Fearful financial markets, an uncertain growth outlook, fiscal anxieties, long unemployment lines….no other financial crisis since the Great Depression has led to such widespread dislocation in financial markets, with such abrupt consequences for growth, trade, and employment.
The crisis exposed fundamental weaknesses in many areas of the world economy, the most obvious being dramatic deficiencies in the regulation and supervision―nationally and internationally―of financial institutions and markets.
On the bright side, the crisis has provided the impetus for a major overhaul of the financial regulatory system. So, are we making the most of this opportunity to fix the system?
Three years into this crisis, the good news is that policymakers have made important progress in some areas, and the work underway is moving in the right direction.
The bad news is that we are barely half way there and the hardest part may lie ahead. In a new Staff Position Note, Shaping the New Financial System, we examine just how far we’ve come and, more importantly, how much further we have to go. Indeed, unless we—the collective “we”—make concrete progress over the next 12 months in a few key areas, we may well sow the seeds of the next financial crisis.
What are the guiding principles of this urgent work? The first is to build a financial system that provides a solid foundation for strong and sustainable economic growth; one that satisfies, first and foremost, the needs of households and firms. The second is to address the risks posed by the entire financial system, not just banks.
The recent proposals of the Basel Committee on Banking Supervision represent a substantial improvement in the quality and quantity of bank capital, but these apply only to a subset of the financial system, and they don’t yet include macroprudential considerations, that is, systemic issues and the impact of the business cycle on how financial institutions function.
Real progress is therefore needed over the next year in several key areas―areas where much has been said, but less accomplished. The financial sector remains the Achilles’ Heel of the global recovery. Prompt action is essential to alleviate regulatory uncertainty, which is acting as a drag on credit and economic growth, and to reduce the likelihood of another crisis.
Policymakers need to make progress in the following five areas:
More than just focusing on the right issues with sufficient vigor, the official sector needs ‘buy in’ from the private sector for these new rules. This will require rules that encourage the industry to reduce their collective risk taking, through better risk measurement and risk management, and with boards of directors that are empowered to rein in excessive risk taking, and be held accountable for it.
Finally, since the issues are complex and involve many conflicting interests, we need political commitment at the highest levels. To borrow from the success of the Nike spirit in the corporate world, policymakers need to “just do it”.
