Financial Crises and the World Banking System

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You can see that banks in Europe continued to have problems for a longer period, and the overall economic problems in Europe [stayed] longer and [were] deeper than in the U. I think to some extent this is still the case today. By and large the banking system here is in better shape than in Europe. Europe has some issues that are specific to them that they still have to deal with.

Most of it is about coordination across the different countries in the EU. All of these issues are just increasing the uncertainty about the stability of the banking union and central regulation … [and] are clearly weighing on the European banking system.

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Herring points to another challenge. Thus, in addition to the financial crisis, Europe has had to contend with a series of country debt crises.

Households have reduced debt, but many are far from financially well

Getting the financial crisis under control globally took a coordination of policies by the G20 governments, wrote IMF Managing Director Christine Lagarde in a recent blog. Central banks slashed policy rates and later sailed deep into unknown seas with unconventional monetary policy. Governments propped up demand with large fiscal stimuluses. But more needs to be done. Bank capital should probably go up further. A lot of the murkier activities are moving toward the shadow banking sector. On top of this, continued financial innovation — including from high frequency trading and fintech — adds to financial stability challenges.

In addition, and perhaps most worryingly of all, policymakers are facing substantial pressure from industry to roll back post-crisis regulations. No one knows exactly how this is going to end, and it clearly puts some uncertainty around [the situation]. The financial crisis has cast a long shadow. Public debt in advanced economies increased by more than 30 percentage points of GDP, which she attributed to economic weakness, efforts to stimulate the economy and for bailing out failing banks.

In the U. Nine million jobs were lost in the crisis and eight million homes were foreclosed in the worst recession since the Great Depression. Government Accountability Office. The impact on the rest of insurers was fairly limited. Today, U. They have been reassessing and adjusting business strategies, growth plans, balance sheet positions, cost bases, organizational structures, scope of activities and geographic presence, according to a January report by the Committee on the Global Financial System CFGS , a central bank forum that monitors global financial markets for stability and other issues.

This is particularly apparent in global, systemically important banks, according to the CFGS. In Europe, the ratio of bank assets to GDP was a mixed bag, plunging in some and rising in others. Banks in emerging markets have not been as impacted by the crisis and continued to show robust growth, the report said. It is now the largest in the world. Since then, the bank has taken steps to strengthen its balance sheet.


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It decided to focus on lending to U. RBS also reduced its global operations down to 13 countries from The bank is expected to continue in a period of major restructuring through The Swiss government rescued UBS in Since then, the bank has moved away from investment banking activities and refocused on its other businesses, in particular global wealth management and retail and corporate banking in Switzerland. As American and European banks regrouped after the crisis, financial institutions in emerging market economies continued to grow.

Chinese banks, in particular, rose to the top of the banking hierarchy with their massive assets. But they also took on a lot of debt. Emerging markets are now a much larger proportion of world GDP than they were 20 years ago, and our economy and that of other industrial economies is much more dependent on their health, but this is more an issue of economic interdependence than financial stability. Another area to watch is financial innovation, which brings risks along with benefits.

But one silver lining is that technology brings about much improved financial data collection and transparency, which helps alert policy makers and investors about potential risks, she adds. For instance, Schwarz says, the new Office of Financial Research has detailed data on the composition of money market mutual funds on its website. The U. Commodity Futures Trading Commission now provides volume data for some of the over-the-counter derivatives such as interest rate swaps and credit default swaps, she adds.

The Federal Reserve now publishes data on repo and funding rates. But, there are still risks, mostly outside of the heavily regulated banking system.

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Schwarz believes that money market mutual fund reform is incomplete. By squeezing one part of the balloon, the pressure goes to another part of it. Meanwhile, the U. Yet finance can also terrorise. When bubbles burst and markets crash, plans paved years into the future can be destroyed. As the impact of the crisis of subsides, leaving its legacy of unemployment and debt, it is worth asking if the right things are being done to support what is good about finance, and to remove what is poisonous. History is a good place to look for answers. Often what starts out as a post-crisis sticking plaster becomes a permanent feature of the system.

If history is any guide, decisions taken now will reverberate for decades. This makes the second trend more troubling. The response to a crisis follows a familiar pattern. It starts with blame.

Committee for the Abolition of Illegitimate Debt

New parts of the financial system are vilified: a new type of bank, investor or asset is identified as the culprit and is then banned or regulated out of existence. It ends by entrenching public backing for private markets: other parts of finance deemed essential are given more state support. It is an approach that seems sensible and reassuring. But it is corrosive. Yet well-intentioned reforms have made this problem worse. The fact that professional investors can lean on the state would have made him angry.

But they also highlight the way in which successive reforms have tended to insulate investors from risk, and thus offer lessons to regulators in the current post-crisis era. If one man deserves credit for both the brilliance and the horrors of modern finance it is Alexander Hamilton, the first Treasury secretary of the United States. In financial terms the young country was a blank canvas: in , just 14 years after the Declaration of Independence, it had five banks and few insurers.

Hamilton wanted a state-of-the-art financial set-up, like that of Britain or Holland. This new bank was an exciting investment opportunity. The initial auction, in July , went well and was oversubscribed within an hour. This was great news for Hamilton, because the two pillars of his system—the bank and the debt—had been designed to support each other.

The plan therefore stoked demand for government debt, while also furnishing the bank with a healthy wedge of safe assets. The bank opened that December. The first was an old friend gone bad, William Duer. The scheming old Etonian was the first Englishman to be blamed for an American financial crisis, but would not be the last. Duer and his accomplices knew that investors needed federal bonds to pay for their BUS shares, so they tried to corner the market.

To fund this scheme Duer borrowed from wealthy friends and, by issuing personal IOUs, from the public.

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He also embezzled from companies he ran. The other problem was the bank itself. Awash with credit, the residents of Philadelphia and New York were gripped by speculative fever. Markets for short sales and futures contracts sprang up. As many as 20 carriages a week raced between the two cities to exploit opportunities for arbitrage. The jitters began in March The BUS began to run low on the hard currency that backed its paper notes. As credit tightened, Duer and his cabal, who often took on new debts in order to repay old ones, started to feel the pinch.

Households have reduced debt, but many are far from financially well

By March 23rd Duer was in prison. But that did not stop the contagion, and firms started to fail. As the pain spread, so did the anger. A mob of angry investors pounded the New York jail where Duer was being held with stones. Hamilton knew what was at stake. And he knew Thomas Jefferson was waiting in the wings to dismantle all he had built.

Hamilton attacked on many fronts: he used public money to buy federal bonds and pep up their prices, helping protect the bank and speculators who had bought at inflated prices. He funnelled cash to troubled lenders. Even as the medicine was taking effect, arguments about how to prevent future slumps had started.


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Everyone agreed that finance had become too frothy. Seeking to protect naive amateurs from risky investments, lawmakers sought outright bans, with rules passed in New York in April outlawing public futures trading. In response to this aggressive regulation a group of 24 traders met on Wall Street—under a Buttonwood tree, the story goes—to set up their own private trading club.


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That group was the precursor of the New York Stock Exchange. With confidence restored, finance flowered. Within half a century New York was a financial superpower: the number of banks and markets shot up, as did GDP. But the rescue had done something else too. By bailing out the banking system, Hamilton had set a precedent. Subsequent crises caused the financial system to become steadily more reliant on state support.