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Sir Paul Tucker is not shy about making an audience feel uncomfortable.
In fact, the crowd was rather ill at ease during Tucker’s presentation at the 70th CFA Institute Annual Conference, and not just because the topic was systemic risk.
“A stable financial system is deeply in the interest of your clients,” the former deputy governor of the Bank of England and current chair of the Systemic Risk Council told the audience. “You and your clients have a massive stake in the direction of banking reforms.”
But we are still only a third of the way through the adjustment process following the vortex of 2008–2009. Globally, only the US Federal Reserve is unwinding the monetary stimulus initiated during the financial crisis. The European Central Bank is actually contemplating further stimulatory measures.
With interest rates effectively still at 0%, the current environment is still quite artificial. Investors can’t really have robust views on relative asset prices and risk premia with rates at zero, according to Tucker. Yet when he plucked the figure of 5% rates out of the air, he caused audible alarm, if not a shiver of fear, among the audience.
Should we be concerned if financial reforms are rolled back? The stakes are high. Tucker believes the very fabric of capitalism would be stretched by another crisis, a perspective with which it is hard to disagree. Some regulatory reforms around the world are not even fully implemented or finalized yet. When a recession inevitably develops, Tucker believes there will be fewer policy tools left to deal with it.
So, is the system even safe? Although averse to rules-based regulation, Tucker thinks the core banking system is now actually better capitalized, with more equity and resilience to absorb shocks, than before.
Exclusively rules-based regulation is doomed to failure. Endemic regulatory arbitrage. Sir Paul Tucker #CFAedge
— Dana Day (@DanaMarieDay) May 23, 2017
But the global environment is less stable after 10 years of monetary stimulus than policymakers could have imagined a decade ago. And their hands are tied. The absolute level of debt is higher now than in 2007, and today most debt sits in the public domain rather than the household sector, where it was 10 years ago.
The authorities have less ammunition in their macroeconomic arsenals than in 2008–2009. Growth must come from productivity improvements. The scale of quantitative easing undertaken in the recent past precludes future asset buying because, for one thing, there isn’t much left for central banks to buy. Finally, Basel III was formulated without the current circumstances in mind.
Tucker had several observations that, taken together, suggest deregulation might perhaps have gone too far since the crisis.
- The core of the banking system must carry more tangible common equity.
- The core system needs to be much less exposed to liquidity risk.
- Central bankers and regulators should take a system-wide view that focuses less on legal form than the economic realities, and more on what an intermediary structure actually does.
- We should seek a simplified network of exposures among banks and insurers.
- Enhanced resolution policies for financial intermediaries should be introduced.
This last point is most important for Tucker. Resolution policies must incentivize intermediaries to make the financial system resilient.
Any bank or intermediary failures should not be socialized. Failure is a critical aspect of the market process and the healthy functioning of capitalism, according to Tucker. But we can’t rely on government regulators to always spot when a firm might be failing. Instead, we should harness market forces and make transparent the kind of information bond managers need to correctly price securities. Central clearing and counterparties must be part of this transparent system. If banks are allowed to fail, then so should the counterparties.
Referring back to the last crisis, in which the US subprime housing bubble may have nearly brought down the world financial system, Tucker believes politics will inevitably come into play because the ordinary people pay the price for failures.
Sir Paul Tucker: reduce crisis impact by 1. Central clearing 2. More liquidity for levered players 3. Plan to clean ip failures #CFAedge
— Keith Black (@CAIA_KeithBlack) May 23, 2017
Tucker does not want to discourage innovation, but he said current circumstances require a system-wide perspective. We cannot go back to the 1950s world of Glass-Steagall, nor should we seek to distinguish too much among forms of non-bank finance. The regulators will always be one step behind the industry.
Finally, Tucker reminded the audience that the United States has a massive stake in international collaboration, a point particularly apt given the worrisome political climate of national isolationism.
In financial terms, countries are highly interlinked and interdependent. A return to capital controls regimes is the only technical way to create a fail-safe system, but regulators are highly unlikely to go back to that. The only strategy that will make our banking and financial systems safe is to collaborate internationally.
“Customers matter,” Tucker concluded, telling the audience of finance professionals, “The success of financial capitalism relies on no community more than yours.”
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Photo courtesy of W. Scott Mitchell