A Decade After Lehman, the Financial System Is Safer. Now We Must Avoid Reform Fatigue
IMF Blog, October 3, 2018
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Bibliographic details
- Authors: Adolfo Barajas, Claudio Raddatz, James P Walsh
- Published: October 3, 2018
Overview
- Publication date: October 3, 2018.
- Context: "In the decade since the collapse of US investment bank Lehman Brothers" triggered the most severe economic crisis since the Great Depression.
- Primary message: Regulation and supervision of the financial sector have been strengthened considerably, reducing the risk of another crisis, but "reform fatigue" risks undermining completion of the agenda and addressing new threats.
- Reference: Findings and recommendations draw on Chapter 2 of the latest Global Financial Stability Report.
Evidence the financial system is safer
- Banks have "thicker and better capital cushions to absorb losses."
- Banks are "better able to convert assets into cash in times of stress."
- Countries use stress tests to check the health of the biggest banks.
- Oversight authorities have been set up "to monitor risks to the financial system."
Remaining gaps in the post-crisis reform agenda
- Leverage ratio:
- The so-called leverage ratio "should be completed" to constrain banks’ ability to expand excessively during boom times.
- Liquidity:
- Pre-crisis behavior: many financial firms borrowed short term in wholesale markets to fund longer-term assets, leading to fire-sale asset sales when rollovers failed.
- Basel Committee reforms introduced the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR).
- Status: "Most countries have adopted the LCR, but the NSFR is still a work in progress. This work must be completed."
- Macroprudential regulation:
- Some countries, including India and the United States, have set up authorities to monitor and contain systemic risks.
- In many places, these authorities "lack sufficient powers and tools to rein in excessive buildup of leverage and mismatches in non-financial corporations and households."
- Cross border cooperation in data sharing and systemic risks "should be improved."
- Shadow banking:
- Progress has been made in overseeing and, to a lesser extent, prudentially regulating shadow banks such as asset-management companies.
- "In many countries, including China and other emerging markets, the rapid growth of shadow banking could pose risks to other areas of the financial system."
- Bank resolution:
- Post-crisis measures make it easier to wind down large banks with greater costs on shareholders and limits on public money.
- "There has been less progress on resolution regimes for insurance companies."
- "Cooperating across borders to address the failure of the world’s largest banks is a particular challenge."
Emerging risks and new challenges
- Cyber risk: "The threat of destabilizing cyber-attacks on financial firms and exchanges."
- Financial technology:
- New technologies offer benefits such as faster and cheaper electronic payments.
- They also "pose challenges" and "pose risks that could amplify shocks to the financial system."
- International cooperation is vital because "innovative technologies spread quickly across borders."
- Risk migration: "Risk tends to rise during good times, and it migrates to new, unexpected corners of the financial system."
Policy recommendations and priorities
- Complete unfinished regulatory work:
- Finish implementation of the leverage ratio.
- Complete work on the Net Stable Funding Ratio (NSFR).
- Strengthen supervisory capacity:
- Supervisors "must not weaken oversight of major banks whose failure could pose a threat to the financial system."
- Empower macroprudential authorities with sufficient powers and tools.
- Improve cross-border cooperation:
- Enhance cross border cooperation in data sharing and systemic risk monitoring.
- Coordinate resolution planning and regimes for global systemically important financial institutions.
- Regulate and monitor nonbank sectors:
- Continue to oversee and extend prudential regulation where warranted to shadow banking and asset-management activities, especially in jurisdictions with rapid growth.
- Balance innovation and safety:
- Strive to "encourage beneficial innovation while safeguarding against risks" from new financial technologies.
- Leverage international cooperation to manage cross-border diffusion of innovations and risks.
- Evaluate impacts:
- With "ten years of experience in implementing the new reforms," conduct an evaluation of the impact of reforms on the broader economy to assess tradeoffs between costs and benefits.
Concluding assessment
- Warning against complacency: "Regulators must avoid complacency."
- Realistic expectation: "It’s not possible to reduce the chance of a crisis to zero, nor should we seek to."
- Strategic imperative: Regulators "mustn’t get caught fighting the last war" and should remain vigilant to shifting sources of risk.
Source: A Decade After Lehman, the Financial System Is Safer. Now We Must Avoid Reform Fatigue — IMF blog, October 3, 2018.
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