Opinion Pieces

Avoiding a Repeat Performance of the Financial Crisis

As economists predict that another global recession is in the wings, have international leaders done their homework in the wake of the last global financial crisis?

Some 12 years after the global financial crisis that began in 2007, increasing numbers of economists are predicting that another recession could be just around the corner. This is a worrying possibility given that the economic recovery from the previous recession was uncertain, slow, and only gained pace in recent years. This mediocre performance was achieved, in part, through highly unorthodox policies on the part of central banks, notably the mass purchases of billions of dollars’ worth of financial assets known as quantitative easing, conducted across most of the developed world. These policies ensured stability and prevented a Great-Depression-style calamity, but may have fostered unsustainable financial bubbles, notably in the property and tech sectors. Economic booms and busts are however notoriously difficult to predict.

The specter of recession offers a timely juncture to take stock of progress that has been made since 2007 to stabilize global financial markets. After all, when it comes to economic policy, governments can learn lessons from their setbacks, giving them a chance of avoiding the same problems recurring in the future.

The Bertelsmann Stiftung’s Sustainable Governance Indicators (SGI) provide some insight into the work which has been achieved thus far. The SGI notably scores OECD and EU countries according to their contribution to the global financial system, taking into account their support for international financial regulation, tier 1 capital ratios, and the share of their banks’ non-performing loans.

Most developed nations are moving forward

According to these indicators, the vast majority of developed countries have clocked up progress since 2014, with only a few countries backsliding. A notable example of progress is Ireland, which according to the 2018 SGI country report, improved its rating on its contribution to the global financial system, rising from 4.0 of a possible ten points in 2014 to 6.1 in 2018, thanks to the adoption of European financial norms, an improvement in Irish banks’ capital ratio, and a drastic reduction in non-performing loans (although these remain somewhat high).

The best-performing states include Canada, Germany, Sweden, and Finland. These nations are among the leaders in addressing the weaknesses in their domestic financial sector and in setting the agenda for high global standards. Other Western European countries and Australia are also generally strong performers.

Many nations, however, have taken a less proactive approach. Secondary players or weak performers are concentrated in Latin America and Eastern Europe although the comparatively small size of these economies mean that they do not pose a threat to global financial stability. And even here, banks have often taken advantage of the recovery to consolidate their finances, as seen in Romania and Romania.

Only a few countries have seen their SGI rating for global financial stability decline in recent years. But notably, there are big names among them: South Korea, Japan, and the United States of America. South Korea and Japan have remained relatively indifferent to international regulatory initiatives, preferring to focus on own national approaches, a common East-Asian developmental model.

American vulnerability

America’s backsliding is more novel. While Wall Street formed the epicenter of the global financial crisis, the United States had taken a leading role to push for tougher financial regulation. As the SGI report for the U.S. noted: “U.S. regulators generally preferred stronger rules than international standards required.” However, the report goes into detail on how under President Donald Trump’s erratic and nativist administration, the U.S. has ceased to support stronger financial regulatory standards at the G20.

This overview of the pace of regulatory reform must be qualified by the general diversity of national economies and financial systems, as well as the complex interdependencies between systems due to cross-border lending and investment. In some countries, property bubbles or over-indebted consumers might mean financial systems are more vulnerable than they appear on the surface.

The question is whether the global financial system as a whole can take the strain of the next crisis and whether the new rules and institutions set up will prove sufficient. Only time will tell. However, if governments wish to have an open international financial system – which theoretically may foster greater growth and more efficient allocation of resources – then strong rules must be in place to prevent the problems of one country’s financial system from contaminating the rest of the world. With the United States withdrawing – at least for now – from global leadership in this area, this leaves an opening for other countries to come forward to set the direction for the world’s financial architecture.