In the decade since the financial crisis, the G20 has driven an ambitious programme of reforms that are making the global financial system safer, simpler and fairer.
The challenges now are to ensure there is no return to the errors of the past, and no complacency about the risks of the future. That requires the right attitude and the right institutions.
Global cooperation on financial stability occurs at the Financial Stability Board (FSB). Having agreed all the major international reforms to address the causes of the crisis, FSB members are now pivoting to implementation. In parallel, we are scanning the horizon to identify and address new vulnerabilities that emerge as the structure of our economies and financial systems change.
The G20 reforms since the crisis acknowledge that we cannot anticipate every risk or plan for every contingency. But they also recognise that we can, and must, plan for failure. That means creating an anti-fragile system that is robust to both known risks and unknowns.
Following G20 reforms, the world’s largest banks must hold 10 times more equity than before the crisis.
Regulation has made banks less complex and more focused. Business strategies that relied on high leverage, risky trading activities and wholesale funding are disappearing, as intended. Trading assets have been cut in half, and interbank lending is down by one-third. Banks lend less to each other and more to the real economy.
In response to new global liquidity standards, banks have fundamentally changed their funding models, relying more on deposits, long-term borrowing and capital, and less on flighty short-term debt. UK banks have increased their contingent liquidity tenfold since the crisis.
Ending Too Big to Fail
Higher capital and liquidity requirements are necessary but not sufficient. Banks must also be able to fail without systemic consequences.
A decade ago, large complex banks operated in a ‘heads I win tails you lose’ bubble. To bring back the discipline of the market and end reliance on public funds, FSB members agreed standards to ensure that globally systemic banks can fail safely in the future.
These banks have had to make themselves easier to resolve. They must now hold sufficient debt such that, in the event that one fails, its successor can be recapitalised to support the continued operation of its most important activities.
An anti-fragile system must be as robust to operational failures as to financial ones. While past crises had their roots in financial losses, in our digital era systemic shocks can also come from non-financial sources, including cyberattacks.
Therefore we are literally planning for failure. Many authorities have begun setting standards for how quickly critical financial institutions must restore vital services following a cyberattack. We will conduct cyber stress tests, and prescribe remedial action plans if they fail. The FSB will report next year on a project to develop effective practices relating to a financial institution’s response to and recovery from a cyber incident.
An anti-fragile system requires a comprehensive macroprudential framework. Macroprudential frameworks encourage authorities to meet the next challenge, not simply fight the last war. They prompt exploration of ‘what could happen?’ rather than the false comfort of being ready for what is most likely to happen.
Macroprudential authorities must consider the safety of the financial system as a whole. That requires both comprehensive and varied stress testing of the core as well as regular examination of the risks that may lie beyond the regulatory perimeter.
Success is an orphan
Looking forward, the challenge for policymakers is that, when it comes to financial stability, success is an orphan. As memories fade, complacency sets in and pressure to compromise re-emerges.
G20 members bear the responsibility to safeguard recent progress and address emerging vulnerabilities.
Safeguarding progress does not mean defending all aspects of reform at all costs. The FSB is now assessing what is working as intended and addressing any inefficiencies or unintended consequences.
We will not abolish crises (which have their roots in changes to the real economy and irreducible uncertainty). But with targeted and efficient regulation, and with continued vigilance, we can reduce their frequency and lessen their impact.
As a result, households and businesses can be confident that their financial system will be there for them in bad times as well as good.