published 8 July 2009
08 July 2009
This document sets out for discussion and comment over the Summer, the UK Government’s view of causes of the financial crisis (world economy hit by the worst global economic downturn for 60 years)in terms of:
- actions taken to restore financial stability; and
- further reforms to strengthen the financial system.
The document lists the main causes of the crisis:-
- failures of market discipline (corp. governance, risk mgt, remuneration policy) (for my discussion see also www.bankingeconomics.blogspot.com)
- banks, boards, investors did not fully know complexities of their own businesses;
- regulators and central banks failed to fully account for excessive risks taken by firms, and inadequately understood system-wide risk; and
- failure of regulations to respond to changes in fin. mkts. increasing complexity and systemic risk, or
- failure read the trends of systemic risks build up during economic upswings.
In my view these are working assumptions more than proven causes. Regulations were in place but not fully implemented; Basel II was too late to make a big difference. It takes years for the culture around new regulations to mature, especially the requirements to correlate banking with the wider economy. The warning signs of asset bubbles and systemic risk were available to those willing to look for and spot them. The problem was more that bankers did not have to accept sound advice and cogent warnings delivered by regulators and central banks. The stability reviews published alongside general financial sector statistics were read by relatively very few people. Banks were being managed at the top by directors lacking comprehensive understanding and training about the totality of banking. Warnings were too sophisticated and academically (or 'intellectually') expressed. Central bankers have presumed banks possess more risk management and liquidity management sensitivety and than top bankers have been willing to tolerate or take seriously, especially maco-prudential banking economics.
The report defines the UK Government-led efforts, at home and abroad, "to respond to the immediate challenges of the financial crisis by restoring stability, and reforming banking regulation." Actions to reform banking regulation include the Banking Act 2009; Turner Review of financial regulation; and Walker Review of Corporate Governance of UK Banking Industry. This statement ignores the more important contribution to G20 and EU joint initiatives as also expressed in the following graphic:
As set out in this paper there are a number of core issues that the Government's regulatory reform must respond to: - strengthening UK’s regulatory institutional framework, so that it is better equipped to deal with all firms and globally interconnected markets and firms;
- supervising high impact firms seen as “too big to fail”;
- identifying and managing systemic risk across financial markets and over time;
- working with international partners for global responses to the financial crisis.
The idea here is more thoroughly improved market discipline and improved supervisory focus on major firms. A huge problem with the objective is that 'market discipline' is generally poorly defined, especially in the context of systemic risks where all major firms are feeding asset bubbles.
The document says Governments around the world have acted decisively to support their financial systems. This is variously true, but generally correct. Insolvency and liquidity risk management reuire considerably more detailed work than made explicit in global standards and risk accounting frameworks. The Treasury report says of support for financial systems that this "has been necessary to protect depositors , ensure that banks lend to the economy and restore financial stability".
This is so, but it is not at all clear yet that banks are living up to their side of the bargain with governments to maintain lending or actively doing whatever is needed to restore financial stability. Individual banks are not acting to mitigate and cure systemic risk problems; they are too focused on saving themselves only.
The report states the usual general abstraction that "Government remains firmly committed to ensuring that the UK financial services market remains competitive and fair for consumers, who, faced by the events of the global financial crisis, need additional support and protection. The Paper brings forward proposals to support consumers and bolster competition."
It is not at all clear what is truly meant by competition and competitiveness, and it is doubtful that the government itself knows what it means either, just sounds good. Financial services firms do more trading and collaborative ventures with each other than they directly compete with each other. While there are many areas where banks compete such as for investment fund, high net worth and corporate finance mandates, there are just as powerful business activities where they collaborate or co-conspire, and this is also reflected in a myriad of cross-shareholdings.
The media barely registered the Treasury Report and have been fixated on the issue of structural reform of the so-called tripartite national regulatory system. Banking regulation is more complex than this since it includes international dimensions. But the Treasury Report sets out the remit of a Financial Stability Council. This effectively should provide a turret to focus on systemic risk and especially on the financial sector's impacts on the UK economy. maintaining credit flow to the economy and diversified credit risk across the economy are emphasised repeatedly. The banks are to become more cyclically-minded while at the same time more resilient in order to maintain credit to the economy through the worst of cyclical downturns. What is not clearly enunicated are the dimensions of this and there is not statement of the counter-cyclical role of government finance and spending that operates with or without the collaborations of banks! The Treasury paper has I believe also missed the opportunity to clearly enunciate and provide scale and macro-model results for what the government measures, both fiscal stance and financial infusions, are expected to achieve. There is a failure to express adequately the basis whereby the proportionality of the government's measures was determined.
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