Five years ago the global financial system was on the brink of a meltdown as liquidity froze and several large financial institutions failed. Panic, fear, and uncertainty permeated markets. Bank runs, not seen on a mass scale since the Great Depression, dominated the news. Trust broke down between counterparties in the interbank liquidity market cutting off a valuable, in some cases core, line of funding for banks. Stock markets tanked as investors rushed towards the safety of government bonds and gold. The crisis on Wall Street infected economic activity on Main Street, crimping lending and sapping confidence. The financial crisis bled into a sovereign debt crisis, forcing governments in Athens, Dublin, Madrid and Nicosia (amongst others) to seek outside help to bail-out their banks. It has been a tough five years, both for the financial sector and the real economy that depends on it.
Governments reacted swiftly on a local basis to the unprecedented wave of institutional failures, rescuing some institutions and letting others go down. Central banks pumped billions of cheap money into the financial system with generous conditions. The public purse was ravaged to save financial institutions and provide credible backstops to restore confidence. Politicians declared that the financial system could never again hold the balance sheets of sovereigns and the fortunes of the real economy to hostage – "no institution can be too big to fail" became their mantra.
Global leaders pledged to work together to take the steps necessary to achieve that end. The G20 leaders stepped up to the plate, and got the FSB, IOSCO, the IAIS and other international bodies working with local regulators to develop the policies and regulation to improve financial stability.
The G20 agenda is wide-reaching but two key commitments address directly the threat banks pose to the financial system and the real economy. The Basel III accord, requiring financial institutions to hold more and better quality capital, is central to significantly improving banks’ resilience against future crises. Of the 27 Basel Committee jurisdictions, 24 have implemented Basel III fully.
The crisis showed that risks to the global financial system do not rest solely with banks. Some unregulated or lightly regulated segments of the financial markets contributed to or exacerbated the crisis overall. EU regulators have been successful in bringing hedge fund managers and private equity funds under more scrutiny via AIFMD. Hedge funds in particular were blamed for exaggerating security prices and withdrawing liquidity at crucial points during the crisis. While AIFMD officially kicked-off 22 July, regulators continue to prepare for the new regime. In August ESMA finalised its guidelines on key concepts of the AIFMD and outlined practical arrangements for the late transposition of the AIFMD. The FCA also introduced new forms and remuneration guidelines.
Regulators are now moving on to other players in the financial system, for example policy recommendations designed to strengthen the oversight and regulation of the shadow banking system. We are likely to see a lot new policy coming through on the shadow banking agenda over the coming year.
The economic situation has improved in the UK over the summer, and there are tender signs of improvements in the rest of the EU. But we shouldn’t be too complacent. We have come a long way since 2008 but systemic risks persist in the financial system. The EU Parliament has a fully packed agenda of financial market reform for the autumn, which will be challenging to complete before it recesses for elections next spring. Regulators need to continue along the path of reform while ensuring they don’t impose policies that might damage the recovery or over-burden our financial institutions. Hopefully the government and regulators ultimately will find a path that supports the development of a vibrant financial services industry across the EU – enabling the real economy to create sustainable growth with more employment opportunities.