After one of the most tumultuous decades in both living memory and by any historical measure, we are seeing overall global stability and economic recovery finally beginning to gather steam. Many lessons have been learned since August 2007 and, even during the darkest hours of the global financial crisis, there was much that world leaders did well. At the same time, 10 years from the onset of the crisis, there’s much still to be done to ensure that the (1) world economy continues its upward trajectory and (2) we’re fully prepared to weather any future shocks.
So what has the world done well?
The G20 set a precedent for emergency coordination of monetary and fiscal responses to the crisis, and this unity and common purpose was a critical building block. Starting with the London Summit in 2009, the United States set the tone with a $1.1 trillion stimulus to help avert the threat of global depression. World leaders did their utmost to give a global response to a global crisis, to keep each other appraised of developments and, importantly, to speak with one unified voice. That also laid the foundations for strengthened cooperation to help prevent future crises. At the same time, international gatekeepers such as the International Monetary Fund were revived and repurposed to provide an invaluable financial safety net, with members increasing its emergency lending capacity while reforming its governance structures.
Important macro-prudential and supervisory changes were adopted during this period. First, capital requirements were established ensuring that a minimum common equity Tier 1 ratio of 4.5% would be maintained at all times by banks. Second, an increased leverage ratio of more than 3% was ushered in. Third, liquidity requirements were increased.
Basel III and Solvency II, as well as the EU Single Resolution Mechanism, were inherited from this new regulation paradigm. As a result, bank activity is now much less risky and more secure for consumers. In the United States, the Volcker Rule against speculative investments and the Dodd-Frank Wall Street Reform and Consumer Protection Act secured the backdrop for the financial sector to play its critical facilitating role during the recovery.
Stress tests were generalized and standardized during this period and financial sector communication was more rigorously scrutinized to deliver essential transparency. Endogenous and contagion risks were also looked at in detail. That was exemplified in the “too big to fail” reforms, which identified systematically important financial institutions (SIFIs) and imposed on them higher capital adequacy requirements, more intense supervision, and better tools for resolution, including the establishment of the Financial Stability Board in Basel.
What do we still need to learn?
World leaders only meet and truly make progress in times of crisis. The G20 has, arguably, lost some of its luster in recent years while risks have increased. From the major debt overhang to experimental monetary policy, to political risk and protectionism, including financial protectionism, the world must address looming challenges proactively to avoid further divergence.
Multilateral bodies must advance policy coordination, avoiding half-baked reforms such as the generalization of resolution mechanisms that protect taxpayers, the so-called “bail-ins.” These bodies must also continue to promote responsible use of, and access to, finance, while standing ready for the next crisis.
The recovery in the banking system has been unequal. Some banks remain undercapitalized while non-performing loans plague the balance sheets in southern Europe. In addition, asset ring-fencing has increased the linkage between banks and governments. In the United States, financial regulation may be overhauled at a time of unprecedented liquidity, creating new financial risks. Indeed, an asymmetric regulation nudge could create unnecessary competition, excessive speculation, and moral-hazard type behaviors. Regulatory blind spots — such as shadow banking, especially in emerging markets, are many. At the same time, excessive regulation has fueled the savings glut and hindered investment growth.
Financial stress is evident everywhere, from household debt levels to the sovereign bond markets, to bubbling asset classes. As a result, complexity and over-engineering can give a false sense of security. There will always be unknown unknowns. Simplicity, critical thinking and in part, self-regulation should complement regulatory change, which often arrives too late.
This last point is critical for future success. Too many rules often mask a lack of trust and purpose; yet both are paramount, as finance is a good servant but a poor master.
Ludovic Subran is global head of macroeconomic research at Allianz and chief economist at Euler Hermes, where he has worked since 2011. He heads a team experts responsible for macroeconomic forecasts and sector analyses worldwide. Before joining Euler Hermes, Subran worked for the French Ministry of Finance and the United Nations’ World Food Program as economic advisor.