With further bank failures, tough regulation is urgent, so society is no longer held hostage by finance.
How many more financial crises do we need? Three banks failing within a week in March showed how vulnerable the system remains 15 years after the crash.
The renewed experience of bank rescues and financial turmoil should be a wake-up call. Imagine if a bank in the European Union had failed—EU rules are no better than those in Switzerland or the United States. We need to put ambitious reform back on the agenda.
In the wake of the global financial crisis, governments around the world promised to introduce clear rules for a stable system. The EU had on the table a far-reaching set of proposals. There was a global consensus never again to save banks with public money. But the promises were not fulfilled. The rules adopted since 2008 are not adequate to ensure stability.
Diluted or stymied
As the crisis receded into the distance and public pressure on governments eased, the financial lobby was able to prevent or decisively weaken some of the key reform projects. Important legislative schemes—such as sufficient capital buffers for banks, separation of retail and investment banking and a financial-transactions tax—were diluted beyond recognition or stymied altogether.
For example, separating retail from investment banking was to ensure investment banks could no longer seek high rents at high risk, by relying on implicit public guarantees in place to protect their retail clients. Rather than being deemed ‘too big to fail’, they would be forced to be more prudent and pose less threat to overall financial stability.
A proposal for European regulation was thoroughly prepared by a high-ranking expert group, led by the then governor of the Finnish central bank, Erkki Liikanen, and members of the council of the European Central Bank. This was however overturned, under pressure from the financial lobby, and there has been no effort to revamp it since.
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Or take private ratings agencies. After 2008, there was widespread concern about their high market concentration. There was also a shared understanding of their structural conflict of interest: ratings agencies are paid by the actors whose products they are rating. Yet this problem persists almost unchanged, with only ‘light touch’ regulation.
Finally, consider capital requirements for banks. They may be right to claim they have more equity than before 2008—but only because that was an extremely low base. Before the crisis, larger banks operated with around 2-3 per cent equity capital; today, it is around 4-5 percent. So 95 percent is still debt-financed. Anyone running a business or taking out a mortgage would recognise such a high share of debt financing as extremely risky.
In short, many sensible reforms were blocked by the industry as soon as pressure waned, to the detriment of the public good. And regular financial crises have become the new normal. Germany rescued the Norddeutsche Landesbank, one of the regional public banks, with government support as recently as 2019. Indeed, if another crisis as devastating as 2008 has not materialised it is in large part due to central banks repeatedly intervening to stabilise financial markets.
In the four years before the Silicon Valley Bank and Credit Suisse failures, there were three significant crises. In October 2022, the Bank of England had to inject £65 billion (almost €75 billion) to save British pension funds. Two years previously, on March 9th 2020, financial markets around the world were in free fall at the beginning of the pandemic. The Federal Reserve set up a historic emergency programme and provided loans totalling $2.3 trillion to support the economy. In an unprecedented move, at the same time the ECB set up a €750 billion pandemic emergency purchase programme, later expanded to as much as €1.85 trillion. And let us not forget that, on September 17th 2019, a crisis in the market for short-term refinancing forced the Fed to use more than $700 billion to prevent a collapse of the international financial system.
Banking supervisors and central bankers act as mere firefighters. The European Union institutions, on the other hand, are the architects responsible for ensuring the whole financial edifice follows proper safety standards. They must urgently and fully implement internationally agreed prudential and resolution rules (Basel III) and bring any deviation from these into the continuing negotiations on the EU banking package.
It is time to put ambitious financial reform on the agenda for next year’s elections to the European Parliament. Broad support from civil society is needed to push for tough regulation. The lesson of 2008 and its aftermath is that financial-market issues cannot be left to the specialists and the finance lobby. We need to keep them in the spotlight and ensure citizens never again have to foot the bill for a banking system that holds society hostage.