The international institutions of financial regulation have not only failed to anticipate the recent financial crisis, but also they have contributed to its occurrence.
Abstract
Since the early 1980s, international institutions of financial regulation have been flexing their muscle to get involved in the management of miscellaneous economic and financial issues. The overarching role of the International Monetary Fund (IMF) and Bank for International Settments (BIS) in this process has not changed, though it has become more complex and not as easily defined as at the time of their institutionalization. At present, both of these multilateral institutions control financial transactions and full-dress political dialogue covering all aspects of the participating countries’ development. The World Bank and a number of other institutions of financial regulation have also expanded their traditional interests. These structures give contradictory advice, forcing Member States to choose what institution to finance.
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The purpose of this academic paper is to identify and dissect disproportions in the world economy as well as shortcomings of the regulatory and supervisory policies of the world’s most powerful countries. In this regard, functions and regulatory mechanisms of the IMF and BIS are investigated.
In the course of this research, the author arrived at the conclusion that neither the IMF nor the BIS should be held responsible for the outbreak of the global financial crisis in 2007. A plethora of gadflies still indulges in retrospection about how those institutions should have acted in order to fend off a financial crisis, but it is always comfortable to take a retrospective glance. Indeed, these organizations failed to anticipate it, but they could not do it even hypothetically due to the rapid character of its development. Nowadays, when the causes of the global financial crisis are well-known, a bevy of appropriate measures should be taken. Provided that the international community manages to forge ahead with necessary reforms, the outlook for the future of these institutions and, thus, the world economy in general is luminous.
Introduction
The recession, which began at the end of 2007 in the United States as a regular short-term economic downturn, gained global dimensions after an unexpected bankruptcy of the investment bank Lehman Brothers in 2008. In many ways, it was the most serious recession since the Great Depression. The global economic financial crisis was caused by the imbalances that had accumulated in the global economy in recent years, weaknesses of the institutional sector (especially in the regulation and supervision), as well as increased competition and interdependence of world countries due to the acceleration of globalization (Taylor & Clarida, 2011). The crisis proved to be very difficult and unpleasant for the overwhelming majority of world economies and had the following characteristics: sharp reductions in the production volumes, foreign trade and international reserves; increased unemployment, especially in the so-called “monotowns” created around large enterprises, and the economies of which were based on a single industry. The main measures designed to help the world economies to extricate themselves from the consequences of this foolhardy recession and determine the crisis altogether included interventions to support commercial banks, provision of sovereign guarantees to commercial banks, nationalization of the bankrupted commercial banks, and a bevy of other instruments such as provision of preferential duties and grace periods (Blanchard, Romer, Spence & Stiglitz 2012). The above instruments are regarded as the aspects of government economic regulation and, thus, obviously overlap with the IMF’s threefold approach to ending a crisis, which envisages provision of liquidity, redemption of the devaluated assets, and financial infusions.
Thus, this paper illuminates a handful of important issues. First of all, it sheds light on the underlying reasons of the recent financial crisis. Second, it dissects the mechanisms and functions of such international institutions of financial regulation as the International Monetary Fund (IMF) and Bank for International Settlements (BIS). What is more important, it embarks on the quest to establish the reasons why these institutions failed to anticipate the crisis. To this end, the author of this paper delves into numerous books and journals and keeps abreast with the latest developments in the financial world. The structure of this paper is exceedingly simple. It consists of the outline, introduction, abstract, literature review, methodological part, empirical analysis, conclusion, recommendations and bibliography. The byzantine complexity peculiar to some academic papers is intentionally avoided in order to ensure the maximal simplicity of the material, as the author does not aspire to obfuscate the reader, but to aid him instead.
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Literature Review
Scientific interests have dedicated colossal efforts to investigate the recent global financial crisis. Thus, a plethora of distinguished economists (Joseph Stiglitz, Nouriel Roubini, Paul Kraugman) has predicted the onrush of the financial crisis. However, this academic paper relies on facts and not predictions. Therefore, the author has thoroughly scrutinized the treatises about the global financial crisis that went into press after its outbreak. Berlatsky (2010), Bruno (2009), Nanto (2009), Palley (2012), Scott (2009), Taylor and Clarida (2011) have made an arduous attempt to explain the causes of the recession, the smouldering effects of which still bother many governments. At the behest of the IMF, Blanchard, Romer, Spence and Stiglitz (2012) have carried out a fruitful research into the implications of the recent financial crisis for the world economies. Truman (2006) assessed the role of the IMF in the process of curing malaises of the global financial system and outlined a roadmap of the organizations’ actions in such a situation. In his prodigiously illustrative book Tower of Basel: The shadowy history of the secret bank that runs the world, LeBor (2013) analyzed functions of the Bank for International Settlements and established its relation to the incipience of the global financial crisis that struck the world a couple of years ago. By and large, all of the 14 sources used in this research give clear excursuses and insights into the problem analysed in this paper. There is also an avalanche of TV and press coverage of the issue. Even though the author of this paper does not call credibility of those sources into question, they were not used in the research.
Methodology
International institutions of financial regulation must be able to anticipate a crisis in order to prevent the emergence of these unpleasant situations in the future (with the help of counter-cyclical regulation etc.). Negative aspects related to the cyclical economic development cannot be completely overhauled due to the natural disproportions (such as the ones between supply and demand or between consumption level and level of savings) that occur in the market (Roubini & Setser 2004). To some extent, these disproportions are peculiar to the market economy, as their manifestations force market participants to reconsider strategies and business tactics, lead to capital mobility, and facilitate efficient production. However, in the post-industrial society, states (in the national economy) and international institutions of financial regulation (in the world economy) are designed to manage market processes (Truman 2006). It is imperative that they are able to anticipate the formation of imbalances and pre-empt excessive accumulation of these imbalances, steering the development of these processes in the right direction.
It is also essential that a balance between macro- and micro-regulation should be struck in the banking and financial sectors of economy in general and the risk management sector in particular (Roubini & Setser 2004). The system of limiting credit, market and financial risks can be successfully utilized during counter-cyclical regulation. It is of paramount importance that the new financial and credit instruments should be included in the regulation system, while the limit on them must be set promptly in accordance to the objectives of macroeconomic regulation.
Empirical Analysis
The depth and duration of the financial crisis can be explained by the fact that it, firstly, is part of the socio-economic system crisis and, secondly, overlaps with economic, structural and energy crises. All these spawns inconsistency and incongruity of measures taken by the authorities to stabilize the economy.
In 2009, international financial institutions, including the IMF and BIS, predicted a dramatic decline in GDP of the developed and some of the developing countries (Scott 2010). Thus, the global GDP in 2009 decreased by approximately 1.1%, while the GDP of the developed countries shrank by 3.4%. The crisis has significantly affected important component of GDP – the value of consumer spending. In 2008, consumer spending in the developed countries increased by a paltry 0.4% and decreased by 1% the next year. Fixed asset investment, another component of GDP, fell by approximately 12.4% in 2009 (Berlatsky 2010). Such a pronounced decline in GDP led to an increase in unemployment. According to the IMF, unemployment in the developed countries increased to 8.1% in 2009 (Dolezalek 2011). In some countries (Slovakia, Ireland, Iceland etc.) this figure was much higher, reaching the apogee of 18% in Spain. The economic crisis has also affected the global trade. In 2009, according to the World Trade Organization (WTO) its volume declined by 12% for the first time in the post-bellum period. In the developed economies, exports fell by about 13.5%, and imports by 12.1% (Berlatsky. 2010). According to the IMF estimates, the level of savings also reduced significantly (Scott 2010).
However, it was crisis in the financial sphere that acquired the most viral form. Stock and foreign exchange markets, as well as banking and insurance sectors bore the brunt of the crisis. As a result, some of the largest financial institutions in the US have experienced a debacle, including an investment bank Lehman Brothers. Mortgage companies Fannie Mae and Freddie Mac, as well as the largest U.S. insurance company AIG, found themselves on the verge of bankruptcy (Nanto 2009). A bunch of influential European banks also faced similar problems. Monetary authorities in almost all developed countries and certain developing countries were able to take a number of fast and essential measures to mitigate the crisis. These were a massive support for the banking sector based on its recapitalization, refinancing and liquidity provision, as well as encouragement of consumer demand and support to the real sectors of economy (Forster 2010). The wherewithal spent to combat the global financial crisis is virtually hard to calculate. Dolezalek (2011) argues that the United States dissipated $3.5 trillion (25% of GDP), United Kingdom – $1 trillion (37% of GDP), and China – 570 billion (13% of GDP).
Notwithstanding the above-mentioned measures, the global financial crisis demonstrated that institutions of financial regulation cannot adequately assess the totality of the financial risks, while the systemic risks are completely ignored. Derivatives designed to securitize financial risks and distribute them among different types of instruments have gone through subtle changes, which camouflaged a state of collective irresponsibility and led to a cascade-like dissemination of the uncovered risks (Forster 2010). Proliferation of the risks underestimation tendencies created the preconditions for an accumulation of loan capital by borrowers and, thus, gave a fillip to the growth of asset prices.
In the pre-crisis period, international institutions of financial regulation, as well as regulatory bodies of separate countries, had not demonstrated enough zest in their opposition to the desire of financial institutions to take superfluous risks with a simultaneous disregard of the systemic ones (Blanchard et al. 2012). During the economic boom, banks and non-financial companies significantly increased their leverage without regard to the fact that asset prices were significantly inflated, which could not but undermine their financial situation after the market price adjustment. In general, financial institutions and their management had a penchant for taking excessive risks under the pressure of competitors at their own peril. As of April 2010, direct budgetary spending on the recapitalization of the financial sector in the G-20 major economies reached 2.7% of their GDP. In some countries, government spending on the stabilization of the financial sector was pretty low, while other countries spent the lion’s share of their budgets on these needs. In the broad sense, economic and social costs of the financial crisis exceeded 4% of GDP allocated for the public support of the financial sector. By 2010, the cumulative decline in GDP of the G-20 major economies that suffered from the symptoms of systemic crisis reached 27%. According to the IMF estimates, national debt of these countries will increase by 40% of their respective GDPs by 2015 (Savona, Kirton, & Oldani 2011). In the countries with emerging markets, national financial systems turned out to be unable to mediate large-scale flows of capital. Inefficient systems of financial supervision and prudent regulation allowed excessive concentration of credit risks and enabled financial institutions to accumulate foreign exchange imbalances.
On the initial phases of economic convalescence, international institutions of financial regulation settled on a strategy of predicting rapid recovery of the global economy. Thus, according to the IMF forecast, global growth in 2010 should have been equal to 3.1% (Nanto 2009). Even more impressive economic growth was projected for several developing countries. In the People’s Republic of China, it was estimated to reach 9%, while India and Brazil should have been able to brag of 6.4% and 3.5% respectively (Zandi 2009). It should be noted that the BIS also projected inflation slowdown and reduction in the balance-of-payments deficit of both developed and developing countries (LeBor 2013). At the same time, measures to stimulate the economy, as noted in the report of the IMF, have already led to an increase in the budget deficit and public debt in virtually all developed and many developing countries (Bruno 2009).
Conclusion and Recommendations
It is essential that the causes of the financial crisis should be liquidated in the first place, and the model of regulating world economy altered in the second. Summarizing the first changes in the system of regulating global economy, it would be wise to pinpoint several steps of transformation. First of all, governments must go to every expedient (countercyclical regulation etc.) in order to predict crises. This would enable them to prevent similar situations in the future. Second, it is important that the role of the IMF, the BIS and other institutions of financial regulation in the sphere of projecting and preventing crises should be enhanced.
Simultaneously, reformation of the status, purposes and regulating system of the very IMF should constitute one of the main prongs of the anti-crisis policy. Leaders of the G-20 major economies have recently achieved a consensus that this institution should play a key role in ensuring global financial stability and sustainable economic growth. The BIS suggests that the world’s most powerful economies should ruminate about reformation of the crediting mechanisms as well as the launch of an innovative flexible credit line (LeBor 2013). Reallocation of quotas for countries with the emerging market economies should also appear on the agenda.
Many analysts concur that national authorities should comply with the new international standards and safeguards that are being adopted by the international financial institutions in the sphere of regulation, supervision and trade. Priority of international standards will rule out any possibility of the fragmentation of markets and protectionism in international trade. Moreover, international institutions of financial regulation should promote recapitalization of national banks. Capital should be hoarded by means of both recapitalizing the bulk of profit and increasing reserves. The measures of this kind will strengthen stability of the banking sector in the first place, and expand its abilities to finance economy, cushioning it against unpredictable risks, in the second.
By and large, it would not be fair to accuse the IMF and BIS of a failure to anticipate the global economic crisis. In fact, if it had not been for these two organizations, ramifications of the crisis would have been much worse. Apart from being held responsible for the recent financial crisis, some eccentric analysts animadvert upon the IMF, because it is allegedly subordinated to the US government, intervenes in the internal affairs of its member countries and sets predatory lending rates. Simultaneously, they derogate the flagship achievements of this institution. However, both the IMF and BIS are the leading world organizations, which promote international monetary and credit cooperation, an indispensable component of the contemporary international relations.
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