global financial and eurozone reform: five questions on a
TRANSCRIPT
Global Financial and Eurozone Reform:
Five questions on a common theme
Riksbank
Stockholm, 18 February 2013
Adair Turner
Five questions on a common theme
1
Are optimal capital ratios higher still than Basel III
standards, and if so, what should we do about it?
Should macro-prudential regulators seek to constrain
aggregate economy wide leverage and if so, how?
How much federalism is needed to make the Eurozone a
sustainable and successful monetary union?
Are we too worried about fragmentation of global banking?
Should banks have the right to cross-border branching
within the European Union?
Measures of increasing financial intensity
0
50
100
150
200
250
300
350
400
450
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
$Tr
OTC interest rate contracts, notional amount outstanding
0
100
200
300
400
500
600
700
800
900
1,000
1,100
1977
1982
1987
1992
1997
2002
2007
$bn
Global nominal GDP, $bn Global FX turnover, annual, $bn Global exports, $bn
2
Growth of interest rate derivatives
values, 1987-2009 FX Trading values & world GDP
1977-2007
Global issuance of asset-backed
securities
1929
1935
1941
1947
1953
1959
1971
1977
1983
1990
1996
2002
2007
10%
50%
100%
150%
200%
250%
300% 1929
1935
1941
1947
1953
1959
1965
1971
1977
1983
1990
1996
2002
2007
10%
50%
100%
150%
200%
250%
300% 1929
1935
1941
1947
1953
1959
1971
1977
1983
1990
1996
2002
2007
10%
50%
100%
150%
200%
250%
300% 1929
1935
1941
1947
1953
1959
1965
1971
1977
1983
1990
1996
2002
2007
10%
50%
100%
150%
200%
250%
300% US debt as a % of GDP by
borrower type
Share of the financial industry in US GDP
3
Source: Philippon, T (2008), The
Evolution of the US Financial
Industry from 1860 to 2007:
Theory and Evidence. (As
referenced by Andrew Haldane in
The Future of Finance, LSE
Report, 2010)
0
1
2
3
4
5
6
7
8
9
50 70 90 10 30 50 70 901850 1870 1890 1910 1930 1950 1970 1990
4
Market perception of private credit risk
Source: Merrill Lynch
Firms included: Ambac, Aviva, Banco Santander, Barclays, Berkshire Hathaway,
Bradford & Bingley, Citigroup, Deutsche Bank, Fortis, HBOS, Lehman Brothers, Merrill
Lynch, Morgan Stanley, National Australia Bank, Royal Bank of Scotland and UBS
CDS series peaks at 6.54% in September 2008.
Source: Moody’s KMV, FSA calculations
Non-investment grade
corporate bond spreads Average CDS of major
financial firms
0
200
400
600
800
1000
1200
1400
2002 2003 2004 2005 2006 2007 2008
Op
tio
n-a
dju
ste
d s
pre
ad
Global, non-financial corporates BB-rated
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
De
c 0
2
De
c 0
3
De
c 0
4
De
c 0
5
De
c 0
6
De
c 0
7
CD
S-S
EN
IOR
Average CDS-SENIOR
NASDAQ index: 1990 – 2002
5 Source: Datastream
6 6
Three drivers of financial instability
Debt contracts create specific risks
Unregulated bank credit and private
money creation is inherently unstable
Lending secured against real assets can
be strongly pro-cyclical
Real economy leverage,
credit creation dynamics, and
credit/asset price cycles are
crucial macro-economic
variables, and phenomena
7
Observed payout distributions for debt and equity
Debt payouts Equity payouts
100% of principal and due interest
Full distribution
continuously observed
Observed in good times
100%
Not observed
in good times
Credit and asset price cycles: the upswing
Expectation of future
asset price increases
Increased credit
extended
Low credit losses: high
bank profits
• Confidence reinforced
• Increased capital base
Increased asset
prices
Increased lender
supply of credit
Favourable
assessments of
credit risk
Increased borrower
demand for credit
8
9
Leverage in real and financial sectors
Source: Oliver Wyman
UK debt as a % GDP by borrower type
(1987-2007), Debt Liabilities on B/S
Household
Corporate
Financial
USA debt as a % GDP by borrower type
(1929-2007)
Household
Corporate
Financial
1987
19
29
19
35
19
41
19
47
19
53
19
59
19
65
19
71
19
77
19
83
19
90
19
96
20
02
20
07
10%
50%
100%
150%
200%
250%
300% 1987
0%
100%
200%
300%
400%
500%
600%
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
Private non-financial corporate deposits and loans:
1964 – 2009
10
0%
5%
10%
15%
20%
25%
30%
35%
40%
1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
% o
f G
DP
Securitisations and loan transfers Deposits Loans
11
Household deposits and loans: 1964 – 2009
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
% o
f G
DP
Securitisations and loan transfers
Source: Bank of England, Tables A4.3, A4.1
Financial deepening: the pre-crisis consensus
12
Neutral: “We assumed we could ignore the details of the financial system”
(Olivier Blanchard, October 2012)
The dominant new Keynesian model of monetary economics “lacks
an account of financial intermediation, so that money, credit and
banking play no meaningful role”
(Mervyn King, October 2012)
Welcome: Axiomatically beneficial since reflects more complete markets and
contracts between rational private agents
13 13
Private credit to GDP ratio and growth
Source: S. Cecchetti, BIS
Working Paper No. 381
"Reassessing the impact
of finance and growth"
Long-term trends in bank capital & liquidity ratios
14
Sterling liquid assets
Source: US: Berger, A. Herring, R and Szegö, G (1995) and FDIC.
UK: Sheppard, D.K (1971), BBA and Bank of England calculations.
Source: Bank of England and Bank calculations.
Capital ratios for US and UK banks
0
5
10
15
20
25
30
1880 1900 1920 1940 1960 1980 2000
UK
US
0
5
10
15
20
25
30
35
1968 1975 1982 1989 1996 2003 2010
Broad ratio (b)Reserve ratio (c)Narrow ratio (d)
% of total assets
(all currencies)%
Five questions on a common theme
15
How much federalism is needed to make the Eurozone a
sustainable and successful monetary union?
Are we too worried about fragmentation of global banking?
Should banks have the right to cross-border branching
within the European Union?
Are optimal capital ratios higher still than Basel III
standards, and if so, what should we do about it?
Should macro-prudential regulators seek to constrain
aggregate economy wide leverage and if so, how?
Single currency and single market completion
16
“A major effect of EMU is that balance of payments
constraints with disappear […] private markets will
finance all viable borrowing, and savings and
investment balances will no longer be constraints at
the national level”
One Market, One Money, European Commission, 1990
Eurozone current account deficits
17 Source: International Monetary Fund, World Economic Outlook Database, October 2012
-16
-14
-12
-10
-8
-6
-4
-2
0
2000 2001 2002 2003 2004 2005 2006 2007 2008
%
Year
Greee
Ireland
Portugal
Spain
% of GDP 2000-2008
Eurozone government bond spreads
18
Source: Bloomberg
10 year benchmark spreads to German bunds
Note: Bloomberg doesn't quote a 10Y benchmark for Ireland and so 9Y has been used instead.
-2
0
2
4
6
8
10 Jan
02
Ju
l 02
Jan
03
Ju
l 03
Ja
n 0
4
Ju
l 04
Jan
05
Ju
l 05
Jan
06
Ju
l 06
Jan
07
Ju
l 07
Jan
08
Ju
l 08
Jan
09
Ju
l 09
Jan
10
Ju
l 10
Jan
11
Ju
l 11
%
Italy Portugal Spain Greece Ireland
19
Credit extension and house prices
House prices 2000 – 2007 Household debt as a % of GDP 2000 – 2007
Source: BEA; ONS; ECB
0
20
40
60
80
100
120
Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007
% G
DP
US UK Spain Ireland
0
50
100
150
200
250
Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007
Index:
2000 =
100
Spain US UK Ireland
Source: Ministry of Housing (Spain), S&P (US), DCLG
Decomposition of cumulative capital inflows (% of 2007 GDP)
SPAIN
PORTUGAL
IRELAND GREECE
-30%
-10%
10%
30%
50%
70%
90%
110%
Jan
-02
Jul-
02
Jan
-03
Jul-
03
Jan
-04
Jul-
04
Jan
-05
Jul-
05
Jan
-06
Jul-
06
Jan
-07
Jul-
07
Jan
-08
Jul-
08
Jan
-09
Jul-
09
Jan
-10
Jul-
10
Jan
-11
Jul-
11
Jan
-12
Jul-
12
PRIVATE INFLOWS TARGET Liab.
PROGRAMME Disb. TOTAL INFLOWS
-70%
-50%
-30%
-10%
10%
30%
50%
70%
90%
20
02
Q1
20
02
Q3
20
03
Q1
20
03
Q3
20
04
Q1
20
04
Q3
20
05
Q1
20
05
Q3
20
06
Q1
20
06
Q3
20
07
Q1
20
07
Q3
20
08
Q1
20
08
Q3
20
09
Q1
20
09
Q3
20
10
Q1
20
10
Q3
20
11
Q1
20
11
Q3
20
12
Q1
20
12
Q3
PRIVATE INFLOWS TARGET Liab.
PROGRAMME Disb. TOTAL INFLOWS
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Jan-0
2
Jun-0
2
No
v-0
2
Apr-
03
Sep-0
3
Feb
-04
Jul-0
4
De
c-0
4
Ma
y-0
5
Oct-
05
Ma
r-0
6
Aug-0
6
Jan-0
7
Jun-0
7
No
v-0
7
Apr-
08
Sep-0
8
Feb
-09
Jul-0
9
De
c-0
9
Ma
y-1
0
Oct-
10
Ma
r-1
1
Aug-1
1
Jan-1
2
Jun-1
2
PRIVATE INFLOWS TARGET Liab. TOTAL INFLOWS
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Jan-0
2
Jun-0
2
No
v-0
2
Apr-
03
Sep-0
3
Feb
-04
Jul-0
4
De
c-0
4
Ma
y-0
5
Oct-
05
Ma
r-0
6
Aug-0
6
Jan-0
7
Jun-0
7
No
v-0
7
Apr-
08
Sep-0
8
Feb
-09
Jul-0
9
De
c-0
9
Ma
y-1
0
Oct-
10
Ma
r-1
1
Aug-1
1
Jan-1
2
Jun-1
2
PRIVATE INFLOWS TARGET Liab. TOTAL INFLOWS
Cross border capital flows:
Hierarchy of economic value
21
Foreign direct investment
Equity portfolio flows
Debt portfolio flows
Long-term bank lending
Short-term bank lending Inc
rea
sin
g s
tab
ilit
y
See: Committee on the Global Financial System: Report of the Working Group on Capital Flows
to Emerging Market Economies, BIS, 2009
Total cross-border capital inflows: 1980–2011
22
Loans and deposits
Bonds
Equity
Foreign direct investment
2005 2000 1995 1990 2007 2011
12
10
8
6
4
2
0
-2
-4
5.8
2.0
11.7
4.9 4.8
5 5 13 15 7 21 % Global
GDP
Source: Future of Long-term Finance, Group of Thirty Report, MGI, December 2012
US
D t
rilli
on
s, co
nsta
nt 2
011
exch
an
ge
ra
tes
Coefficient of variation of inward cross-border
flows by maturity
23 Source: Future of Long-term Finance, Group of Thirty Report, MGI, December 2012
Long maturity Short maturity
FDI Equity Bonds Long-term
bank claims
Short-term
bank claims
Emerging
Markets
Developed
Markets
Five questions on a common theme
24
How much federalism is needed to make the Eurozone a
sustainable and successful monetary union?
Are we too worried about fragmentation of global banking?
Should banks have the right to cross-border branching
within the European Union?
Are optimal capital ratios higher still than Basel III
standards, and if so, what should we do about it?
Should macro-prudential regulators seek to constrain
aggregate economy wide leverage and if so, how?
Required steps to Eurozone long-term viability
25
Banking union – including ability to recapitalising with
“federal” resources
“Federal level” deposit insurance
Eurobonds – held as banking systems safe liquid
assets
Significant but still limited (e.g. 5% of GDP)
federal fiscal budget – and associated automatic
stabilisers
Cutting the
sovereign/bank
solvency link
Macro–prudential levers deployable at
national level?
Five questions on a common theme
26
How much federalism is needed to make the Eurozone a
sustainable and successful monetary union?
Are we too worried about fragmentation of global banking?
Should banks have the right to cross-border branching
within the European Union?
Are optimal capital ratios higher still than Basel III
standards, and if so, what should we do about it?
Should macro-prudential regulators seek to constrain
aggregate economy wide leverage and if so, how?