Piroska Nagy-Mohasci, 12 Feb 2018
Starting off with a bit of scolding of financial sector regulators and professionals, Piroska Nagy-Mohacsi asserted that, in the wake of the financial crisis, financial institutions and individuals who manage them have been prone to congratulate themselves on their success on returning the market to its pre-2008 levels, rather than taking responsibility for the crisis which they, in fact, caused. To be fair, there have been significant advances in regulation during the crisis and post-crisis period. A new layer of micro-prudential policies, affecting individual banks, was instituted, along with macro-prudential policies, and the identification of international and domestic banks whose central place in a given economy necessitated higher capital requirements.
Overall, studies show that post-crisis banks are both better capitalized and more liquid than before. The benefit of this achievement should not be underestimated. Domestically, macro-prudential policy has arguably avert crises in the cases of Iceland, Croatia, and Spain. Additionally, in 2013, with the economic shock created by the US’s “taper tantrum” it was the countries with the strongest macro-prudential policy which were least affected. Notwithstanding this success on the part of financial regulators, Nagy-Mohacsi points to several “elephants in the room” which are not being properly addressed by the financial community.
The first such “elephant” is, fittingly, excessively large banks. In the post-crisis period, the average bank is even larger than before. This raises the question: is it necessarily a negative to have larger banks? Some would argue that larger banks allow for more efficient financial transactions. To dispel this theory Nagy-Mohacsi looks at the history of the German
banking system. Following the end of World War II the three largest German banks were broken up into 30 units. In 1952, due to the modernization of Germany and the threat of communism, German banks were allowed to re-monopolize into three entities. Analyses of this period show that the reformation of the banks did not result in greater cost efficiency or volumes of lending. What was seen was an increase in these banks’ media output, and thereby in their political presence.
The second “elephant” is China. From 2000 to the present, China’s economy has quadrupled. As a result of this growth China has now the world’s largest banking sector, with deep connections to the international market. Additionally, China has a large domestic shadow banking sector. The underground nature of this sector makes it difficult to assess its stability or predict its behavior. The concern is that a domestic shock could spread from China’s shadow banking sector into the international market.
The third and final economic elephant is an even more shadowy financial market: cryptocurrency. Currently, the cryptocurrency market is valued at 0.5 trillion USD, although it is extremely volatile, having previously peaked at around 0.8 trillion USD. This unregulated economy has recently drawn the ire of many regulators, with Augustin Carstens of the BIS stating “Bitcoin is a combination of a bubble, a ponzi scheme, and an environmental disaster.” Nagy-Mohacsi did not fully accept such an alarmist outlook but addressed the main criticisms of cryptocurrency. The first criticism is that private money, not tied to a central bank, has been unsustainable historically. A clear argument against this is that, prior to the creation of central banks, all currency was private currency and so it is hard to claim that there is no precedent for its success. Furthermore, there are many examples of government action eroding trust in a currency, so the same argument could be applied to central banks. Another concern is that consumers don’t understand the risk of investment in cryptocurrencies, and it is the government's duty to protect its citizens from the volatility of such investments. Besides the obvious objection that this is an excessively paternalistic view of the role of government, Nagy-Mohacsi argues that it is important to allow some degree of risk, as unsuccessful investments are necessary to convince investors to be prudent in the future. Finally, many bankers are concerned that, blockchain, the technology behind cryptocurrencies, is not as robust as it looks, and could unleash a storm of instability if not properly shored up. In particular, it has the potential to take the place of banks in many transactions. This threat to banks should not be looked on by regulators as a threat to the economy but rather the opposite, as the fact the blockchain is taken so seriously by banks shows its potential to create innovation and economic growth.
by Solomon La Piana
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