1. Financial Stability: Still Unsettled for the Future

‘Macroprudential’ was mentioned for the first time at the meeting of the Cooke Committee (28–29 June 1979), the forerunner to the Basel Committee (Clement, 2010, p. 59); never implemented prior to the GFC. Microprudential regulation has been around since 1979.

Hedge funds, lightly regulated, pool capital and invest it in a variety of assets.

There are three UK financial regulation committees. The Prudential Regulation Authority (PRA), which is part of the Bank of England (BoE) and is responsible for the supervision and regulation of banks, building societies, credit unions, insurers and major investment firms, at the level of individual institutions. There is also the Financial Conduct Authority (FCA), which regulates the financial services industry. It is accountable directly to Treasury and Parliament. The Financial Policy Committee (FPC) is an official committee of the BoE, with its focus on macroeconomic financial issues, and is responsible for managing the financial sector, with its primary objective to deliver financial stability. It cooperates and coordinates with the PRA and FCA. The PRA and FPC are co-located with the Monetary Policy Committee, at the BoE. They enjoy overlapping membership, and the Governor of the BoE chairs these committees.

‘Risk-weighted assets’ are calculated by risk coefficients, based on credit ratings. The higher the risk of an asset, the higher the relevant coefficient.

Available at: https://​www.​crowdfundinsider​.​com/​2017/​05/​100601-financial-stability-board-publishes-report-shadow-banking/​

The yield curve depicts the difference between the yields on government short-term and long-term bonds. A normal yield curve slopes upwards, with long-term government bonds bearing higher interest rates than short-term ones. When the two yields move closer to each other, the yield curve becomes flatter. When the short-term yields become higher than the long-term ones, the yield curve is inverted.

The majority of CLOs are held by non-banks, such as insurance companies, pension funds and other similar companies. An amount of around $750bn in CLOs is now outstanding globally. One third is held by banks in the United States, Europe and Japan (where banks hold a significant number of US and European CLOs); the rest is held by non-banks.

There is a difference between CLOs and CDOs. CDOs are based on mortgages, thereby housing, and are, therefore, vulnerable to common shocks. The CLOs spread across investors and are diversified; not all investors are likely to become vulnerable to a common shock.

The US-China tariff war poses serious risks to the global economy. Trade tensions emerged in view of the US President’s decision to increase the tariffs on Chinese imports from 10% to 25% on $200bn initially, and later a 25% tariffs on additional $325bn imports (10 May 2019). China responded by imposing tariffs on $60bn of US imports, at 25%. The US President responded by imposing 10% tariffs on $300bn of Chinese products to take effect in September 2019, subsequently postponed for mid-December 2019. China responded by announcing new tariffs on $75bn of US products. The United States added tariffs of 15% on $112bn of Chinese imports on 1 September. Existing tariffs on $250bn of Chinese imports increased to 30% from 25% on 1 October 2019, and the US President called on US companies to shut down their operations in China. However, due to negotiations on 11 October, China suspended tariffs for a year on certain imports from the United States, while the United States postponed tariff increases scheduled for 15 October 2019. The truce, though, did not account for the levies imposed previously. Negotiations continued. The IMF (2019a) suggested that trade tensions affected negatively emerging and advanced economies. China’s growth was affected negatively by the trade tensions. Failure of the talks would have serious negative effects not just on China but also on financial markets and the global economy. The United States would also be at risk in terms of the escalation of trade tensions. Additional imposition of tariffs would produce drop in the US growth sharply and more so than in China and the Euro Area (ECB, 2019). However, a ‘Phase 1’ trade deal between them was signed on 15 January 2020. This deal involves a gradual reduction of tariffs, in view of the fact that significant tariffs were not removed until a more comprehensive agreement could be reached. Imposition of tariffs may emerge in view of the fact that both countries reserve the relevant right if the other party does not adhere to its commitments. The current tension between China and the United States with regard to the coronavirus syndrome threatens the ‘Phase 1’ trade deal between them; actually, tensions have worsened. China and the EU agreed to reach a deal on China opening its market to foreign investors, which was a ‘breakthrough’ in the relations between China and the EU (Financial Times, 10 April 2019). China stated that “strong Europe helps international stability and benefits Beijing” (Financial Times, 21 March 2019). A trade deal between the EU and the United States is also expected (Financial Times, 23 January 2020).

Spain’s 2019 growth, due to lower labour costs, improved Spain’s competitiveness and helped its exports increase. Healthier banks and an increase in aggregate demand due to expansionary government measures in the 2018 budget helped the economy. Further economic recovery has a long way to go, especially so in view of the high 14.5% unemployment rate (May 2020). The exports of Germany, which dominate the Euro Area and depend on global trade, are 50% of GDP. Global trade uncertainty is a serious concern for Germany and the Euro Area. Germany’s GDP growth is the lowest over the last six years (Financial Times, 16 January 2020), and its banks are the least profitable in the Euro Area (Financial Times, 8 April 2020). Germany’s economy is expected to shrink by 10% in the three months leading to June 2020 (Financial Times, 4 April 2020).

Monetary policy in the Euro Area has not been effective, especially in the case of the low-cost loans stimulus (known as ‘targeted longer-term refinancing operations’, TLTRO). It has not been effective in view of poor loan demand for business and consumer credit, due to uncertainty in economic activity and high debts. Inflation rate was 1.2% in 2019 (The Economist, 28 March 2020), the lowest since 2016 and below the ECB’s target inflation rate.

Germany’s constitutional court, on 5 May 2020, threatened to block fresh QE that would include German bonds, because the ECB would thereby exceed its mandate. This is against the EU treaty in terms of the ECB independence; also, it puts unnecessary pressure on the ECB, especially under the current situation, when relevant policies are urgently needed. The ECB President’s response was that note of this situation was taken, but the bank would remain committed to undertake what would be necessary to achieve the inflation target.

The ECB, along with heads of national central banks, proposes the creation of a ‘bad bank’ to remove toxic debt, left over from the GFC and from the coronavirus syndrome (Financial Times, 20 April 2020).

Slowdown in other sectors in the United States emerged. Residential investment has been shrinking in the United States since early 2018. Employment in the housing sector has fallen since March 2019. Manufacturing activity has also faltered, with manufacturing output having fallen by 15% by August 2019 since December 2018 (The Economist, 31 August 2019).

China’s central bank deputy director of its Research Bureau made a recent statement to suggest that no QE or significant reduction in interest rates would be undertaken. Instead, fiscal policy and economic restructuring, along with coordination of fiscal and monetary policies, is planned.

The ECB is the only central bank that, in addition to its inflation target, has a ‘reference value’ for the M3 money supply. This is 4.5%, and deviations from this reference value would ‘signal risks to price stability’. This target has proved unstable and so the ECB focuses less on the M3.

Global economic uncertainty is at its highest, according to the Policy Uncertainty Geopolitical Risk Index (The Economist, 23 November 2019).

The FPC of the BoE decided that the appropriate setting of the CCyB should be “in the region of 1% in standard risk environment” (Kohn, 2019).

Another possible new financial stability policy is what the Fed Chairman suggested at the press conference following the Fed’s monetary policy meeting (29 January 2020). Control of the yield curve is the relevant suggestion (see, also, Bernanke, 2020). This policy would require the central bank to intervene in the bond market to keep yields on target, in the same way as it intervenes to set its base rate.

In the Euro Area, Eurobonds could emerge as safe assets to serve as an anchor of financial stability. They would also signal the determination of the authorities to overcome the coronavirus crisis.

Digital currencies are private digital means (credit cards, payments such as mobile ones) and technological innovations of what is called ‘cryptocurrencies’ (Nuno, 2018)—cryptocurrencies have raised concerns by financial authorities, in view of their operations without institutional backing and the fact that they are borderless. In the United Kingdom, the FCA regulates crypto assets, and recently, it investigated companies in view of concerns about growing relevant risks (Financial Times, 31 December 2018).

The current IMF Managing Director, speaking to the Financial Times (9 October 2019), suggested that the global economy is in ‘a synchronised slowdown’, in view of monetary policy being constrained. Fiscal response to the slowdown is required.

The cost of servicing the debt, especially of developed countries, is the lowest currently over the last four decades. Fiscal authorities should and could use relevant fiscal policies to stimulate their economies.

The financial sector, however, and according to Mark Carney (The Economist, 18 April 2020), has enough capital, a lesson learnt from the GFC experience.

A relevant example is the IMF and the World Bank joint announcement (IMF Press Release, No. 20/161, 15 April 2020) that their suggestion for a debt relief to 25 of the world’s poorest countries, worth $214m, was accepted by the G20 Finance Ministers’ meeting.