resilience.

Addressing procyclicality in the financial system

The present crisis has demonstrated the disruptive effects of procyclicality – mutually reinforcing interactions between the financial and real sectors of the economy that tend to amplify business cycle fluctuations and cause or exacerbate financial instability. Addressing procyclicality in the financial system is an essential component of strengthening the macroprudential orientation of regulatory and supervisory frameworks.

The recommendations set out in this report mitigate mechanisms that amplify procyclicality in both good and bad times. They encompass a mix of quantitative/rules-based and discretionary measures that are interrelated and reinforce one another. They will be implemented over time once conditions in financial markets return to normal.

Principles for Sound Compensation Practices

The Principles require compensation practices in the financial industry to align employees' incentives with the long-term profitability of the firm. The principles call for effective governance of compensation, and for compensation to be adjusted for all types of risk, to be symmetric with risk outcomes, and to be sensitive to the time horizon of risks. Implementation by firms will be reinforced through supervisory examinations at the national level.

Principles for Cross-border Cooperation on Crisis Management

Through these Principles , relevant authorities, including supervisory agencies, central banks and finance ministries, commit to coooperate both in making advanced preparations for dealing with financial crisis and in managing them.

Update on the Implementation of the April 2008 FSF Recommendations

The update on progress in implementing the recommendations of the April 2008 Report on Enhancing Market and Institutional Resilience covers actions in five areas: (i) strengthening capital, liquidity and risk management in the financial system; (ii) enhancing transparency and valuation; (iii) changing the role and uses of credit ratings; (iv) strengthening the authorities' responsiveness to risks; and (v) putting in place robust arrangements for dealing with stress in the financial system.

The previous follow-up report, issued in October 2008, is available here.