Financial stability was not the most headline-grabbing topic discussed at the Brisbane G20 meeting, but judging from the official communique word-count (a full 175-word paragraph in the three-page document, plus four substantial items in the annexes), a fair bit must have happened.
Governor of the Bank of England and Chairman of the Financial Stability Board, Mark Carney.
The main promise given before the meeting was that the issue of 'too-big-to-fail' would be solved. Indeed, progress has been made on this issue, at least at the highest level of banks which are so large that their failure would present a threat to the global financial system.
There are around 20 such banks (G-SIBs), and new rules dictate that they will have to hold substantially more capital. Capital can be measured in various ways (either as a simple leverage ratio comparing capital with the total assets, or comparing capital with the risk-weighted assets). But measured either way, the G-SIBs will have to have about twice as much capital as ordinary banks.
Even this level of loss-absorbing capital is not a guarantee against failure, but it makes it much less likely that these banks would have to be bailed out by taxpayers as happened too often in the 2008 crisis.
The most accessible description of what was achieved can be found in Bank of England Governor Mark Carney's speech in Singapore on his way home from the Brisbane meeting. As Chairman of the Financial Stability Board (the operational body which has been working hard to put these new measures in place), Carney wants to put the new measures in the best light. And of course progress has been made. But does it fix the problem?
One dissenting voice, economist Avinash Persaud, doubts that the extra capital will really be available in the event of a systemic crisis. Much of the extra capital comes in the form of contingent convertible bonds (COCOs), which pay a yield like a normal bond but can be compulsorily 'bailed in' if the bank is in distress and needs a top-up of capital. Persaud argues that these bonds will be held by insurance and pension funds and that in a systemic crisis, bailing them in will be politically unacceptable. Certainly judging from the yields at which COCOs have been issued so far, the investors see them as more-or-less the same as ordinary bonds, with little or no chance of ever being bailed in.
Others see additional capital as a misdirected answer to the problem. What went wrong in the period before the crisis reflected managerial failure in the troubled banks. They were run by people who had the wrong mindset and the wrong incentives. They were not conservative risk-averse bankers but risk-takers, egged on by boards and shareholders demanding that they shift along the risk/return trade-off to pump up profits and share prices.
The answer, then, is not more capital but a different managerial style. To make banks safe they have to be separated from the free-wheeling go-getting parts of the financial sector and put back in the old-fashioned world of dull commercial banking. Various attempts to do this (Dodd-Frank in the US and ring-fencing in the UK and Europe) have not gone far enough. But to implement this solution would see the end of universal banking and a return to something at least as restrictive as Glass-Steagall, which is unacceptable to the powerful financial sector.
All is not lost. The new measures will undoubtedly put a bigger loss-absorbing capital buffer into the G-SIB balance sheets. Now individual countries will have to try to do the same for their banks which are not G-SIBs, but which are big enough to bring down their own domestic financial systems. Thus Carney is right to take some pride in what has been achieved in the six years since the crisis, while at the same time acknowledging that there is still further to go.
There is time for further improvement. The fresh memory of the 2008 crisis is the main insurance against a repetition. As well, the 2008 experience affirms an old truth, that where macro policies are sound and prudential regulators are diligent and politically well supported, financial systems are pretty safe.
Photo courtesy of Flickr user www.bankofengland.co.uk