"Financial Sector Reform: Building A Banking System for a Global Economy"
Dr. Philippa Malmgren
Deputy Head of Global Strategy
Warburg Dillon Read
Good afternoon distinguished guests. I always think it is quite hard to keep people's attention right after a sumptuous lunch which is why I am delighted to introduce a session on "Financial Sector Reform: Building A Banking System for a Global Economy". The debate about the new financial architecture has evolved as dramatically as the world's economic recovery. In the aftermath of the financial crisis there was a good deal of debate about whether or not the global banking system had served us well. As a result the US in particular pushed for a new financial architecture. Then the debate was about whether or not there really has been any new financial architecture. Now we have a debate about whether or not we should retain whatever remains of the old financial architecture. Just in the last few weeks we have seen the Meltzer Report on the IMF commissioned by Congress argue that the powers and the balance sheet of the IMF should be substantially reduced. We have come full circle.
Meanwhile the world economy has shifted out of crisis and into perhaps complacency; at least this is what former Treasury Secretary Robert Rubin has been arguing lately. We need to examine our banking systems especially when times are good. It is therefore important for business people and policy-makers alike to know that the financial markets are deeply divided about whether or not the global economy and the global banking system are vulnerable.
The division of views is between those who believe the world economy is safe and those who believe it is not. Here are two quick examples. Japan and the US. Japan still dealing with the aftermath of its last banking crisis. The market is divided between those who argue that the banking system remains incapable of providing the credit necessary to support a sustainable recovery, therefore the banking system is a source of vulnerability for the world economy. Then there are those who argue that it is a very good thing that the banks are no longer making loans on the back of property valuations or keiretsu relationships. Clearly a new lending culture is being put in place, one which is based on cash flow analysis. This will make the banking system stronger not weaker in future. Perhaps this same debate is going on throughout many emerging markets as well.
Then there is the US. Here opinions are perhaps even more deeply divided about the robustness of the banking system. There are those who believe the US is in the best of all possible worlds, the economy is booming without serious inflation and the banking system has full and fair disclosure, the best transparency and the best regulatory oversight in the world. There is nothing to worry about. Then there are those like Alan Greenspan, who just 2 weeks ago gave a speech in which he reminded America's banks to be vigilant about lax standards and the traditional causes of bank failure such as fraud and credit concentration. He said, I quote
"a more troubling trend is that many banking institutions view the current strong economic conditions as no longer extraordinary and exceptional but rather as ordinary and expected. Lending granted on that basis could have grave consequences."
I won't even get into the question of whether or not US asset prices are a bubble or not. But observers should be aware that some argue the reason the Nasdaq stays so strong is because it represents a healthy future and others who argue that the only reason it goes up is because there are so many short positions in the market that it cannot go down. The same argument is true about the value of for example the US Dollar versus the Euro. The Euro cannot rally because everybody is already long Euros. Investors have already sold US dollars due to their deep fear of a US asset price correction. This same logic lies behind the low share prices of many banks.
We should therefore ask ourselves how the banking systems in Europe, Japan, the emerging markets might respond to a slowing of the US economy, even if only slowing is gradual and we get a "soft landing". And we have to ask how the global banking system might respond to an asset price shock. And we have to ask how the rest of the world will respond if the US does not slow down. This sounds like a macro economic point but it is not. The bottom line for everybody in business and in policy is that none of us can be sure about what the future holds. We know for sure that it is the unexpected that almost always actually happens. Therefore, we need to stress test the global banking system now when times are good against all possible surprises. We know for sure that it is the unexpected that almost always actually happens.
There remains a question about moral hazard in the global banking system. Again views are deeply divided. There are those who believe that the Mexican bailout, the rescue efforts of the IMF and the G7 during the Asian financial crisis and the rescue of Long Term Capital Management have all worked to create a belief that when things get really bad, the markets and the banks will be rescued. These events have created a much riskier world, in which speculative excess has become well entrenched. Many believe that Mr. Greenspan, for all his threats and rates hikes will be the first to hit the monetary gas pedal if anything should go wrong. While he has denied that he has an asymmetric approach to markets, the belief that he does is making markets more complacent than they would be otherwise. Others argue that the financial crises of the past would have been much worse if it were not for the interventions by governments and international organizations.
So the question which investors and policy-makers and business people face every day is whether the compression of credit and yield spreads is too much or not enough. The answer depends on whether there are any vulnerabilities in the global economy, in the global banking system which could be disruptive. The question is whether or not we have the banking system in place which will serve us well in the next moment of crisis.
To answer this question we have three guests who are especially well placed to provide their insights.
- Rafael Buenaventura, the Governor of the Central Bank of the Philippines
- David Eldon the Chairman of the Hong Kong and Shanghai Bank
- Donna Tanoue the Chairman of the Federal Deposit Insurance Corporation