MDAE Speaker Series with Anoop Singh: A Report
Dr. Anoop Singh has been among India’s finest macroeconomists for the better part of four decades. In his distinguished career, Dr. Singh has worked on issues related to macroeconomic policy and financial regulation while holding various positions at the World Bank, IMF, JP Morgan and the Reserve Bank of India.
Dr. Singh delivered a lecture entitled “The Global Financial Crisis of 2008 and Rebuilding the Financial System” as part of the Speaker Series at the Academy. The financial crisis of 2008 was a monumental event in global financial history and continues to define our understanding of economies today. Dr. Singh focused on trends that had begun to emerge in the United States as well as in other major economies prior to the onset of the financial crisis. One of the pillars of Dr. Singh’s lecture was a discussion on emergence and source of excessive liquidity in markets, and the subsequent formation of asset bubbles.
Speaking to a packed house, Dr. Singh encouraged the audience to reflect on some of these issues: Why was there so much excess liquidity in the U.S. in 2007-08? What effects may have occurred due to this in other nations? Why was the US economy continuing to allow capital inflows from China? Is there a crisis emerging today and what is the role of Systemically Important Banks (G-SIBs) in the coming decades? Where could such a situation take hold, and what would be the contagion effects at this time of immense financial integration? Given the disastrous consequences of excessive leveraging, was it possible for the financial industry to de-risk itself?
A key takeaway from the talk was the nature of the deep complexity involved, particularly in the regulation of capital flows and identification of crises. In Dr. Singh’s view, it is imperative that we ‘’rethink crises” and be better prepared to mitigate the effects of any future financial disasters.
In 2007, Europe’s numbers were bleak but disguised the economic resilience of the German economy. The Japanese economy was still in a period of stagnation and consumer demand remained weak. China’s current account surplus had sky-rocketed to 10% of GDP – a historic high for any country, while severely distorting prices which was no more evident than in the real cost of capital. In the US, household debt was climbing but savings had begun to slide. Excess liquidity and loose monetary policy coupled to rapidly turn an uncertain situation into a downright dangerous one. This effect was compounded by the rise of CDOs, structured policies and the subprime mortgage frenzy.
The harsh reality is that despite the tensions emerging within the global economy, most economists did not see what Central Bankers and markets were caught unawares. To this end, the United States’ Financial Stability Board and other G20 member countries have considerably increased coordination on these issues. As a result, Basel III regulations are now front and center.
These regulations are paving way for reducing systemic risks by developing frameworks related to bank capital adequacy and liquidity at a global level. A major thrust of the new rules is to do with the quality of capital. Low quality capital has led to paralysis within the banking system when swift action is necessary. Addressing this concern is key to the global dialogue on capital. Dr. Singh suggests that such measures would shield the tax payer from the bailouts offered to the big banks. At the same time, Dr. Singh advocates that banks must institutionalize ‘living wills’ to tackle the risk of contagion which often outweighs the risk of the crisis itself. Post crises, there has been an increase in demand for greater regulatory supervision of trades, and legislative actions such as the Dodd- Frank Act in the US were drawn up with this view in mind.
Given the fast changing times we are living in, and a global pivot towards Asia, a number of questions regarding equity and consistency have begun to emerge. Country-wise conditions are unique and this has further complicated the task of deciding upon the capital structure, quality of assets and risk identification techniques that banks should be adhering to. For example, the vast shadow banking system in China has been responsible for a surge in liquidity that is beyond the reach of regulation.This build-up in liquidity can be a bad omen for things to come, but there are few tools to effectively tackle this issue. In such cases, the need of the hour may be cultural and institutional changes that may take a long time to come to fruition.
Another major point of contention, and perhaps the most hotly debated topic in finance and macroeconomics today, is the manner in which banks should access risk. Traditionally, banks have employed in-house technology and expertise to determine the ‘riskiness’ of a loan or any other asset. Cultural risks in particular have been difficult to manage and regulators have not taken any action against specific individuals for excessive speculation or flouting norms. However, the disastrous effects of the financial crisis have convinced many to suggest that banks should be instructed on how risk should be determined. This comes back to the difficulty that a global regime would face in addressing a variety of location specific needs. Dr. Singh fears that such an action may reduce banks to “utilities”. Walking the fine line between regulatory overhaul and regulatory overreach is no simple matter – especially with the sheer variety of interests at play. Not striking a sustainable balance may threaten the independence of banks and may prove costly for the economic system as a whole. For example, a big increase in the capital requirements of banks could suddenly make it harder for start-ups and other innovative enterprises to access capital due to the absence of a proven business model.
Despite the many obstacles, greater global coordination of macro-level capital flows has come to dominate the discourse on preventing another crisis like that of 2008. According to Dr. Singh, countries like India do have a lot to gain from participating in these negotiations. Much of the growth in the coming decades will depend on foreign capital flows and properly accommodating these should be a priority. The sustained efforts and initiatives such as Basel III norms constitute a great intellectual achievement. However, the sheer complexity and the fluid nature of the challenges at hand make this an incredibly important but difficult and controversial issue to grapple with.
Date(s) - 08/12/2016
4:00 pm - 6:00 pm