The tenth anniversary of the collapse of Lehman Brothers is a good opportunity for us all to reflect on the global financial crisis and the lessons we have learned from it.
By now, there is widespread agreement that the crisis was caused by excessive risk-taking by financial institutions.
There were increases in leverage and risk-taking, which took the form of excessive reliance on wholesale funding, lower lending standards, inaccurate credit ratings, and complex structured instruments.
But why did it happen?
How could such a crisis originate in the United States, home to arguably the most sophisticated financial system in the world?
At the time, my colleagues and I argued incentive conflicts were at the heart of the crisis and identified reforms that would improve incentives by increasing transparency and accountability in the financial industry as well as government.
After all, if large, politically powerful institutions regularly expect to be bailed out if they get into trouble, it is understandable that their risk appetite will be much higher than what is socially optimal.
So, where are we now, after ten years of reform?
There has been progress in some dimensions: banks have stronger capital positions, and there is emphasis on higher-quality capital. Reliance on wholesale funding instead of deposits has decreased. There is greater oversight of the largest institutions, with stress tests and requirements to submit living wills (resolution plans). Derivative markets are smaller. Bank governance and pay policies have received greater scrutiny.
But much has remained unchanged.
The crisis was resolved in a way that bailed out large institutions, which inevitably makes them more willing to risk insolvency in the future—the so-called “moral hazard” problem.
Safety nets and deposit insurance coverage expanded in countries all around the world. It is particularly difficult to resolve insolvent banks, especially across borders.
This “too-big-to-fail” subsidy not only makes banks more eager to take risk in the future, but also gives them incentives to become larger and more complicated to maximize the subsidy. It is possible to observe in the data how market participants valued this subsidy for large international banks after the crisis, but also by observing simple trends in bank size: From 2005 to 2014, the total asset size of the world’s largest banks increased by more than 40 percent.
This greater concentration and market power in the banking sector is likely to be associated with lower levels of systemic stability. Our research also shows “good” corporate governance of large banks—defined in terms of their board composition, compensation, and independence—is associated with higher risk and lower capital in countries with more generous safety nets, to be able to better exploit them. This suggests that well-managed institutions simply take better advantage of the subsidies for excessive risk-taking, further underlining the severity of the problem.
Another unintended effect of the crisis was the populist reaction. While banks were supported in dealing with the excessive risks they took, insolvent households with subprime mortgages received much less support. It is not surprising that many observers place the blame for the populist backlash we see today against globalization, international finance, and big business on the crisis and the way it was resolved.
How fintech is setting Southeast Asia’s SMEs free
In Southeast Asia, only 27% of adults have formal bank accounts and only 33% of businesses have access to proper financing
BoT and PBC sign agreement on Fintech Collaboration
The two central banks aim to promote the use of innovation and technology to reduce costs and improve efficiency of financial products and services.
On 9 June 2019 Mr. Veerathai Santiprabhob Governor of the Bank of Thailand (BOT) and Mr. Yi Gang Governor of the People’s Bank of China (PBC), signed a Fintech Co-operation Agreement in Fukuoka, Japan.(more…)
Asian real estate and US interest rates
Continued upward movements of US interest rates are starting to impact Asian real estate markets in a number of ways
Subscribe via Email
True Digital Park opens Work Space to ignite future Thai unicorns
Under the concept of ‘One Roof, All Possibilities’, True Digital Park is now ready to ignite startup unicorns and support...
Get vital compliance education in Bangkok this July
Join other professionals for a one-day compliance and ethics conference close to home in Bangkok, 12 July, 2019.
SET signs MoU with Shenzhen bourse to strengthen Thailand-China capital market
The Stock Exchange of Thailand (SET) signed a memorandum of understanding (MoU) with Shenzhen Stock Exchange (SZSE)