Vital insights into the risks facing the global financial system were given when Andy Haldane, Executive Director for Financial Stability at the Bank of England, delivered a lecture at the Oxford Martin School this week.
Looking first at the systemic nature of risk to banks and countries, he said: “One of the key lessons of the financial crisis is that the financial system is a system. That may sound completely obvious but much of the pre-crisis orthodoxy was not to think in this systemic way. Indeed we convinced ourselves pre-crisis that if each individual node in the network was safe that was sufficient to safeguard systemic stability. How wrong we were; each of the blocks in the tower might have looked safe but the tower itself wasn’t."
But Mr Haldane said that while this lesson had been learned in respect of international banking, where new safeguards had been put in place, it had not translated to the international monetary system. “There are no rules of the road, no architecture for co-ordinating monetary systems," he said. "The key lesson we should have learned from the crisis hasn’t yet been applied to the management of international monetary and financial systems. That is the intellectual fault line.
“We need look no further than events of the past six months, or even of the past week. The US federal reserve embarked on a programme of tapering, slowing down the rate at which they supply new money to the US economy. The spillover was pretty immediate and pretty dramatic. Exchange rates are falling and bond yields are rising in South Africa, India, Turkey, Brazil and Russia. It has a direct effect on what’s happening in other economies. People pursue policies for individual economies when what’s at stake is the system as a whole."
He said these spillovers were greater now than ever in the past, due to the global integration of good and services and trade in financial assets. “Global financial integration has gone through a revolution in the last 30 years. Is this good news or bad? The answer is both – it is a double-edged sword. We have improved risk sharing, but at the same time enhanced risk spreading. If pain is sufficiently acute it can become a contagion, and this is something that Professor Ian Goldin has discussed in his books.
“We went from the ‘Great Moderation’, a period of 20 to 30 years when we appeared to have solved the problems of boom and bust, to the ‘Great Recession’, when we fell off a cliff edge. This is evidence of this inter-connectedness, of the greater level of systemic risk."
Mr Haldane said governments now needed to look at what degree of integration made sense from a productivity and growth perspective, and whether the global financial system had adequate insurance against systemic risks. The good news, he said, was that since the Asian financial crisis of 1987-88, countries had chosen to build up larger reserves, and multi-lateral contributions since 2009 had increased the financing ability of the IMF. Liabilities had increased, however, and reserves were “increasingly concentrated in a small number of countries” such as China, Germany and Middle Eastern countries, he explained, adding: “Where they are concentrated is not necessarily where they are needed.”
What was needed to safeguard against systemic risk, he said, was improved multi-lateral surveillance to better spot crises, better debt structure, and improved capital flow and multi-lateral facilities. He said progress had been made on systemic monitoring by the IMF, which now produces ‘spillover reports’, but that it was harder for the fund to monitor “the biggest boys in the playground” than countried such as Iceland or Cyprus.
Concluding, he said: “The biggest lesson we have learnt has been largely ignored when it comes to the international monetary and financial system. That chasm needs to be closed before any more countries find themselves imperilled. It calls for a radical reform agenda if we are to avoid living again the crises of the past.”