Bank for International Settlements

Weak banks should be allowed to fail and artificial financial safety nets removed if worldwide financial stability is to be achieved, the Bank for International Settlements (BIS) says.

'Capital that earns an inadequate rate of return should be withdrawn and firms must be allowed to merge, even with foreign partners, or to disappear,' the BIS said yesterday.

Opening the annual meeting of the central bank for central bankers, BIS president and chairman Wim Duisenberg said a political commitment was also needed to find a balance between market players and the regulatory authorities.

Despite low global inflation and steady growth there were still short-term risks that could derail the buoyancy of markets.

'Perhaps the most pressing concern is that inflationary pressures in the United States may prove more difficult to tame than is anticipated and the expansion may eventually end abruptly,' he said.

'The question is whether the macro-economic risks have been correctly valued and factored into asset prices or whether the materialisation of any of them could trigger some broader form of retrenchment.' He said financial market deregulation helped create faster growth, through a more efficient allocation of resources, but it also laid financial sectors 'prone to costly misadventures, particularly if encouraged by a climate of macro-economic instability'.

'While we have not yet experienced the economic losses that might be associated with a major failure in payment systems, which now routinely process several trillion dollars worth of payments a day, a few close calls in recent decades were wake-up calls as well.' Regulators must encourage cross-border links, become more market-friendly and transparent.

Mr Duisenberg said that having prudential safety guards and free markets also meant reducing safety net arrangements that served to insulate some parts of the financial industry.

'Dealing with these issues is a task that clearly goes well beyond the remit of prudential supervisors and central banks,' he said.