You can watch a video of the event here or listen to an audio only podcast here.
Photographs from the event can be seen here.
A summary of the main points of discussion from the event is below:
On Tuesday 28 January, the Systemic Risk Centre organised a panel discussion titled ‘The Next Crisis’. The event was chaired by Malcolm Knight (Visiting Professor of Finance at LSE, advisor to Deutsche Bank and a Member of the Board of Swiss Re reinsurance group) who began by welcoming the audience and pointing out that ‘The Next Crisis’ is something which everyone should be thinking about. Knight conceded that in the five years since the last crisis the authorities have done a lot to strengthen the financial regulatory system. However questions do remain including: are there new risks that need to be recognized and addressed? And will regulators, managers and the private sector have enough insight to do this?
Asked about the strengths and weaknesses of the combination of micro- and macroprudential regulation, Julia Black (Pro-Director of Research at LSE and SRC Programme Director) underlined two main issues relating to how the two join up at the global level. Firstly, the system is lopsided in terms of membership and the main coordinating body, consisting of the G20 countries, may not understand the full sensitivity of the needs of the emerging markets. Such structure clearly hampers anticipating tensions in areas in which they are likely to arise. Secondly, the connection between micro- and macroprudential policy becomes very complex at the global level and causes sluggish functioning of the system.
Charles Goodhart (FMG/SRC, LSE) began by expressing his opinion that the next global crisis is not likely to resemble the last, which was the outcome of a typical property and credit related boom-bust cycle. He argued that financial managers now avoid the over-expansion which previously led them into trouble, because they have become more risk averse and because tighter regulation has been introduced. Therefore a likely source for a future crisis is political mishandling or miscalculation. Goodhart also referred to the regularity of crises in the UK and the fact they all occurred due to bad retail banking. He stressed that very little has been done to reform housing finance and to prevent another property related turmoil. Furthermore, the next property bust is likely be more damaging because the separation of investment and retail banking, inclines the latter to concentrate on real estate.
Jon Danielsson (Co-Director of the SRC) discussed whether the public sector can more effectively identify emerging risks than the private sector can. He argued that because regulators focus on details instead of fundamentals and adopt a backward-looking view, they are unable to prevent crises. Moreover, he noted that providing credit for small and medium enterprises comes at the expense of a perfectly safe system. However, nowadays authorities try to interfere in every aspect of banking and there is therefore a need for a debate about what, if anything, regulators can do better than the private sector. This, Danielsson said, could help set the boundaries between banking and regulation.
Knight then asked the panellists whether financial innovations should be monitored as a potentially considerable part of the emerging risk. Black agreed with this opinion and indicated a new way of thinking about financial markets as risk distribution systems. This perspective emphasises the importance of understanding exactly where the risk is being transferred to when a new product is introduced into the market. Goodhart highlighted the fact that each new financial instrument may be used both for hedging and speculation which raises the problem that regulators cannot tell for which purpose it will serve. Danielsson shared Goodhart’s view and summarised that it is impossible to ban innovation especially as banks will always find a way to take risk.
Then the discussion turned to the faults of the Eurozone regulations. Goodhart pointed out that, European countries made a mistake by treating each other’s sovereign as equally riskless. Moreover, forcing banks to deleverage when the markets were unwilling to absorb any new equity issues slowed down economy growth in the Eurozone. He summarised that the US solution to bail out banks, which was not adopted in Europe, allowed for a successful recapitalisation of their banking system.
Referring to previous comments, Black added that tensions between macroeconomic policy and financial regulation also arise because states are not neutral players in financial markets. Hence they are interested in making sovereign debt attractive to investors or providing easy housing financing options. This leads to the politicisation of financial supervision which often results in a lack of proper stress tests made by macroprudential regulators. Developing this argument Danielson underlined the improvement made by the US government in preparing stress tests using consistent valuation of assets across institutions. He emphasised the need for considering interactions between financial intermediaries and their impact on prices and also noted that banks should not be forced to unify risk assessment, because through doing so they would amplify the crisis by reacting in the same way to shocks. Goodhart agreed with the other panellists adding that there may also be an accountancy problem to resolve, because regulators tend to use ‘mark-to-market’ methodology when they should actually be considering the values that assets would have during a crisis.
Knight also raised the topic of the buyer of last resort: posing the question of why pension funds and insurance companies, with long investment horizons, did not buy undervalued assets which leveraged institutions had to sell? The panellists agreed that it is due to regulation: which prevents excessive risk taking and triggers flight to safety debt. They concluded that there is a need for a buyer of last resort which can alleviate the pressure on the market because otherwise this role has to be fulfilled by the government.
Lastly, the panellists commented on the areas which macroprudential policy should focus on and whether publishing aggregate data about risk concentration could be helpful. Danielsson argued that collecting coherent data about the entire banking system is impossible because it involves lots of individual institutions, IT systems and data structures. Hence the government is not apt to do it. Goodhart emphasised the problems arising from the fact that macroprudential policy should be countercyclical. This is however very difficult to implement because after the crisis microprudential regulations are usually tightened which slows down recovery. Two of the solutions suggested by Goodhart were: funding for lending and help to buy schemes. In the end Black noted that dynamics of behaviour in equity and credit markets are different and this should be taken into account. She also mentioned that the consequences of macroprudential policy are much clearer compared to monetary policy but that they can exhibit negative spill over effects.
The debate was followed by the lively Q&A session in which the audience asked about: concentration and competition in banking, net value added of the financial system, nationalisation and scope of regulation, fraud and dishonesty in the financial system and difficulties in the international cooperation.