Bank for International Settlements, Basel, Switzerland.

The Bank for International Settlements (BIS) known as the bank for central banks, which was founded in Basel, Switzerland in 1930, today issued its 79th Annual Report, and said financial products should be treated like medicines and sold to consumers only when they are certified safe to prevent a repeat of global financial crisis. The BIS said government efforts to revive the global economy might have only a temporary impact because banks are not being pushed hard enough to fix their underlying problems.

"I think that we are not out of the woods yet," said Guillermo Ortiz, Mexico's central bank governor and the BIS board chairman. "One important question is whether these green shoots actually take root."

The BIS said the balance sheets of many financial institutions have still not been repaired. Further steps are needed to address this. A healthy financial system is a precondition for the effectiveness of expansionary policies and for stable long-run real growth. It is “essential that authorities … repair the financial system,” notes the Annual Report and “persevere until the job is done.” And they should resist financial protectionism, sometimes an unintended consequence of national support for the financial sector, as this would moderate growth and development.

The BIS said governments and the private sector have to work together to build a more resilient financial system. Addressing the broad failures revealed by the crisis means that systemic risk in all its guises must be identified and mitigated, adopting a macroprudential perspective - - a core theme of the BIS’s work for many years. Guillermo Ortiz noted that “the work will have to be coordinated internationally across a wide range of countries. In particular, institutions with expertise in the field – including the Financial Stability Board and standard-setting committees - - will need to play a leading role”.

The BIS Annual Report argues that financial instruments, markets and institutions all require reform if a truly robust system is to emerge. For instruments, it means a mechanism that rates their safety, limits their availability and provides warnings about their suitability and risks. For markets, it means encouraging trading and clearing through central counterparties and exchanges. For institutions, it means the comprehensive application of enhanced prudential standards that integrate a system-wide perspective. Above all, regulators and supervisors must adopt a macroprudential orientation. By focusing on the stability of the system as a whole, as much as on the viability of individual institutions, it would reduce the probability of joint failures that arise from common exposures and at the same time moderate the procyclicality inherent in the financial system. Speaking today, BIS General Manager Jaime Caruana stressed that“there are several projects under way to make the macroprudential approach operational, building on the new-found international consensus supporting it. The BIS is actively involved in all of these initiatives”.

The BIS said better regulation is not enough. Macroeconomic policies can and must play a role in promoting financial stability. For monetary policy, this means taking better account of asset prices and credit booms; for fiscal policy, it means putting a premium on medium-term fiscal discipline and long-term sustainability.

The Bank said there’s a risk central banks will raise interest rates and withdraw emergency liquidity too late, triggering inflation.

History shows that policy makers “have a tendency to be late, tightening financial conditions slowly for fear of doing it prematurely or too severely,” the BIS, which oversees central banks, said in its annual report published today in Basel, Switzerland.“Because their current expansionary actions were prompted by a nearly catastrophic crisis, central bankers’ fears of reversing too quickly are likely to be particularly intense, increasing the risk that they will tighten too late.”

“At some point the economy will recover and monetary and fiscal easing will have to be reversed,” the BIS said. Still, “identifying when to tighten is difficult even at the best of times, but even more so at the current stage.”

With banks reluctant to lend to each others and companies cutting jobs and output to weather a slump in exports, the global economy may struggle to gather strength. The BIS said there’s a “significant risk” that monetary and fiscal stimulus will lead only to “a temporary pickup in growth, followed by a protracted stagnation.”

“True, one risk is exiting too early,”Jaime Caruana said at a press conference in Basel today.“But experience suggests that the bigger risk is exiting too late and too slowly.”

The 79th Annual Report was presented at the Bank’s Annual General Meeting, held today in Basel, and chaired by Guillermo Ortiz. The Bank reported a balance sheet total of SDR* 255 billion ($381 billion) at end-March 2009, a decrease of SDR56 billion over the past year. Net profit was 18% lower than for the previous financial year, amounting to SDR446 million ($666 million). Currency deposits by customers represent some 4% of the world’s total foreign exchange reserves.

The BIS’s 55 shareholding central banks will receive a dividend of SDR265 per share, unchanged from the previous financial year.

*The SDR is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries.