Focus on financial system as a whole

dubai — Don’t focus on individual institutions, but look at the financial system as a whole, especially when it comes to detecting the potential for fragile interconnections, is the lesson that Professor Randall S. Kroszner, deputy dean for Executive Programmes and Norman R. Bobins Professor of Economics at the University of Chicago Booth School Of Business, continues to reiterate.

Speaking at a recent session in Dubai that looked back at the start of the global financial crisis in 2008, Kroszner said: “One of the things that we didn’t have was an overview of the risks in the system. What is important is to have an approach that looks at the interconnections in the financial system, in particular the leverage and liquidity, that are not just specific to individual companies but are also looking at various sectors and markets on a global scale. We are making progress on this front, but we still have a long ways to go. It is also important to note that we might not get there perfectly because there are always new innovations that are coming up and there will always be various interconnections that are going to be difficult for experts to monitor.”

Kroszner, who was a governor of the Federal Reserve from 2006 to 2009, also noted that one lesson for the banking sector in the aftermath of the global financial crisis was the need to hold more capital. “The capitalisation of the banking system has gone up significantly. Does this mean that they will be able to weather another similar shock? Surely not, but they are going to able to weather a lot more shock. Also, when it comes to the issues of liquidity, there is a less of a liquidity mismatch than there was before; it is still there since it is a fundamental part of banking, but I think that there is more of an awareness about it by management.”

Asked about the state of global debt, he said that for the situation to improve, it would require a lot of focus from regulators as well as other authorities. “It is great when you create credit in the short run, but no one likes it when you have to pay it off, especially in the longer run. Regulators and other supervising authorities have to constantly ask themselves if there is excess credit creation and if people will be able to pay. Can a country be able to afford the debt that it has? That is always a difficult conversation to have.”

“China, for example, is a country that was very concerned about the vast growth of leverage after the global financial crisis and one of the ways in which they focused on their growth was by dramatically

The capitalisation of the banking system has gone up significantly

Randall S. Kroszner, deputy dean for Executive Programmes, University of Chicago Booth School Of Business

increasing government spending. Now, over the past few years, they have been trying to reign that in, which has resulted in slower growth. This is a classic example of long-term versus short-term. What your key focus should be on is sustainable economic growth, where you look closely at your credit policy, regulatory policy, and your fiscal policy in the long-term,” he explained.

This is where third party institutions such as the World Bank and International Monetary Fund can be very helpful in reminding institutions of the constraints that have to be paid off in the long term, he added.