The Bank for International Settlements, the mother of all the world's Central Banks, released their 82nd Annual Report on Sunday with this to say about the economy: be prepared to lower your expectations.
The world is now five years on from the outbreak of the 2008 financial crisis that started with the implosion of two major U.S. investment banks ? Bear Stearns and Lehman Brothers. Yet, the global economy is still unbalanced and seemingly becoming more so as interacting weaknesses continue to amplify each other.
The goals of balanced growth, balanced economic policies and a safe financial system still elude us. In advanced economies at the center of the financial crisis, high debt loads continue to drag down recovery. Monetary and fiscal policies still lack a comprehensive solution to short-term needs and long-term dangers. And despite the international progress on regulation, the condition of the financial sector still poses a threat to stability.
Whales, Voldermorts and general Wall Street cowboys don't help the matter when they take on huge risks, lose billions, and require government bailout. Or just as bad, are forced to plug up holes by taking corks out of smaller holes already punctured in the financial structure.
From time to time, encouraging signs raise hopes, but they are always dashed, delivering another blow to the confidence of consumers and investors.
For now, the destructive feedback created by these problems is concentrated in the euro area, where the fiscal authorities in some countries,
forced to consolidate, can no longer support either their banks or their economies. The rapid loss of investor confidence in these countries has caused an equally rapid fragmentation of euro area financial markets. In this environment, how can the common currency regain its credibility so that Europe can return to prosperity and continue on the road to further integration?
Here are some takeaways from that 214 page report on the global banking system going forward.
Private banks need to recognize losses.
The financial sector needs to recognize losses and recapitalize; governments must put fiscal trajectories on a sustainable path; and households and firms need to deleverage. As things stand, each sector's burdens and efforts to adjust are worsening the position of the other two. The financial sector is putting pressure on the government as well as slowing deleveraging by households and firms. Governments, with their deteriorating creditworthiness and need for fiscal consolidation, are hurting the ability of the other sectors to right themselves. And as households and firms work to reduce their debt levels, they hamper the recovery of governments and banks. All of these linkages are creating a variety of vicious cycles. Central banks find themselves in the middle of all of this, pushed to use what power they have to contain the damage: pushed to directly fund the financial sector and pushed to maintain extraordinarily low interest rates to ease the strains on fiscal authorities, households and firms. This intense pressure puts at risk the central banks' price stability objective, their credibility and, ultimately, their independence. In the post-crisis period, the banking sector faces both short-term and longterm challenges. In the short term, banks need to repair their balance sheets. This will entail write-downs of bad assets, thus imposing losses on banks' stakeholders, and recapitalization, which public funds could facilitate. With their balance sheets repaired, banks will be in a better position to regain markets' confidence and strengthen their liquidity positions, both domestically and internationally, by drawing on traditional funding sources. In the long term,banks should have sufficient inherent financial strength to perform key intermediation functions without resorting to official support. And since the new regulatory environment will put pressure on their profitability, banks will need to adopt more aggressive cost management strategies than in the past."
Monetary easing more controversial than before.
In the recovery from a financial crisis monetary policy is likely to be less effective in stimulating the economy than otherwise. Overindebted economic agents do not wish to borrow in order to spend, and an impaired financial system is less effective in transmitting the
policy stance to the rest of the economy. This means that, in order to have the same short-term effect on aggregate demand, monetary accommodation will naturally be pushed further. But this cannot substitute for direct corrective action to address debt burdens and impaired balance sheets. Ultimately, there is even the risk that prolonged monetary easing delays balance sheet repair and the return to a self-sustaining recovery through a number of channels. First, prolonged unusually accommodative monetary conditions mask underlying balance sheet problems and reduce incentives to address them head-on. Necessary fiscal consolidation and structural reform to restore fiscal sustainability could be delayed."
This crisis is not over.
Markets do not perceive the crisis to be over. Concerns about the banking sector's vulnerability continue to depress equity valuations and raise spreads in debt markets. Official support has provided only a partial reprieve."
Shadow banking system ungovernable and growing.
Shadow banking activity can amplify financial cycles since it tends to grow during booms and contract during busts. Such was the role of this activity in the global financial crisis as well as in the crises in Sweden and Japan in the 1990s. At present, intermediation by shadow banks in China is reportedly feeding the credit and asset price boom there. During booms, shadow banking facilitates increases in leverage and in liquidity and maturity mismatches, thus contributing to the build-up of vulnerabilities. As shadow banking grows, so does the proportion of financial intermediation that policymakers cannot easily assess and control. While data scarcity and inconsistent statistical definitions make it difficult to gauge the size and scope of shadow banking activity, rough aggregate measures suggest that it expanded during the years preceding the global financial crisis. According to data compiled by the Financial Stability Board, financial assets held by "other financial intermediaries" in a sample of advanced economies rose from an estimated $23 trillion in 2002, or around 23 percent of total financial system assets, to more than $50 trillion (or 27 percent) at the end of 2007."
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